If you get bought out before the 10-year timer elapsed, you don't get the tax-free appreciation because you haven't met the holding period.
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What happens if an operating business I’ve invested in gets bought out?
Getting a big exit from a startup investment sounds like it should be a good thing, but what would happen to my OZ benefits?
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If sold before the 10-year period, gain is triggered and taxes are generally payable.
Any gain on the sale of the business allocable to you is taxable when received. You will have 12 months to reinvest the proceeds from the sale (not just the gain amount) in another QOZB or QOZP to avoid any impairment of your original deferral and to keep your 10-year original holding period intact.
If your Qualified Opportunity Fund (QOF) interest is being sold, the Opportunity Zone tax benefits would cease and the original capital gain should be recognized (less any 10% or 5% reduction possible from a five- or seven-year hold period). There might be ways to structure some continuing benefit if the buyout was of a development level entity and then the cash recirculated by the fund within 12 months.
You would owe tax in the gain (you do not get the no tax on appreciation benefit because sale occurs within 10 years). However, QOF can invest proceeds so that you can continue deferral of original invested gain. Depending on the size of exit, you might want to consider starting fresh with new QOF investment and accelerating deferral.
The second set of regulations provide certain flexibility if the proceeds are reinvested in qualified OZ property.
The business might be operated by the fund, and it might be operated by a corporation, LLC or partnership that the fund invests in. And it might happen before or after 10 years has elapsed. The following are the sale after 10 years has elapsed rules. In general, if you sell your fund interest, then you get a step-up and no tax. If your fund sells a business that it owns directly, you get a step-up and no tax on whatever would have qualified for capital gain treatment. So, anything attributable to depreciation recapture is still taxable. If your fund sells stock that it owns is a QOZ business, you get a step-up and no tax. If your fund sells an interest in a partnership or LLC taxed as a partnership that is operating a QOZ business, you get a step-up and no tax on whatever would have qualified for capital gain treatment. Again, anything attributable to depreciation recapture is still taxable. The following are the sale before 10 years has elapsed rules. A sale of your interest will cause an inclusion event as to the deferred gain (perhaps reduced by any basis step-up or decline in value in your QOF interest) and taxable capital gain on any excess, except that "hot assets" if any (like rent receivables and deprecation recapture) will be subject to ordinary tax rates. A sale by the QOF of its investments, whether directly owned or through a partnership, corporation, or LLC, will be taxable like any sale, without regard to OZ treatment. It will not cause an inclusion event as to the original capital gain that led to your OZ investment, or terminate your eligible for the 10-year step-up, provided that any amount is reinvested in QOF-eligible investments within 12 months, and until that happens, the funds are invested in cash or debt instruments with maturities of less than 18 months. As to the part that is taxable like any sale, you may be able to invest an amount equal to that gain in another QOF and postpone recognizing the gain until 2026.
That is a good question. A buyout is possible, but the gain on the sale would be allocated to the Qualified Opportunity Fund and then to its investors. Also, the cash from the sale, if it distributed to the investors, could trigger an end of the deferral of gains invested and a loss of the OZ benefits (and/or penalties for failure to meet the QOF requirements). There are a couple of alternatives. One, the Qualified Opportunity Fund could reinvest the proceeds in other qualifying investments within 12 months of receiving the sale proceeds in order to retain its status as a Qualified Opportunity Fund. This would not prevent the gain from being allocated up to the investors, but it would retain the status as a QOF and allow the new investment to potentially get the OZ treatment. Or two, the fund could distribute the proceeds to the investors who could reinvest the gain back into the fund (if it is before Dec. 31, 2026) and defer the new gain although that would start a new 10-year clock.
It depends on how the business was structured. Is that the actual fund or an entity that is a QOZB owned by the fund? If it's the fund, then nothing changes as long as the new fund owner/managers maintain the compliance for the fund. If it's a subsidiary entity that is a QOZB owned by the QOZF, then it would effectively mean that the funds must be reinvested so as not to fail the 90% test for any of the six-month testing periods. Safe harbors apply.
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