Reporting taxes for investments in Qualified Opportunity Zones (QOZ) requires filing IRS Forms 8949 and 8997 alongside the annual Form 1040 personal income tax return. Form 8949 discloses capital asset sales and gains or losses, while Form 8997 tracks investments in QOFs. Sponsors of QOZs as funds or partnerships must file Form K-1 annually, detailing taxable income and deductions. REIT-structured QOZ investments are reported on Form 1099, with taxable distributions on Schedule B of the investor’s Form 1040. Form 8996 confirms a corporation or partnership as a QOF and reports on its investment standard compliance.
Compared to §1031 like-kind exchanges, QOZ investments differ significantly. The deferral for QOZ funds ends on December 31, 2026, with a potential step-up in basis, while §1031 exchanges offer continued deferral until cash-out or death. Profit from a QOZ held for 10 years is tax-free, though 85% of the original tax bill must be paid in 2026. QOZs allow reinvestment of gains from pass-through entities without a 45-day identification window, providing flexibility for investors.
Considering the current market highs, QOZ investments offer a chance to defer and reduce capital gains tax, reinvesting gains into undervalued assets. Diversification, potential income, and tax advantages make QOZ investments appealing for investors looking to benefit from tax breaks while revitalizing targeted communities. However, as tax regulations have sunset provisions, investors should act promptly to maximize the benefits of QOZ investments.
QOZ Investments vs. §1031 Like-kind Exchange Investments
The difference between §1031 like-kind exchange investment and Qualified Opportunity Zone investments are numerous and significant.
An IRC §1031 exchanges allow for a continued deferral of both capital gain and depreciation recapture until either a cash-out event or a step-up in basis at the investor’s death. In comparison, the original capital gain invested into the qualified opportunity zone fund is only deferred until December 31, 2026—albeit with a potential step up in basis of 10 percent or 15 percent depending on the length of the investment.
Unlike a §1031 exchange, if the QOZ fund investment is held for 10 years, the profit from the opportunity zone investment is tax-free. This does not mean that the tax liability from the invested capital gain in the Opportunity Zone is completely deferred, as at least 85 percent of that tax bill must be paid in 2026.
Unlike a §1031 exchanger, the taxpayer that disposed of the relinquished asset does not have to be the same one that acquires the replacement property in a QOZ fund. Thus, partners who receive gains from a pass-through entity may reinvest the gains as if they had received them directly and thereby receive the OZ benefits. Furthermore, unlike investors in a §1031 exchange, investors in a QOZ fund have no 45-day identification window, and those who are reinvesting gains from a partnership have 180 days from the end of the partnership’s taxable year, not from the date of the sale.
Lastly, it must be considered that the funds for paying the tax bill can be invested in the Opportunity Zone in 2026, especially if the intention is to keep the investment for 10 years to achieve tax-free gains. Accordingly, investors need to plan to cover their tax bill using other funds, unless there is a tax-free distribution from the fund, a loan refinance, or a partial liquidation.
With values in the stock and real estate markets, QOZ investments present investors with a timely and tremendous opportunity to realize built-up capital gains, defer and reduce capital gains tax, and redeploy the full pre-tax gain into uncorrelated investments in undervalued assets with significant upside potential. Any realized appreciation is not taxed as gain. Thus, QOZ investments provide diversification, potential income, and significant tax advantages while helping society reinvigorate targeted communities throughout the country. However, time is of the essence for the investor to “do well by doing good” and take full advantage of qualified opportunity zones since the tax regulations have certain sunset provisions.