The gain is deferred until the replacement property is sold. Often, taxpayers who engage in 1031 exchanges continue to defer gain under the rules again and again — for example, by purchasing a second replacement real estate property with the proceeds from the first replacement property.
Balancing the Issues for Clients
While 1031 rollovers have significant tax benefits, they can also be difficult to execute. Often, taxpayers don’t have replacement real estate investments identified when it becomes advantageous to sell an original real estate investment.
Under the 1031 rules, replacement real property must be identified within 45 days after the original property is sold, and that replacement property must be purchased within 180 days of the original sale. Strict tracing rules apply, so that the proceeds of the first sale must be used to execute the second sale.
Opportunity zone investments must also be made within 180 days after the sale of the original property, but there are no tracing rules. Taxpayers can use any funds to purchase the OZ investment (and the investor only must invest as much as the amount of gain they wish to defer).
Further, with opportunity zone investments, the cost basis and capital gains on the investment are separated. Investors can choose to only invest the capital gains — retaining their cost basis for different investment opportunities. In a 1031 exchange, the taxpayer must roll all of the proceeds from the original real estate sale into the replacement investment.
Under 1031, additionally, taxpayers can only continue to defer gain as long as they remain in the real estate investment business. It’s possible to avoid recognizing any gain at all if an opportunity zone investment is held for a 10-year period.
Note also that in the context of 1031 exchanges, sale proceeds are held by a qualified intermediary during the time between sale of the original property and purchase of the replacement property.
In the opportunity zone context, investors can maintain control of their funds (and use them for other purposes) during the 180-day window.
Opportunity zones present a relatively new opportunity — currently, only for a limited amount of time. However, it is entirely possible that Congress will act to extend and expand the benefits of the opportunity zone program, so interested clients should pay close attention to developments in the law.
- Learn more with Tax Facts, the go-to resource that answers critical tax questions with the latest tax developments. Online subscribers get access to exclusive e-newsletters.
- Discover more resources on finance and taxes on the NU Resource Center.
- Follow Tax Facts on LinkedIn and join the conversation on financial planning and targeted tax topics.
- Get 10% off any Tax Facts product just for being a ThinkAdvisor reader! Complete the free trial form or call 859-692-2205 to learn more or get started today.