Post RE QOZ Loophole

I have been thinking of a possible angle ("loophole") in the QOZ rules. If this works, I will mention it in an article which I'm submitting on 12/10. Feedback welcome ( or twitter @gradmantax).

In a QO Fund partnership, profits interests received for services are not Qualifying Investments. Thus, they aren't eligible for the 10-year basis step-up. My proposal: don’t compensate the manager with a profits interest.  Compensate him with fees.  This makes it possible for 100% of the partnership interests to be Qualifying Investments in the hands of the limited partners.

Granted, this does burden the manager with more tax (ordinary income). However, this should be offset by an equal-and-opposite adjustment to the limited partners (deduction against ordinary income).  (I don't mention 199A because this expires in 2026, and anyhow does not apply to net capital gain.)

Since the partnership interest is literally worth more in the hands of the partners than it would have been in the hands of the manager, this makes it possible to gross up the manager (i.e. pay him additional fees) sufficient to make it worth his while to cooperate with this arrangement, with the partners still coming out ahead. 


  • Assume the QO Fund sells the building in Y10.  This creates a gain at the partnership level.
  • Immediately after (i.e. during the same year), the Fund pays the manager a fee for services. This creates a deduction at the partnership level.
  • At the end of Y10, the gain and deduction are both allocated among the partners.
  • However, under the following rule,,
    • the partners with Qualifying Investments can elect to exclude this gain;
    • the partnership is deemed liquidated; and
    • the partnership is deemed reconstituted with entirely non-Qualifying Investments.
  • Note that the amount of gain eligible for exclusion should not be reduced by the amount of the fee deduction.
    • The two are separately stated items.
    • And, the regs instruct us "to exclude from the taxpayer's income all gains and losses allocable to the qualifying investment that arise from all such sales or exchanges for the QOF partnership's or QOF S corporation's taxable year."
    • However if that bothers you, you could delay paying the fee until Y11. 
  • Either way, the partners are allocated no gain, but they are allocated a loss (deduction) equal to the fee.
    • Note: This "loss" is not the same as the "loss" which is excluded in the reg quoted above. That refers to a loss as the excess of basis over amount realized, i.e. 1001(a).  Here we're talking about a loss allocation in IRC 702(a)(8).  This is not excluded.
  • Before the partnership terminates, this loss is passive, so it is potentially suspended at the entity level.
  • However, when the partnership terminates (i.e., either automatically in Y10 as part of the election, or else in Y11), this loss is liberated, and it becomes an active NOL in the hands of the partners. IRC 469(g).
  • Thus, the investors can apply the loss against ordinary (high-tax) income.