A QOF sponsor showed a 12.4 percent net IRR on the cover page and buried the tax assumption three exhibits deep.

The depreciation recapture point is the one that actually moves the number in a deal with real cost segregation. On a commercial asset where an aggressive cost seg study front-loads 15-year and 5-year personal property, the recapture exposure at exit can represent a meaningful share of total proceeds, and modeling all of that exit value under the ten-year exclusion inflates the post-tax IRR by a figure that is not trivial to recover from other assumptions.

The assumption doing the most work in that 12.4 percent figure is not the rate bracket, it is the implicit claim that the exclusion applies to the full gain pool. Those are two separate legal questions sitting inside the same line item, and sponsors routinely collapse them.

What was the asset type and roughly how many years into depreciation had it been when the fund acquired it?

This is genuinely useful for anyone preparing to look at QOF materials, so I want to make sure the vocabulary lands for readers who are newer to this.

A few terms that appear in your post:

IRR (internal rate of return) is a way of expressing how fast money grows inside an investment, as a single annual percentage. It accounts for timing, so when you get money back matters, not just how much.

Deferred gain is the capital gain (profit from selling something like stock or property) that you have moved into the QOF instead of paying tax on it right now.

Depreciation recapture is a tax event on exit. When you own a building, the IRS lets you deduct a portion of its cost each year as it "wears out." Those deductions reduce your taxable income while you hold the asset. When you sell, the IRS takes back some of those deductions by taxing that portion of your gain at a higher rate, separate from ordinary appreciation.

Cost segregation is an accounting study that accelerates those depreciation deductions by reclassifying parts of a building into shorter-lived categories. More deductions now means more recapture later.

Your two questions for any sponsor are the right ones to arrive with. I cannot tell you whether any specific QOF is suitable for you, and the tax math here genuinely requires a CPA or tax attorney who knows your full picture, because the effective rate on your original gain changes the whole analysis.

One thing worth adding: the strategy guide for passive OZ investing notes that fund-manager execution is a real variable layered on top of the tax structure. Projection quality is part of evaluating execution.

What kind of gain are you looking to defer, and how far along are you in reviewing QOF offerings?

Both findings are technically accurate and the depreciation recapture point is the one that does more damage in practice.

On the rate assumption: you are right that 23.8 percent is the ceiling, and any investor below that ceiling will see a smaller tax benefit on the deferral side. But the assumption also runs in the other direction. A taxpayer with a large deferred gain and no offsetting losses who holds for ten years is giving up liquidity on that deferred gain for the entire hold. The opportunity cost of that locked capital should appear somewhere in the model. Most QOF decks do not show an alternative deployment scenario, which means the comparison is implicit and flattering rather than explicit and testable.

The recapture point is where the math actually breaks. Under the ten-year exclusion, appreciation on the QOF investment itself escapes federal capital gains tax. Depreciation recapture is not appreciation. Section 1250 recapture is taxed at 25 percent on the portion attributable to straight-line depreciation, and cost segregation accelerates depreciation into earlier years, which increases the recapture exposure at exit. On a commercial asset with aggressive cost segregation, the recapture figure can represent a meaningful share of total exit proceeds. A fund that modeled substantial cost segregation benefits during the hold and then excluded all exit proceeds from tax in the IRR is double-counting in the investor's favor.

The question you added at the end is the right one. I would add a third: ask the sponsor to show you a sensitivity on the exit recapture amount as a percentage of the projected net IRR. If the answer requires several days and a revised exhibit, that tells you something about how the fund was originally underwritten.

What is the fund's stated cost segregation strategy, and did the deck show accelerated depreciation as a current cash benefit without disclosing the corresponding recapture liability at exit?