In late October, the IRS issued new guidance relating to Qualified Opportunity Funds (QOFs). The guidance included FAQs, a revenue ruling and proposed regulations for implementing the QOF provisions that were enacted as part of the Tax Cuts and Jobs Act in December 2017. Intended to create tax incentives for investments in designated economically distressed communities in the U.S., the QOF provisions may trigger some new, and possibly unexpected, tax information reporting requirements, in particular for Form 1099-B reporting.
Background to QOFs
The QOF provisions contain several significant tax incentives. First, it allows an investor to defer capital gains from sale of capital assets if such gains are reinvested in a QOF generally within 180 days of sale. A QOF is generally a U.S. corporate or partnership vehicle that is invested in a designated economic zone and meets specific asset requirements. The investor’s gain would be deferred until the earlier of when the QOF investment is sold or December 31, 2026.
Also, in a funky set of basis adjustment rules, during the period the investor holds onto the QOF investment, the investor’s basis in the QOF investment is increased by 10% of the deferred gain after 5 years and an additional 5% after 7 years.
Moreover, if the QOF investment that has been subject to such gain deferral has been held for at least 10 years, the basis in the investment steps up to fair market value, thus eliminating all gain on the investment.
Draft 2019 Instructions to Form 1099-B
Draft 2019 instructions to Form 1099-B released on October 30, 2018 presage some potential changes that may arise as a result of the new QOFs. First, a QOF might need to file a 1099-B. Currently, only brokers and barter exchanges file Form 1099-B. A person who receives cash, stock or property in exchange for a “QOF security” (not fully defined) would be reportable (presumably by a broker or QOF). And dispositions of QOF securities would require a separate Form 1099-B.
The instructions also indicate that contents of boxes 3 and 12 of the Form 1099-B would be switched. Box 3 (currently for indicating that basis is reported to the IRS) would instead be checked if the proceeds are from collectibles or from a QOF.
There is also a reference in the draft Form 1099-B instructions that a covered security (those generally requiring cost basis reporting) would include a QOF security acquired in 2017. The latter seems a little odd, since while gain from 2017 presumably could be deferred under the QOF provisions (through an amended tax return), QOF investments wouldn’t generally be made until 2018. Perhaps it was intended to mean a QOF security acquired after 2017?
Proposed Regulations under Section 1400Z-2
In the proposed regulations to the QOF provisions released in October, the IRS noted that additional proposed regulations would be issued in the near future that would provide further guidance on QOFs, including guidance relating to information reporting.
The proposed regulations also raise an issue that potentially could affect information reporting for section 1256 contracts. Currently, gain or loss on section 1256 contracts are generally reported on an aggregate basis. In line with such reporting, the section 1400Z-2 proposed regulations only allow gain deferral for reinvestment in QOFs to apply to the net gain from section 1256 contracts for the tax year rather than gains on a contract-by-contract basis. However, the preamble to the proposed regulations requested comments on whether such gain deferral should be broadened in the section 1256 context and allowed on a contract-by-contract basis. If the IRS were to change its position to allow for contract-by-contract gain deferral, this would require a significant change to current section 1256 contract reporting on Form 1099-B.
Thus, QOFs and the additional IRS guidance in this area expected in the near future deserve monitoring by those in the information reporting space.