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Qualified Opportunity Zones vs. 1031

by Larry Kemm and Cristin Keane

For years, Code § 1031 has been a popular way to defer taxation on the sale of capital gain assets. However, Code § 1031 has significant requirements, including complex timing and identification requirements and a requirement that the capital gain asset be exchanged with “like kind” property that, as of the enactment of the so-called Tax Cuts and Jobs Act in 2017, must be real property. With the enactment of Code §§ 1400Z-1 and 1400Z-2 in the Tax Cuts and Jobs Act, the ability to defer current capital gains (and potentially avoid taxation on future appreciation) by investing in real property in a Qualified Opportunity Zone has expanded options for taxpayers with capital gains. The following chart compares the requirements, pros, and cons of Code § 1031 Like Kind Exchanges and Code § 1400Z-1 Qualified Opportunity Zones.

 

§ 1031 Like Kind Exchanges § 1400Z-1 Qualified Opportunity Zones
Relinquished Property – Character and Use
  • Must be real property
  • No personal property, even property used in or on real property as part of business
  • Any property that generates capital gain
  • Can be real or personal, tangible or intangible property
Replacement Property – Character and Use
  • Must be real property
  • No personal property, even property used in or on real property as part of business
  • Tangible property used in a trade or business located in a Qualified Opportunity Zone
  • Can be real or personal property
Does replacement property have to be “like-kind” to relinquished property?
  • Yes
  • All real property is like-kind to other real property
  • No
Identification requirements for  replacement property?
  • Replacement property must be identified in 45 days, with limit on number of properties
  • No separate “identification” requirement, but must be in a Qualified Opportunity Zone
Acquisition of replacement property
  • Within 180 days
  • Must invest in Qualified Opportunity Fund within 180 days
  • Qualified Opportunity Fund must meet 90% Asset Test
Proceeds that must be rolled over into qualifying investment
  • Entire proceeds from sale
  • Only the gain from the sale
Taxpayer vs. Property Analysis
  • Taxpayer selling property must also acquire replacement property, creating issues when partners don’t all want to engage in like-kind exchange
  • Either partnership or its partners may  elect deferral. Similar rules apply to other pass-through entities, such as S corporations and their shareholders, and estates and trusts and their beneficiaries

 
Partnership or LLC interests
  • Not allowed
  • Allowed, as long as meet the requirements of Qualified Opportunity Zone Partnership Interest
Stock in corporations
  • Not allowed
  • Allowed, as long as meet the requirements of Qualified Opportunity Zone Stock
Additional Capital Requirements
  • No
  • Qualified Opportunity Fund must either create a new business located in the Qualified Opportunity Zone or substantially improve an existing business located in the Qualified Opportunity Zone.
Timing of inclusion of deferred gain
  • Upon sale of replacement property (unless further deferred in another like-kind exchange)
  • Earlier of: sale or exchange of Opportunity Zone Fund investment or 12/31/26
Reduction in deferred gain inclusion through basis step-up
  • None
  • 10% basis step-up if hold investment 5 years before December 31, 2026, 15% basis step-up if hold investment 7 years before 12/31/26
Timing of inclusion of gain over and above deferred gain
  • Upon sale of replacement property (unless further deferred in another like-kind exchange)
  • Upon sale of opportunity zone fund unless held for more than 10 years, in which case there would be no gain
Related parties
  • Not prohibited, but 2 year holding period after exchange required
  • Sale to related party cannot be deferred

 

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