There's a special election under the regulations the QOF can make when it sells.
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How can investors receive OZ benefits when a QOF sells its underlying assets?
How can the investors qualify for these benefits?
Answers
In a passthrough QOF in order for an investor to be able to step up their basis, the interest must have been held for 10+ years. Any sales prior to the 10 year mark will result in taxable income to the investors.
There is no sheltering any gains when a QOF sells underlying assets within the OZ benefits. However, a QOF may engage in a 1031 exchange. Note that the original investor gains may continue to be deferred if the proceeds from the QOF asset sale are reinvested within 12 months. However, any gain on sale from the assets acquired and sold within the OZF follow normal tax rules (i.e., generally taxable).
If the entities are partnerships and you as investor has held it for 10 years or more, there is a special election that can be made to cover that gain on disposition.
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