The Tax Cuts and Jobs Act of 2017 provided for certain economically distressed census tracts to be designated Qualified Opportunity Zones (QOZ) for the purpose of attracting investment. A Qualified Opportunity Fund (QOF) is a corporation or partnership created for the purpose of investing in QOZs. To encourage investment, the TCJA allows a taxpayer to defer a taxable capital gain by electing to invest in QOFs and QOZs.
Taxpayers use Form 8997 to inform the IRS of
- the QOF/QOZ investments and deferred capital gains held at the beginning and end of the current tax year,
- any capital gains deferred by investing in a QOF, and
- QOZ investments disposed of during the current tax year.
Form 8997 is required to be filed every year in which the taxpayer is deferring a gain through an investment in a QOF or QOZ. While most of the entries you make in the form are informational, entries regarding QOZ investments disposed of during the current year flow to Form 8949.
Features of a QOF/QOZ investment
- Capital gains are deferred until December 31, 2026 or until the interest in the fund is disposed of, whichever occurs first.
- If electing to invest in a QOF or QOZ, the initial basis is zero.
- Investments held for 5 years receive a step-up in tax basis equal to 10% of the amount of initial deferred capital gain. Investments held for 7 years, i.e., the investment began before 2020, receive an additional step-up in tax basis equaling 5% of the deferred capital gain.
- For investments held for 10 years, the stepped-up basis will be equal to the fair market value of the QOF/QOZ on the date of disposition, further reducing the deferred capital gain.
Basis of a QOF/QOZ at disposition
The basis of a QOF/QOZ is determined by the length of time investment is held:
- If held less than 5 years, the basis is zero and the reported gain value is the initial deferred gain. The value for which the QOF/QOZ was disposed does not impact the taxable value of the gain to be recognized. It is the value of the initial deferred gain and the character of the original investment, i.e., short-term or long-term.
- If held 5 or more years, the basis is equal to 10% of the initial deferred gain which is then excluded from the reported taxable gain.
- If held for 7 years, the basis increases by an additional 5% of deferred gain.
- If held 10 years, the basis is the fair market value, and the only gain reported is the variance of the FMV to the original deferred gain.
Determining the deferred gain
A QOF/QOZ investment may be disposed of by sale, transfer of ownership, gift, or liquidation. The amount of deferred gain to report as of the date of disposition or December 31, 2026, whichever occurs first, is as follows:
The lesser of the value of the deferred gain or the FMV
the QOF/QOZ investment basis.
Deferred gains are reported at time of disposition on Form 8949.
Completing Form 8997
To access Form 8997 in TaxSlayer Pro, from the Main Menu of the tax return (Form 1040) select:
- Capital Gains/Loss (Sch D)
- Other button
- Form 8997 - Qualified Opportunity Funds Investments Statement
Form 8997 has four parts that may require entries:
- Part I: Total QOF investment holdings at beginning of year. List here the QOF investments that were held at the beginning of the year, including the amount of short-term and long-term deferred gain remaining in each.
- Part II: Current tax year capital gains deferred by investing in QOF. List here this year's short-term and long-term deferred capital gains from QOF investments made during the current year.
- Part III: QOF investments disposed of during current tax year. List here the current year's "inclusion events", e.g.,
- the taxpayer sold or transferred a QOF (including between spouses in a divorce, but not including a transfer due to the taxpayer's death),
- the taxpayer received a property distribution from a QOF,
- the taxpayer declared their QOF interest worthless,
- a QOF ceased to be a QOF.
- Part IV: Total QOF investment holdings at year end due to deferrals. List here QOF investments held at the end of the year, including for each QOF the amount of short-term and long-term deferred gain.
Note: This is a brief guide to entering Form 8997 in the TaxSlayer Pro program. This is not intended as tax advice. You are encouraged to read the IRS instructions as well as their FAQ, especially with respect to information about inclusion events.