Many real estate investors are familiar with the parameters and tax advantages of a Section 1031 tax-deferred exchange to defer the payment of capital gains taxes when exchanging certain qualifying property for other qualifying property. However, there is a newer investment concept that may prove to be just as advantageous to some investors—Opportunity Zones.
The concept of Opportunity Zones (OZs) stemmed from a truly philanthropic idea designed to benefit distressed communities while being lucrative to investors. It also provides enticing tax breaks and returns for their investment. From a real estate professional’s perspective, OZs offer benefits not only for investors but for realtors, attorneys, communities, and many other associated real estate professions as well. Jason Gordon wrote an informative overview of some of the pros and cons of The Investment in Opportunity Act, which was the legislation that created OZs. However, qualified OZs, and whether they pose a real threat to the 1031 qualified intermediary business, remains at the forefront of the minds of many qualified intermediaries.
To understand whether they genuinely pose a threat or if they can co-exist, one must define what exactly is a Qualified Opportunity Zone. Formed under the tax reform package, the Tax Cuts and Jobs Act of 2017, OZs offer capital gains tax deferral and relief for new investments in specific economically distressed areas nationwide. An investor may earn a profit from the sale of an asset and invest that profit within 180 days in an opportunity fund. (The investor must invest at least 90% of their assets in OZs. This is defined as a real estate investment in an opportunity zone or a partnership or stock ownership interest in a business that conducts all or most of its operations in a designated zone.) As such, the investor can obtain substantial tax incentives, including the following: having the tax liability on that gain deferred or reduced, reducing tax liability by 10% if invested for 5 years, reducing tax liability by 15% if invested for 7 years, and no capital gains liability on any appreciation of the opportunity fund when shares are sold if they are held for 10 years.
But, as with everything, there are requirements, restrictions, and parameters that must be met with an OZ and with a 1031 exchange in order to take advantage of their benefits. Below is a comparison of some of the benefits and requirements and restrictions of both.
Benefit Comparison:
Opportunity Zone:
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1031 Exchange:
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Requirement Comparison: |
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Opportunity Zone:
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1031 Exchange:
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Given these differences, it seems likely that these two tax-saving mechanisms can co-exist and that the introduction of Opportunity Zones will not cause the demise of the 1031 tax-deferred exchange or even cause much of an impact on the traditional 1031 industry. Speak with an attorney or CPA to determine if either of these tax-saving programs will work for you.