Q: Income Tax question, Regarding Inclusion of gains that have been deferred under section 1400Z-2 (a), QOF
May a taxpayer voluntarily elect to include part of the deferred capital gain without disposing of the QOF asset or other IRS defined inclusion event? For example, if the taxpayer deferred $100,000 of capital gains by purchasing $100,000 worth of QOF several years before, and then in a subsequent year, elects to include $20,000 of the capital gain in his tax return without selling any on the QOF?
A:
Based on the rules for Qualified Opportunity Funds (QOFs) under Internal Revenue Code section 1400Z-2, a taxpayer cannot voluntarily elect to include a portion of the deferred capital gain in their taxable income without a triggering event, such as disposing of the QOF investment or another inclusion event defined by the IRS.
The main purpose of the QOF program is to encourage long-term investment in designated Qualified Opportunity Zones by allowing investors to defer capital gains tax until December 31, 2026, or until they sell or exchange their QOF investment, whichever comes first. The deferred gain must be recognized on the earlier of:
1. The date on which the QOF investment is sold or exchanged, or
2. December 31, 2026.
In the example you provided, the taxpayer cannot voluntarily choose to include $20,000 of the deferred capital gain in their tax return without selling a portion of their QOF investment or experiencing another inclusion event. The gain deferral is an all-or-nothing proposition, meaning that the taxpayer must either continue to defer the entire $100,000 gain or recognize the entire gain if a triggering event occurs.
It's important to note that on December 31, 2026, all investors with deferred gains in QOFs must recognize those gains, regardless of whether they have sold their QOF investments. This is a key date to keep in mind for tax planning purposes.
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