The IRS recently announced via release IR-2022-79 that taxpayers who need to take certain action related to Qualified Opportunity Funds (QOFs) will start receiving letters in the mail beginning in April. The correspondence will notify QOFs and their investors of deficiencies on Form 8996 or 8997 and the actions required to come into compliance.
A corporation or partnership uses Form 8996 to self-certify that it is organized to invest in Qualified Opportunity Zone (QOZ) property. In addition, a corporation or partnership files Form 8996 annually to report that the QOF meets the 90% investment standard of section 1400Z-2 or to figure the penalty if it fails to meet the investment standard. If the IRS finds that the information needed to support the annual certification as reported by the QOF is missing, invalid or the calculation isn’t supported by the amounts reported, then the IRS will notify such entity via Letter 6501 of the action needed to rectify the situation. If the entity intends to maintain its certification as a QOF, it may need to take additional action to meet the annual self-certification of the investment standard requirement.
The QOF may file the corrections through an amended return or an administrative adjustment request (AAR). If an entity that receives the letter fails to act, the IRS may refer its account for examination. Further, investors who made an election to defer tax on eligible gains invested in that QOF entity may also be subject to examination.
Similarly, an investor in a QOF uses Form 8997 to inform the IRS of the QOF investments and deferred gains held at the beginning and end of the current tax year, as well as any capital gains deferred by investing in a QOF and QOF investments disposed of during the current tax year. Just as the IRS would use letter 6501 to notify the QOF of its reporting or calculation deficiencies, the IRS will notify the investors using Letter 6502 or Letter 6503 if the investors have failed to report complete or accurate information related to their QOF investments and deferred gain on Form 8997, Initial and Annual Statement of Qualified Opportunity Fund (QOF) Investments. If these taxpayers intend to maintain a qualifying investment in a QOF, they can file an amended return or an AAR with a properly completed Form 8997 attached. Failure to act may lead to disqualification of their investment in the QOF and loss of deferral on gains resulting in assessment of current taxes due with interest and penalties.
It is therefore very important to have all documentation in order and to properly follow the instructions of the Forms 8996 and 8997 to avoid any compliance deficiencies which may result in costly tax consequences.
If you receive QOF-related correspondence from the IRS and need assistance responding, please contact your Grassi advisor or Shashi Singal, Tax Partner.