Opportunity Zone Reporting Risk and Reward: What Happens If You Get It Wrong?

May 19, 2022 Jonathan Ewert, CapZone Impact Investments

Laptop with graphs and data

With contributions by Auyon Rahman of Summit Consulting

In the fourth and final post of this series, we cover the work of the Treasury Inspector General for Tax Administration, IRS, Senate, and House of Representatives in developing processes and legislation to track and regulate Opportunity Zone businesses and investors.

Today, the advantages of Opportunity Zones (OZs) are well known to capital gains investors and communities that benefit from their investment. OZs were designed to encourage the creation of jobs and economic growth in low-income communities. They serve as powerful tax incentive vehicles for individuals to reinvest capital gains so long as they invest in high-impact projects and businesses in underserved communities.

The attractiveness of the incentive in a rising-tax environment has prompted some public debate over the effectiveness of OZs in making real change in these communities. The Treasury Inspector General for Tax Administration (TIGTA), the Internal Revenue Service (IRS), and the U.S. Senate and House of Representatives have been working to develop processes and legislation to track and regulate OZ businesses and investors.

In this post, we’ll discuss the strict legal reporting requirements coupled with OZs and what happens if you get it wrong.

Reporting Requirements Increase Transparency

In our first post, “The Essential Guide to Opportunity Zone Compliance,” we reviewed the three required IRS forms to disclose OZ investments. Individual investors must file Forms 8949 and 8997 along with their annual tax return, providing detailed information to justify their tax deferrals. Meanwhile, Qualified Opportunity Fund (QOF) directors or partners must return Form 8996 annually for the QOF to self-certify as a qualifying fund.

The recent Opportunity Zones Transparency, Extension, and Improvement Act (the “bill”) codifies and expands the information required to be reported on the IRS forms. The IRS will collect the additional data to track job creation and business growth while placing much of the information burden on the QOF and the Qualified Opportunity Zone Businesses that received the funding.

For example, Form 8996 will require the QOF’s name, address, tax identification number, fund structure, total assets held, and value of all qualified OZ property held by the fund. Under the proposed legislation, QOF managers will also have to disclose employment data of their investments, the North American Industry Classification System (NAICS) code of the business they have invested in, and if the business is a housing development, the number of residential units and full-time employees at the development. This will allow the IRS to cross-reference and correlate demographic changes in Opportunity Zones over time. For additional information on data the proposed legislation would track to measure impact, refer to our recent analysis of the bill, “A Whole-of-Government Response to Persistent Poverty.


Comprehensive Reporting Is Required

The bill requires some back reporting by the Secretary of the Treasury on the impact of OZ tax incentives. This includes a comprehensive report of the following aggregated information as soon as the bill passes and annually thereafter:

  • Total number of funds
  • Total assets of such funds
  • Distributions of QOF investments into OZ property across different industries by NAICS codes
  • Percentage of all tracts that have received QOF investment into OZ property
  • The aggregate total amount of QOF investments by census tract
  • The average monthly number of full-time employees of the Qualified Opportunity Zone Business in the qualified OZ for the preceding 12-month period
  • Distribution of OZ investments in real property versus business equity
  • The aggregate number of residential units resulting from investments made by QOFs in real property for each population census tract

The bill also places responsibility on the Treasury to provide a comprehensive report in the 6th and 11th years after enactment. The report will include data that points to socioeconomic impacts on job creation, poverty reduction, and other metrics deemed necessary by the Secretary of the Treasury.

Failure to Comply Is Expensive

The bill establishes new penalties for noncompliance with respective information reporting requirements relating to QOFs. Under the Opportunity Zones Transparency, Extension, and Improvement Act, the penalties will be added to the Internal Revenue Code.

The bill establishes penalties starting at $500 per day with a $10,000 cap. The cap is expanded to $50,000 when the total assets for the QOF exceed $10 million for the tax year. We also see a significant increase in the penalties for cases of intentional disregard. The penalties for funds increase to $2,500 per day with a $50,000 cap and a $250,000 cap for large QOFs that exceed $10 million in assets.

Additionally, the bill sets penalties for investors starting at $5,000 for failing to comply with the reporting requirements and just 60 days to correct the noncompliance, or a $500 penalty is added. Intentional disregard for reporting requirements can land investors a $25,000 penalty.

These penalties can limit, or even erase, the incremental profits on an investment derived from the tax incentive. And the IRS may refer the entire tax account for examination if a mistake is made on any form. Getting it right is now an investment imperative, and the IRS is already taking compliance action.

The IRS Is Already Taking Action

On April 12, 2022, the IRS announced (IR-2022-79) that it had begun mailing three types of noncompliance letters to notify taxpayers who may need to take additional action relating to QOFs.

Letter 6501, Qualified Opportunity Fund (QOF) Investment Standard, will be sent to taxpayers who attached Form 8996 with missing or invalid information necessary to support the annual certification of the investment standard. Additional action may be needed to meet the yearly self- certification.

Letter 6502, Reporting Qualified Opportunity Fund (QOF) Investments, or Letter 6503, Annual Reporting of Qualified Opportunity Fund (QOF) Investments, will go out to taxpayers who have not correctly completed Form 8997. Based on the findings in the TIGTA report, the number of letters could be considerable.

Taxpayers can file an amended return or an administrative adjustment request to cure the noncompliance. Failure to act may mean a QOF will not meet the investment standard requirement or a taxpayer may not be deemed to hold a qualifying investment in a QOF. Recipients may owe taxes, interest, or penalties on any gains not correctly deferred pursuant to the regulations.

In Sum

The reporting requirements for QOF administrators and investors are evolving on the foundation of Senate inquiries, the TIGTA investigation, IRS management, and the proposed legislation championed by Senators Cory Booker (D-NJ) and Tim Scott (R-SC). When introducing the new standards set forth in the bill, Senator Booker said, “The Opportunity Zone incentive has the potential to unleash much-needed economic growth in high-poverty communities across the country—communities that investors too often overlook. But without robust guardrails in place, the incentive could be undermined or abused by those who aren’t committed to uplifting rural and urban communities across the country.”

Many qualified Opportunity Zone investment groups also support the new legislation as a means to strengthen the program and align investors with the true intent of the incentive. That said, the penalties for noncompliance are set to be stringent and should not be taken lightly.

For more information about evolving QOF compliance and reporting requirements, investors may reach out to CapZone at info@capzonegroup.com.

Photo by Carlos Muza on Unsplash

Share This: