If the QOF investor has held their interest for the full 10 years, then all gains, whether ordinary or capital gains, will be exempt.
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What happens if a QOF or business has generated ordinary income from the sale of depreciated personal property at the time of exiting after 10 years?
Regarding the “depreciation recapture” upon exiting, will gain from ordinary income or amortization of intangibles be exempt from taxability?
Answers
Under a technical reading of the rules, there is no depreciation recapture in an exit 10-plus years.
According to the second set of regulations, only when there is a sale of the interest in QOF that operates as a partnership will the exclusion apply to both capital and ordinary gains. The same will not apply to recapture on the sale of assets by the partnership or S corp. It's important to remember this part of the regulations cannot be relied upon until final regulations are published.
There's a bit of a treatment mismatch between a sale of QOF equity and a sale of QOZB equity or QOZB assets. For the sale of QOF equity, all gain, whether ordinary or capital, is excluded from gross income by way of a step-up in basis. Under the proposed regulations as written, the only gain excluded from an asset sale (be that QOZB equity or QOZB assets) would be capital gain. The mismatch might be corrected upon issuance of final regulations, but the current state of affairs is awfully strange.
I do not believe this is an issue because, after 10 years, basis is stepped up to sale price, so there is not gain to be converted to ordinary income by the recapture rules. Please note, however, that the no-tax benefit only apply to a sale by the taxpayer of an interest in the QOF or a sale by the QOF of an interest in the QOZB. As of yet, it does not apply to the QOZB's gain from the sale of assets.
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