What if I don’t have enough funds to pay any tax liability that has been accrued from the initial investment by Dec. 31, 2026?
Unfortunately, the tax will be due on your 2026 tax return unless the value of your investment has suffered. Understanding the distribution plan (or lack thereof) by your QOF is an important part of the investment decision. Additionally, when determining to make a QOF investment, it is important to make considerations for payment of tax to avoid needing to liquidate your investment early and thereby negate the 10-year benefit.
The IRS will come knocking.
You need to plan to save cash reserves for the future payment of the tax liability in 2026. This could be done with other assets, savings, cash, etc. It is also possible that a fund could refinance a property and distribute cash to allow you to make a payment of tax, but there are debt-financed distribution rules and other inclusion event issues to consider as to whether this would be allowable in your personal situation.
You will need to line up a loan, make a distribution from the Qualified Opportunity Fund or work with the tax authorities to set up installment payments. Plan ahead.
You’d be subject to penalties for underpayment of your 2026 tax liability.
The liability that has been deferred from the original capital gain to 2026 is simply a liability on your personal tax return, like any other. It doesn't matter whether the QOF makes distributions to you. If you don't pay your taxes, then be prepared for the IRS to initiate collection activity to collect the amount owed.
That would be bad, same as what would happen if you did not have enough cash in any April to pay your taxes for the year before. Because an OZ investment is made with gain, not sale proceeds, you should retain the return of basis portion of the sale proceeds for the 2026 tax. If the sale is of low basis or $0 basis property, you have seven years to set aside the cash.
Depending on how long you’ve held your QOF interest, on Dec. 31, 2026, so long as you’ve not experienced an inclusion event, you must recognize either 85%, 90% or 100% of your deferred gain. The tax on the recognized deferred gain must be paid in 2027, even if you have received no cash from the QOF.
You still owe the taxes. The government will not give you a mulligan. If you're syndicating and you don't have a plan to create the necessary liquidity for your investors, be prepared for some really upset LPs.
There is no relief from this deferred tax. This is why we caution investors to have access to reserves if a fund cannot make a distribution in 2026 or 2017 to cover deferred tax. The one caveat is that a fund that does not have adequate cash flow will likely have impaired earnings. The taxable income that must recognized is the lower of deferred income less step-ups or appraised value less step-ups. The lower appraised value may reduce the tax due on April 14, 2017.
This will not be good! You need to pay the taxes on the deferred gain no matter you have funds or not. Penalties and interest will accrue in addition to the tax.
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