IRS Finalizes Form 8997, Form 8949 and Schedule D for Reporting QOF Investments
Taxpayers must report their investments in Qualified Opportunity Funds (QOF) on new IRS Form 8997, Initial and Annual Statement of Qualified Opportunity Fund (QOF) Investments. Individuals who dispose of any QOF investments during the year must also report the gain or loss on Form 8949, Sales and Other Dispositions of Capital Assets; and on Schedule D (Form 1040), Capital Gains and Losses.
Form 8997, initial and annual statement of Qualified Opportunity Fund (QOF) investments
Any taxpayer who holds a QOF investment during the tax year must file Form 8997, even if they did not dispose of any QOF investments. Thus, individuals, C corporations, S corporations, partnerships, estates and trusts with QOF investments must file Form 8997.
Filling out Form 8997
Form 8997 has four sections:
- Part I asks for information about QOF investments held at the beginning of the tax year.
- Part II asks for information about capital gains realized during the tax year, but deferred because they were invested in the QOF.
- Part III asks for information about QOF investments disposed of during the tax year.
- Part IV asks for information about QOF investments held at the end of the tax year.
The taxpayer cannot combine QOF investments; each must be reported on a separate line.
Information required for Form 8997
Each part of Form 8997 requires five pieces of information:
- The QOF’s employer identification number (EIN)
- The date the taxpayer acquired the QOF interest
- A description of the taxpayer’s QOF investment, such as the number of shares in a corporate QOF or the percentage interest in a partnership QOF
- The amount of short-term gain that the taxpayer has deferred by investing it in the QOF (or that’s included in income if the taxpayer disposed of the interest during the year)
- The amount of long-term gain that the taxpayer has deferred by investing in the QOF (or that’s included in income if the taxpayer disposed of the interest during the year)
A taxpayer who disposes of a QOF investment should be able to get most of this information from the Form 1099-B, Proceeds from Broker or Barter Exchanges, that the QOF (or a third party) should provide. Part III for Form 8997 also includes a box for taxpayers to check if they did not receive a Form 1099-B.
QOF reporting on Form 8949 and Schedule D
All taxpayers use Form 8949 to report:
- their initial decision to defer capital gain by investing it in a QOF, and
- any disposition of an interest in a QOF.
Thus, taxpayers must file Form 8949 for the first year and the last year of a QOF investment. However, they do not have to file Form 8949 for years in which they merely hold a QOF investment.
Form 8949 reporting may be simplified for some particular gains and losses, but these streamlined rules don’t apply to QOF reporting. Thus, taxpayers cannot:
- skip Form 8949 and report QOF deferrals and dispositions directly on Schedule D,
- aggregate QOF deferrals and dispositions, or
- report summary totals from QOF deferrals or dispositions.
Instead, taxpayers must provide detailed information about each QOF deferral and each QOF disposition.
However, QOF deferrals from different transactions may be combined on a single line if the gains are of the same character (that is, short-term or long-term) and the taxpayer invests them in the same QOF on the same date.
Reporting QOF investments on Schedule D
After Form 8997 and Form 8949, Schedule D reporting for QOF dispositions is a breeze. Taxpayers need only check a box on Schedule D if they disposed of a QOF investment. Of course, they also need to attach Forms 8997 and 8949, and carry relevant amounts from them over to Schedule D. Taxpayers also must use Schedule D to report any capital gain that they are deferring when they make a QOF investment.
Deferring capital gain with QOF investments
QOF investments offer taxpayers immediate tax savings—but more importantly they also offer potentially extraordinary savings to long-term investors.
QOFs are corporations or partnerships that are organized to invest in qualified opportunity zones (QOZ). The IRS has designated 8,764 low-income tracts as QOZs.
Taxpayers may defer capital gains by rolling them over into a QOF within 180 days. The taxpayer generally must recognize the gain when the QOF investment is sold or exchanged or, if earlier, on December 31, 2026. However, some of the gain is not taxed at all if the taxpayer holds the investment for at least five years.
Longer-term investors may realize an even bigger bonanza. A taxpayer who holds a QOF investment for at least 10 years may elect to avoid federal income tax on the appreciation in the investment that is attributable to the deferred gain. The taxpayer’s basis in the appreciation is also stepped up to fair market value when the investment is sold or exchanged.
This combination of immediate deferral of gains, plus potentially tax-free long-term gains, is why many taxpayers think QOF investments are worth the paperwork.
By Kelley Wolf, JD, LLM