To report qualified opportunity zone investments and defer the capital gains, the two IRS forms that must be filed are Forms 8949 and 8997 together with the investor’s annual Form 1040 personal income tax return. IRS Form 8949, Sales and Other Dispositions of Capital Assets, tells the IRS that you sold capital assets and realized either a profit (capital gains) or a loss (capital losses). IRS Form 8997, Initial and Annual Statement of Qualified Opportunity Fund (QOF) Investments, is required to track capital gain investments in opportunity zone funds and is required to be filed annually with the investor’s federal income tax return. The sponsors for QOZ structured as a fund or limited partnership are required to file a Form K-1 on an annual basis. The Form K-1 reports partner-allocated taxable income and pass-through tax deductions for depreciation. Subsequently, these items are reported on the investor’s 1040 individual income tax return on Schedule E.
If a QOZ investment is structured as a REIT, investors receive a standard Form 1099. The form reports the investor’s share of taxable distributions or dividends from the REIT (net of depreciation and other deductions). Then these items are reported on the Investor’s 1040 individual income tax return on Schedule B. The IRS Form 8996 is used to clarify that a corporation or partnership is a qualified opportunity fund and as an annual report on whether the fund met the investment standard during its tax year.
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.
In conclusion, 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.