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Briefing: QOZ Update: IRS Provides Relief for Early Investments of Net Section 1231 Gain

There are many complex and confusing aspects to the qualified opportunity zone (QOZ) program, and the treatment of Section 1231 gain is no exception. 

Internal Revenue Code Section 1231 applies to depreciable property and real property used in a trade or business that is held for more than one year. On the last day of a taxpayer’s tax year, the taxpayer’s gains and losses from sales of Section 1231 property are netted to determine if the taxpayer has net Section 1231 gain or net Section 1231 loss. Net Section 1231 gain is treated as long-term capital gain (subject to a recapture rule) and net Section 1231 loss is treated as an ordinary loss. 

Because a taxpayer will not know if it has net Section 1231 gain until the end of a tax year, the April 2019 Proposed Regulations treat net Section 1231 gain as recognized on the last day of the tax year and start the first day of the taxpayer’s 180-day period to roll over the gain on the last day of the taxpayer’s tax year. This creates a less favorable result for net Section 1231 gain than for other capital gain because, unlike other capital gains, only the net amount, not the gross amount, may be rolled over into a qualified opportunity fund (QOF). 

Under the April 2019 Proposed Regulations, a taxpayer cannot roll over net Section 1231 gain by investing an amount equal to that gain in a QOF before the last day of the taxpayer’s tax year. Prior to the April 2019 Proposed Regulations, most practitioners and taxpayers thought that the 180-day rollover period started on the date of the sale giving rise to the gain, even for Section 1231 gain. As a result, some taxpayers invested Section 1231 gain into a QOF before the end of their tax years, which technically would make the investment ineligible for QOZ benefits. 

The IRS fixed this timing problem by posting a new FAQ on its qualified opportunity zone webpage. The FAQ guidance allows a taxpayer whose tax year ended before May 1, 2019, to elect to defer net Section 1231 gain by investing in a QOF within 180 days of the sale that produced that Section 1231 gain to qualify as an eligible investment, even if that investment was made before the last day of the taxpayer’s tax year.  However, this new FAQ does not provide relief for a taxpayer that invested more than the amount of its net Section 1231 gain, either timely or within 180 days of a sale, but before the end of its tax year.

Among the QOZ benefits available to taxpayers is elimination of 15 percent of the taxpayer’s rollover gain if the investor does not have an inclusion event before December 31, 2026, and the investor holds its QOF interest for at least seven years. The last day to make an investment in a QOF that is eligible for this seven-year benefit is December 31, 2019. As a result, the rule that prohibits a qualifying rollover of net Section 1231 gain until the last day of a taxpayer’s tax year means that the first day net Section 1231 gain from a 2019 sale may be invested in a QOF is December 31, 2019, for calendar year pass-through entities and for almost all individual taxpayers. This means that Tuesday, December 31, 2019, could be a very busy day for many taxpayers.

Copyright © by Ballard Spahr LLPNational Law Review, Volume IX, Number 178



About this Author

Wendi Kotzen, Ballard Spahr Law Firm, Philadelphia, Tax Law Attorney

Wendi L. Kotzen is the Co-Practice Leader of Ballard Spahr's Tax Group. She advises clients on the taxation of all types of real estate transactions, has an extensive background in Pennsylvania and Philadelphia realty transfer tax planning, and advises clients on mergers and acquisitions. Ms. Kotzen is also experienced working with REITs; real estate partnerships (both for developers and investors); leasing transactions, including sale-leasebacks; Pennsylvania state tax incentives; and structuring like-kind exchanges (forward, reverse, and TIC exchanges).

Molly Bryson Tax Lawyer Ballard Spahr Law Firm

Molly Bryson is Team Leader of Ballard Spahr's Tax Credits Team. She focuses her practice both on using federal and state tax credits to finance affordable housing, businesses in low-income communities, historic preservation, and solar energy, and on using the Qualified Opportunity Zone (QOZ) program to finance community economic development throughout the U.S. and its territories.

In the QOZ portion of her practice, Molly focuses on advising investors, fund managers, and developers on the evolving tax, organizational, and business structuring requirements of this new program created by the Tax Cuts and Jobs Act of 2017.

Molly focuses the affordable housing portion of her practice on providing strategic tax and business advice for both low-income and mixed-income projects financed by the Low-Income Housing Tax Credit (LIHTC) available to housing authorities, state housing finance agencies, developers, investors, and syndicators. Many of these matters involve additional federal and/or state subsidy programs, like HUD's Rental Assistance Demonstration (RAD) program. She also regularly advises on tax-exempt issues that can arise with the involvement of nonprofit developers, Year 15 issues, and risk assessments of LIHTC investment funds. She served as the firm's representative on the Board of the Affordable Housing Tax Credit Coalition from 2015 to 2017, and regularly advocates on Capitol Hill for the strengthening and expansion of the Low Income Housing Tax Credit on behalf of the Affordable Rental Housing Action Campaign.

Molly focuses the New Markets Tax Credit (NMTC) portion of her practice on CDE (lender) and QALICB (borrower) representation. Recently, she represented a CDE in its lending to borrowers that were renovating office and school spaces in low-income communities in the Maryland and D.C. areas, and represented a borrower in structuring the NMTC and historic rehabilitation tax credit (HTC) financing of a health center in Baltimore, Maryland. Molly's additional representative matters involving HTCs include representing a developer/sponsor in the structuring and negotiating of the HTC financing of a historic hotel in Baltimore, Maryland.

Molly's investment tax credit (ITC) portion of her practice focuses on the tax structuring of community solar and commercial, residential, and utility scale solar projects on behalf of developers/sponsors and lenders.

Molly is a frequent lecturer on tax credits and has spoken at a number of conferences, including ones sponsored by the American Bar Association Forum on Affordable Housing & Community Development, the National Council of State Housing Agencies, the Pennsylvania Housing Alliance, the NMTC Coalition, SEIA, CohnReznick LLP, and Novogradac & Company LLP.

Linda Schakel, Ballard Spahr Law Firm, Washington DC, Tax Law Attorney

Linda B. Schakel served as an attorney adviser in the Office of Tax Policy of the U.S. Treasury (May 1995 to August 1997) after practicing with Ballard Spahr for nine years. At the Treasury Department, she had primary responsibility for tax legislative and regulatory projects in the areas of tax-exempt bonds, Low Income Housing Tax Credits, empowerment zones and enterprise communities, work-opportunity tax credits, and welfare-to-work tax credits. Ms. Schakel returned to Ballard Spahr after her work with the Treasury Department. Before law school, she taught gifted...

Christopher Jones Tax Attorney Ballard Spahr

Christopher A. Jones is a contract attorney who advises clients on a wide range of federal, state, and local tax matters. His practice includes advising clients regarding the tax consequences of complex transactions and associated planning opportunities. Additionally, Chris assists clients in federal, state, and local tax audits and controversies and has represented clients in administrative appeals and in court. He provides clients tax advice in labor and other litigation matters including withholding tax and information reporting issues.