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Like-kind exchanges and opportunity zones are both ways investors can defer taxes. But, what are the differences between the two, and is there a better option?
Opportunity zones are one of the hottest topics in the real estate and investment communities right now. They're an attractive tax strategy because of the three separate tax benefits available: the deferral of tax, the reduction of tax, and the eventual exclusion of tax.
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The opportunity zone program offers a unique incentive to defer your capital gains while investing in an economically distressed community. But how do opportunity zones compare to a like-kind exchange?
A like-kind exchange has been the tax-deferral mechanism of choice for many investors for decades. Can the opportunity zone program even compete? Or is a 1031 exchange now obsolete? I'll let you be the judge. Below are the general rules and requirements for each tax-deferral vehicle for you to compare side-by-side.
| 1031 Exchange Requirements | Opportunity Zone Requirements |
|---|---|
| All eligible gains must be reinvested within 180 days of recognition (with a 45-day identification window) | All eligible gains must be reinvested in a QOF within 180 days of recognition |
| Capital gain is deferred initially (there is potential for indefinite deferral, as the law exists today) | Capital gain is deferred initially (no indefinite deferral available) |
| Only real property is eligible | Any capital gain, generated from an unrelated party, from any type of asset is eligible |
| Deferred gain is recognized when new property is sold in a taxable transaction | Deferred gain is recognized at the earlier of (a) the sale of interest in the QOF, or (b) December 31, 2026 |
| Basis in the new property is equal to the basis in the original property, plus any additional amounts invested | Initial basis in a QOF investment is zero |
| Location of new property can be anywhere in the United States | Location of new property must be within an Opportunity Zone |
| Property included in the exchange must be of like-kind (ie, rental property for rental property) | No like-kind requirement between old property and new property (ie, stock for rental property) |
| Funds from the sale of property must be held with a Qualified Intermediary | Funds from sale of property do not have to be held with an intermediary. There are also no tracing requirements – reinvested funds do not have to be the same as funds received |
| There is no opportunity for a step-up in basis or reduction of gain as a result of extended holding periods (other than in the case of death) | Potential step-up in basis based on holding periods: - After 5 years: 10% - After 7 years: 5% (for total of 15%) Permanent gain exclusion on appreciation: |
| No specific investment structure is required | A QOF is the required investment vehicle for an OZ investment. There is some flexibility within this requirement though. |
| Related party transactions are allowed | Related party transactions are subject to strict requirements |
Interested in exploring either of these tax-deferral vehicles? Contact us today. We'd love to get the conversation started!
