Gain from selling a note portfolio, then lending back into the same QOF

Question

Working through something on the debt side. Say I sell a seasoned performing note portfolio at a gain and I want that gain to go into a QOF rather than pay tax on it now. Two things I can't get comfortable on.

First, eligibility. The gain on sale of the notes themselves is capital gain to me as an investor, or at least that's how it has been treated. But part of what I collect on those notes is accrued discount, which is ordinary. So some slice of the proceeds may be ineligible for deferral even though the wire is one number.

Second, and this is the one that interests me more, I'd rather be the lender to the OZ project than the equity. So could I put the gain into the QOF as equity for the deferral, and separately originate the construction loan to the QOZB? At that point I'm a lender to an entity I hold an interest in. If my equity stake stays under the related-party threshold, does the loan stand on its own, or does having debt and equity in the same project start to unwind the qualifying property treatment? I've seen the 20% figure thrown around and I don't know which test it belongs to.

jessreyes12 · Answer

A year ago I wouldn't have asked this out loud: if you're lending to the project, what does the deferral even buy you? Your return is the interest rate on the loan. The ten-year appreciation exclusion only works on the equity you put in, and the loan sits outside all of it. So you're running two completely separate economics through one project and one of them gets no OZ benefit at all.

kevin_lombard · Answer

Where does the 180 days start if the note portfolio sells in tranches? Because if it's per-closing you'd have several separate 180-day windows and several separate investments to track, which sounds like a nightmare on the reporting side. Also I thought all sale proceeds counted, not just the capital gain piece.

tashaford30 · Answer

@juniper only the eligible gain goes in, not the proceeds. If you sell for 500k with 300k of basis, the 200k gain is what you'd roll, and the 300k is just yours. That's the piece tender is flagging, because the ordinary-income slice of that 200k probably isn't eligible for deferral either.

dmitri_v6 · Answer

The 20% you're thinking of is the related-party definition that pulls in sections 267 and 707 with the thresholds knocked down to more than 20%, and it matters mainly for property acquired from a related party failing to be qualified opportunity zone business property. It isn't a rule about lending. A loan from an owner isn't automatically fatal, but it gets looked at on whether it's really debt, and interest to a related lender runs into the ordinary related-party interest rules. Whether your specific stack holds up is a question for tax counsel who will read the loan documents and the operating agreement together. What I'd want to see in the subscription docs is whether the fund even permits an investor to be a project lender, because most PPMs I've read flatly prohibit side arrangements between investors and portfolio entities.

monica_tran3 · Answer

My accountant quoted around $1,100 just to read one of these offering documents alongside the deferral election, and that was before anyone mentioned a related-party loan. Two structures stapled together in the same project is going to be a multiple of that, every year, on the K-1 side too. Might still be worth it, but price the compliance before you fall in love with the structure.

Gain from selling a note portfolio, then lending back into the same QOF

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