The IRS seemed to indicate in its proposed regulations that this would be permissible, but the issue has been left to future guidance. As of today, we really don’t know the answer to this question.
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What happens when a QOF sells an asset before 10 years but reinvests those proceeds in another QOZ?
What happens when a QOF sells an asset before 10 years but reinvests those proceeds in another QOZ?
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Today is the first day I can answer this question with confidence. The second set of regulations clarifying the answer to your question were just released today. When an asset is sold the 10-year clock continues as long as proceeds from the sale are reinvested within 12 months. There is a second wrinkle. When the asset is sold, any gain or loss on the sale is passed through to the investor. If the asset being sold is real estate, it is possible to re-invest using the 1031 exchange rules and defer the gain that would otherwise be passed through to investors. If a 1031 exchange is not viable, a distribution of the gain component should be made to cover the taxable gain.
This question was unresolved until the new regulations (Tranche II) were issued last week. One half of the questions was resolved and one half is still being worked on by Treasury. If a taxpayer sells an asset before the 10-year holding period, the new regulations clarify that for up to 12 months, the QOF can hold the funds in cash, cash equivalents or debt with 18 months or less maturity date and the property will be treated as QOZ property for purposes of the 70% and 90% semi-annual tests. However, Treasury is still evaluating how the taxable income from the sale will be treated. They seem inclined to want to allow deferral if reinvested, but are unsure whether they have the authority to make such a decision.
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