IRS Targeting Noncompliant Qualified Opportunity Funds and Their Investors

Jones Day

Jones Day

The IRS has begun enforcement efforts related to qualified opportunity zones, announcing that it will begin sending letters to Qualified Opportunity Funds and their investors advising that corrective actions may need to be taken related to past filings.

On April 12, 2022, the Internal Revenue Service announced that starting this month, it will send letters to taxpayers requesting that they take corrective actions related to the reporting of investments in qualified opportunity zones. The IRS's outreach is part of a larger effort to address potential noncompliance around the reporting obligations of Qualified Opportunity Funds ("QOFs") and their investors. It comes on the heels of a report by the office of the Treasury Inspector General for Tax Administration, which called on the IRS to take further enforcement actions after uncovering "obvious and blatant inaccuracies in reporting." 

The Tax Cuts and Jobs Act of 2017 created the qualified opportunity zone program to spur economic development in lower-income areas by providing tax incentives, principally the deferral of certain capital gains, for taxpayers who invest in those areas through a QOF. A QOF is required to self-certify annually on Form 8996 that it is organized and operated as a QOF. Taxpayers invested in a QOF during a taxable year are generally required to report information for that year to the IRS on Form 8997. 

In its press release, the IRS announced that it would begin sending three letters: 

  • Letter 6501, Qualified Opportunity Fund (QOF) Investment Standards, will be sent to QOFs to advise that information needed to support their self-certification on Form 8996 is missing or invalid, or that the QOF's calculations are not supported by the amounts reported.
  • Letter 6502, Reporting Qualified Opportunity Fund (QOF) Investments, and Letter 6503, Annual Reporting of Qualified Opportunity Fund (QOF) Investments, will be sent to investors in QOFs to advise that the information required by their Form 8997 is missing or invalid, or that the investors may not have properly followed the requirements to maintain their qualifying investment in a QOF. 

The IRS warned that taxpayers receiving one of these letters "may need to take additional action," such as filing amended returns. Failure to respond to a letter could result in adverse tax consequences. A QOF that fails to respond to a letter regarding its Form 8996 may lose its QOF certification, be referred for examination, and further subject its investors to examination. An investor in a QOF who fails to respond to a letter regarding Form 8997 may be determined not to have a qualifying investment in a QOF, and may also be referred for examination, which could result in additional tax, penalty, and interest. 

QOFs and taxpayers engaged in opportunity zone investments should carefully consider responses to these letters, as they are a visible step in promised future IRS enforcement.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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