He gets taxed in his state of residency for 2026.
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What happens if an investor lives in a non-conforming state when investing in a QOF but moves to a conforming state a few years before the 10-year time limit to exit the fund?
An investor resides in a high-income tax state (State A), where the income tax statutes mirror the federal. In 2019, he generates a gain that is properly invested in a QOF, which means he gets to defer recognition to 2026. Meanwhile, the investor moves to a lower income tax state (State B). During the entirety of 2026, the taxpayer spends zero days in State A, owns no property in State A and has no State A source income. In 2026, will the investor have a tax obligation to State A, State B or both?
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Great question. It will remain unresolved until it comes up. To the best of my knowledge, these types of cases (e.g., where a pension is earned in state A but gets paid when recipient moves to state B) typically go against the states of former residence on constitutional grounds. We will probably have to wait and see to be sure, though.
Well, there are a couple of problems with investing in a non-conforming state, currently CA, MS, MA and NC. For starters, you do not get the seven-year tax deferral on the original gain if you are a tax resident in a non-conforming state, so there in no 2026 state tax to report. Most states have not yet dealt (to the best of my knowledge) with your specific issue, but the location of the real estate project will determine the tax impact on your investment when you sell. Since you did not defer your original gain or elect OZ treatment for state purposes, it's highly unlikely a conforming state will grant you OZ treatment when you establish residency.
This might be a very complicated situation that should be consulted about with your tax advisors. Different states have different rules, and it is not a one size fits all.
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