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<\/a><\/h2>\n1031 Exchange – Indefinite Deferral<\/h3>\n
As you probably know, if you sell a piece of real estate, you can take the initial investment money plus the profit and reinvest in another property of equal or greater value.\u00a0 Doing so allows you to defer paying capital gains taxes.\u00a0 You can keep doing this over and over and eventually \u00abdie your way out of the tax.\u00bb<\/p>\n
This set up lends to investors rolling their money into increasingly expensive pieces of property, thereby growing their assets.<\/p>\n
That is very nice, but the investor will eventually have to die or \u00abpay the piper.\u00bb\u00a0 What if there were an alternative?<\/em><\/strong><\/p><\/blockquote>\n
QF – Deferral plus Forgiveness<\/h3>\n
Like 1031 Exchanges, QFs also provide tax deferral on capital gains.\u00a0 One important difference, however, is that the investor will not continue rolling the money over into new projects indefinitely in order to escape paying the capital gains tax.<\/p>\n
Under the OZ 2.0 program, the tax due on the money invested in the QF (Gain #1<\/a>) will have to be paid in five years.\u00a0 So, the ride does come to an end with respect to Gain #1 . . . though you’ll likely get a discount on the tax liability.<\/p>\n
However, as for the capital gains made through investment in the QF (Gain #2<\/a>), that will be tax free<\/em><\/strong> as long as you keep the money in the QF for at least 10 years.\u00a0 So, for Gain #2, there is a way to take your money out without triggering any tax liability at all.<\/p>\n
In other words, you don’t have to die your way out of the tax.\u00a0 So, that’s something …\u00a0\u00a0<\/em><\/strong><\/p><\/blockquote>\n
Liquidity<\/h2>\n
Here is another potential advantage to the OZ program.<\/p>\n
1031 Exchange – All or nothing<\/h3>\n
When you roll your money into a 1031 Exchange<\/a>, you have to invest all<\/em> the money you got back from the sale of the property–i.e.<\/em> both the initial investment and the capital gains.\u00a0 \u00a0That is why you buy increasingly expensive replacement properties.\u00a0 Otherwise, you have to pay taxes on any money not reinvested.<\/p>\n
QF – Free up original principal<\/h3>\n
With a QF, you are not required to roll over the original capital investment.\u00a0 If you choose, you can take that money out and just reinvest the capital gains.<\/p>\n
1031 Example<\/em><\/span>:\u00a0 Investor purchased a home for $300,000 and, two years later, sold it for $500,000.\u00a0 If Investor does a 1031 Exchange, with full tax deferral, he must purchase a replacement property worth $500,000 or more.<\/h5>\n
QF Example<\/span>:<\/em>\u00a0 Investor purchased a home for $300,000 and, two years later, sold it for $500,000.\u00a0 If Investor invests in a QF, he can hold onto the $300,000 without any tax reprecussions.\u00a0 He only needs to put the $200,000 capital gain into the QF.\u00a0 After 10 years, Investor’s $200,000 investment in the QF generates a gain of $400,000.\u00a0 At this point, Investor can take ALL his money out of the QF — i.e.<\/em> $600,000 — tax free.<\/h5>\n
That’s right.\u00a0 I said \u00abTax free<\/a>\u00bb . . . bearing in mind, of course, the deferred tax you will have previously paid.\u00a0\u00a0<\/strong><\/em><\/p><\/blockquote>\n
Deadlines<\/h2>\n
1031 Exchange – 45 days & 180 days<\/h3>\n
With a 1031 Exchange<\/a>, the rule is that the sale of Property A and the purchase of Property B must be parts of a single integrated transaction.\u00a0 That is why it is called an \u00abexchange.\u00bb<\/p>\n
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- You have 45 days from the date you sell Property A to identify a potential Property B.<\/li>\n
- The exchange must be completed no later than 180 days after the sale of Property A or within 180 of the due date to file your taxes (with extensions), whichever comes first.<\/li>\n<\/ul>\n
The second deadline is not too hard to meet, but the first one can cause some stress.<\/p>\n
QF – 180 days<\/h3>\n
The basic rule is the capital gains must be placed in a QF within 180 days of the sale of the asset.\u00a0\u00a0There are some exceptions, all of which provide additional time for the reinvestment.<\/p>\n
Note<\/em>:\u00a0 There are special rules on the timing for reinvestment of 1231 gains.<\/p>\n
So, if you miss the 45-day deadline for a 1031 Exchange, you may still be able to salvage the tax planning by putting the money in a QF instead.\u00a0 \u00a0<\/em><\/strong><\/p><\/blockquote>\n
Control of Funds<\/h2>\n
1031 Exchange – Qualified Intermediary<\/h3>\n
As explained in a previous article<\/a>, one of the major pitfalls with a 1031 Exchange is that the funds from sale of Property A can never be in the possession or control of the investor prior to purchase of Property B.\u00a0 That is why it is crucial to use a Qualified Intermediary (QI).<\/p>\n
Failing to use a QI can easily disqualify the entire transaction and lead to penalties.<\/em><\/strong><\/p><\/blockquote>\n
QF – Relaxed Rule<\/h3>\n
By contrast, investors in a QF are not subject to any \u00abcontrol\u00bb restrictions.\u00a0 As long as the capital gains from sale of Property A are placed in a QF within the relevant timeframe — which, at a minimum, is 180 days — the tax benefits are safe.\u00a0 Investors can even potentially use the money in the interim.\u00a0 They just have to have the money placed in in the QF before the deadline.<\/p>\n
Miscellaneous Differences<\/h2>\n
In some ways, the programs are simply different — not better or worse.\u00a0 For example, there is no \u00ablike-kind<\/a>\u00bb requirement when investing in a QF since the transaction is not really an \u00abexchange.\u00bb<\/p>\n
Similarly, when investing in a QF, the funds can be any kind of capital gains or 1231 gains.\u00a0 (Click here<\/a> for a list of qualifying funds)\u00a0 \u00a0 With a 1031 Exchange, of course, the only money that can be reinvested is the original principal and capital gains from Property A.\u00a0 So, the Opportunity Zone program is much broader in this sense.<\/p>\n
Lastly, a QF is likely to bring some measure of diversification to the investment.\u00a0 Most QFs are large enough to hold multiple projects of differing types.\u00a0 (Click here<\/a> for examples of qualifying projects).\u00a0 That aspect potentially reduces risk, as compared to a 1031 Exchange, where all the money from Property A must go into Property B.<\/p>\n
Conclusion<\/h2>\n
Objectively speaking, the Opportunity Zone program does seem to have many advantages over the traditional 1031 Exchange program.\u00a0 But, that is not to say investment in a QF is for everyone.<\/p>\n
For example, I have investor clients who enjoy the \u00abhands on\u00bb aspect of developing one project, selling, and reinvesting in another.\u00a0 1031 Exchanges are perfect for them because they remain in control of all their projects, and they enjoy the work.<\/p>\n
For most other investors, though, the Opportunity Zone program is an absolute jewel.<\/p>\n
\n
- What are the benefits<\/a> of the Opportunity Zone program?<\/li>\n
- Who<\/a>\u00a0can invest in a QF?<\/li>\n
- What kind of\u00a0money<\/a>\u00a0qualifies for a QF?<\/li>\n
- What kind of\u00a0projects<\/a>\u00a0are in an Opportunity Zone?<\/li>\n
- What is the risk analysis for a QF?<\/li>\n
- Where<\/a> do I find a QF to invest in?<\/li>\n<\/ul>\n