All Forum Posts by: Scott McIntosh

@James York
A QOF must be a corporation or partnership — the IRS needs a regarded entity to be able to collect tax information about where QOF investment is flowing bad about compliance with the OZ investment requirements. 

Most of my clients who want a self-directed QOF create a simple husband-wife partnership, though you could do the same with a trusted friend or family member, too. The partnership does not need to be 50/50– it could be 99.9% and .1%, and both partners are not required to have capital gains. 

@Jason Hsiao the use of refi proceeds is a little trickier a QOF, as the IRS has stated that disguised sale rules will be applied to cash out refi’s of OZ property. If you pull the proceeds of a refi out of the QOF before the end of year 2, the leveraged distribution is presumed to be a disguised sale and would trigger early recognition of the previously deferred gain. If you take a leveraged distribution of refi proceeds after year 2, it’s presumed not to be a disguised sale, so they’re likely would not be an early recognition event.

I like your point about waiting to distribute any refi proceeds until closer to the due date of tax on the deferred gain. 

@Trago WAllace -- yes, the BRRRR method can certainly work in a QOF and is a great way to amplify the back-end tax-free sale after a 10 year hold.

The one thing you have to watch out for is managing your cash at two bi-annual testing periods -- generally June 30 and December 31. A QOF must maintain at least 90% of its assets in qualified OZ property (i.e. the OZ homes you are buying and rehabbing). Cash is NOT a qualifying asset, though, so if you receive significant refi proceeds and aren't able to redeploy them before those end of June/December testing dates, you could fall short of that 90% asset test which would trigger some fund-level penalties. As long as you're mindful of that, though, BRRRR in a QOF can be a beautiful thing. And if you don't want to worry about that timing, then using a second-tier OZ Business can give you added flexibility, including a 31-month working capital safe harbor to deploy/redeploy your capital into the properties you are BRRRRing.

And you're right on the cashflows -- the profit/loss of the QOF during your ten-year holding period doesn't get any special tax treatment, and you can distribute net profit from the QOF to yourself without adverse consequence.

Edward— you do need to create the QOF first and buy the property directly in the QOF. To qualify for OZ benefits, the property must be acquired by the QOF from an unrelated party (and be located in an OZ and substantially improved, as you noted). If you quitclaim the property from yourself to the QOF, it doesn’t meet the first prong and won’t be eligible for the related benefits. 

@Jason Velie -- if the LLC you created to purchase the rental is a partnership or corporation and doesn't own anything other than the OZ property you described, its probably not too late to structure it as a QOF. Any partnership or corporation can self-certify as a QOF on the entity's first tax return, so assuming you created the entity in 2020, you've still got until ~ March 15th, 2021 to do so. There are some other requirements around language in the company's operating agreement, but like the self-certification, that's likely something that could be done at this stage, too.

The other commenters are correct in stating that the OZ incentive is complex and requires careful planning.  In my opinion, the tax savings probably won't justify the complexity if this is the only OZ property you intend to acquire.  That said, the program is open to new investment until the end of 2026, and established QOFs can continue to acquire OZ property and benefit from the tax-free appreciation and avoidance of depreciation recapture benefits the program provides until the end of 2047.  So if you see this as the first of several OZ properties you'd like to add to your portfolio, it may be worth the time and expense of professional advice to get it right now.  

Yes, you can. 

@Duane Richards there aren't any prohibitions on using related party debt in a QOF. You have to be sure it's truly structured as debt so it isn't re-characterized as a non-qualifying equity contribution, but assuming you use a reasonable interest rate and have an amortization schedule for it, you could loan money to the LLC as you describe.

@Duane Richards

You definitely want to purchase in your LLC name. There are strict related party rules in OZ transactions that would keep a property you bought personal and quit-claimed to your QOF from qualifying.

@Raza Rizvi -  You still have plenty of time.  The IRS waived penalties for QOFs who fail to meet their 90% asset test in June and December 2020.  Accordingly, since you started your QOF in December 2019, your fund won't be penalized as long as you acquire significant OZ property by June 30, 2021 to meet your 90% asset test.  And if you fall short of your 90% asset test in June 2021, that doesn't mean you'll lose all your benefits, just that you'd be subject to an underinvestment penalty.  

@Joel Kleyer

There are some additional nuances to the BRRRR Method in an OZ investment. The IRS applies a complicated set of "disguised sale" rules to leveraged distributions from a Qualified Opportunity Fund. There are several layers to the analysis, but in general, a leveraged distribution within the first two years of the Opportunity Fund will trigger early recognition of your previously-deferred capital gain. If the leveraged distribution happens after the two year mark, then it generally won't disrupt your deferral.

That said, if you BRRRR and keep the proceeds in your Opportunity Fund and use them to acquire your next OZ property (rather than taking a distribution of the refinance proceeds), then that won't implicate the disguised sale rules. You just have to watch you 90% asset test -- since cash counts as a non-qualifying asset in a QOF, if you finish your refinance and can't get the cash redeployed in a new property before your June 30 or December 31 testing dates, that extra cash could cause your fund to fail its 90% asset test.