The most recent proposed regulations released in April 2019 [REG-120186-18] (the “New Proposed Regulations”) provide guidance as to the treatment of gifts of Opportunity Zone interests through Qualified Opportunity Funds (“QOF Interests”) to grantor trusts and the implications of transfers at death.
Transfers at Death:
The New Proposed Regulations clarify that the death of a taxpayer owning a QOF Interest is not an inclusion event. Further, neither the transfer of the qualifying investment to the decedent’s estate, nor the distribution of the qualifying investment to heirs or beneficiaries would be an inclusion event. But, note that because the transfer to an estate or a beneficiary is not a disposition, there would be income with respect to the decedent. Because death is not a taxable event, the deferred gains carry over to the successor in interest so that there is no step up in basis at death. Therefore, the deferred gain continues to be deferred gain in the hands of the beneficiary. And, for purposes of the qualified opportunity zone (“QOZ”) statute, the decedent’s holding period tacks, and the beneficiary steps into the decedent’s shoes.
For the recipient beneficiary, this means that unless there is an earlier disposition, come December 31, 2026, the beneficiary holding the QOF interest will be responsible for the deferred tax, possibly without the liquidity to pay it.
Gift Tax Consequences:
Giving away your QOF interest generally subjects the interest to immediate taxation. One exception to this general rule is a gift of the QOF interest to the taxpayer’s grantor trust. The New Proposed Regulations do not treat a taxpayer’s gift of a QOF interest to the taxpayer’s grantor trust as an inclusion event that would accelerate the deferred capital gains tax. The answer goes back to good old Revenue Ruling 85-13 which provides that a transaction between a grantor and the grantor trust does not have tax consequences because the same taxpayer is responsible for the taxes.
Further, termination of grantor trust status due to the grantor’s death would not be treated as an inclusion event. Note, however, that termination of grantor trust status for other reasons would subject the deferred capital gains to tax.
Perhaps the most attractive treatment of the gift of a QOF interest to a grantor trust is that the trust takes the holding period of the grantor. Therefore, future appreciation after ten (10) years is excluded from income tax if still held in the grantor trust.
What about the GRAT?
Estate planners love GRATs, and, as grantor trusts, they are excellent vehicles for estate planning with QOF interests. Remember, however, that the remainder beneficiary of a GRAT funded with a QOF interest should be a grantor trust to avoid an inclusion event that triggers tax on the deferred gain.
Angkatavanish, Todd and David Herzig. INSIGHT: Frozen Ozone (Fr-Ozone) Planning–The Newest Flavored Estate Freeze. Bloomberg Law. May 22, 2019.