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What factors should be taken into consideration when selecting between 1031 Exchanges and the Opportunity Zone tax incentive?

What are the advantages of investing in an Opportunity Fund over investing in a new property using the 1031 Exchange program, and vice versa? How do investors make better decisions when weighing their options?

  • Matthew Rappaport
    July 15, 2019

    This decision requires considering a variety of factors, including the property's income tax basis, the taxpayer's future plans, the taxpayer's inclination to control his/her own investment, the amount of debt on the property being sold, whether the property will be developed, and quite a few more.

  • Scott McIntosh
    July 10, 2019

    Based on your question, I assume you're selling an asset eligible for a 1031, but it's worth noting for others who may be interested in the question that one of the key distinctions between 1031s and an OZ investment is the wide breadth of capital gains -- short and long term from virtually any source -- eligible for OZ deferral, compared to the much more limited world of eligible 1031 assets. Assuming a capital gain is eligible for both, I advise clients to consider the following primary factors in deciding between a 1031 and OZ investment: type/location of desired reinvestment. Though fewer asset sales qualify for a 1031, there are generally more options for a 1031 purchase than an OZ investment. Second is timing. I've seen too many investors get stuck in a bad deal because of 1031 money "burning a hole" in their pockets. The more generous timeline for reinvestment of gains in a QOF, along with the lack of a tracking/intermediary requirement, is a huge benefit. Third is liquidity needs, the ability to take a return on capital from an asset sale and reinvest just the capital gains in a QOF allows investors more flexibility to re-invest only partial-proceeds of a sale as compared to the treatment of "boot" in a 1031 exchange. Fourth is an individual's age/health. A 1031 may be a better choice for an individual closer to a step-up in basis at death. Fifth is anticipated appreciation. The tax-free sale after 10-plus years is the most important benefit for most of my OZ clients because they're primarily buying/developing property in distressed areas poised for a turnaround. Someone whose priority is asset stability and annual cashflow might not expect to see that same appreciation and so the value of that tax-free sale would be diminished.

  • Paul Wassgren
    July 10, 2019

    This comparison has been frequently discussed and requires a longer response, but in brief, Section 1031 is now only available for real property like-kind exchanges. Gains generated from the sale of stock, businesses, collector cars, etc. will not qualify under 1031. Under 1031, the funds must be held by an exchange accommodator. The tax deferral under 1031 is indefinite. For the QOZ program, any capital gain can be deferred until Dec. 31, 2026, but must then be paid (subject to a potential step-up in basis of up to 15%). The qualifying investment into a QOF can be used for broader purposes than real estate investing. Accordingly, the QOZ program could be used to fund a start-up venture having nothing to do with real estate.

  • Maria De Los Angeles Rivera
    July 11, 2019

    One of the major differences is that in the case of OZ, only an amount equal to the gain realized or part of it must be invested. Other is the time required to realized 100% exclusion and that for OZ is a temporary deferral of the gain. Taxpayers’ preferences and priorities are important to consider.