OZ Pitch Day - March 7, 2024
Updated January 22, 2024
Sophisticated real estate investors are familiar with Section 1031 exchanges, and related Delaware statutory trusts (DSTs). Opportunity Zones appear similar at first glance. But there are some substantial differences, summarized below.
In a Section 1031 exchange, an investor must reinvest the entire proceeds from the transaction (principal, plus gain) within 180 days in order to achieve the full tax benefit. Any amount from the proceeds that is not reinvested is taxable “boot.” A Section 1031 transaction must be conducted through a 1031 exchange accommodator, also known as a qualified intermediary.
With an Opportunity Zone investment, an investor is only responsible for rolling over the gain amount within 180 days. The investor is not required to deploy the entire gain, but only the rolled over portion is eligible for tax advantages. Moreover, the principal can be used for anything. It does not need to be rolled over. And, placing an investment in a Qualified Opportunity Fund is much more straightforward, with no intermediary required.
Only real estate gains are eligible for 1031 like-kind exchanges. Conversely, gains from any type of asset sale (real estate, stocks, bonds, etc.) can qualify for investment in a Qualified Opportunity Fund. Section 1231 gain is also eligible for investment in Qualified Opportunity Funds.
A Section 1031 exchange is structured to allow for single asset swaps, usually one real estate property for another real estate property. Multiple properties can be supported, but this option usually comes with higher costs and less flexibility.
On the other hand, Qualified Opportunity Funds can be either single-asset funds that invest in a single property or business, or multi-asset funds that invest in multiple properties across asset classes and geographies.
Capital Gains Tax Deferral
Capital gains tax payments on a 1031 exchange can be deferred indefinitely. With Qualified Opportunity Funds, capital gains of the initial investment may be deferred until December 31, 2026.
Basis Step-Up And Capital Gains Tax Elimination
With 1031 exchanges, capital gains are eliminated via a step-up in basis to fair market value for the property owner’s heirs at death. With Qualified Opportunity Funds, the investor doesn’t have to die first. The basis step-up to fair market value (resulting in zero capital gains tax liability) occurs after the Qualified Opportunity Fund investment has been held for at least 10 years.
Location, Location, Location
With a 1031 exchange, the investor’s real estate can be located anywhere in the country.
Conversely, Qualified Opportunity Fund investments are limited (mostly) to Qualified Opportunity Zone Property located in Opportunity Zones.
A Comparison Table: QOFs vs. 1031s & DSTs
The table below compares how Qualified Opportunity Fund investment differs from 1031 Exchanges and DSTs.
|Qualified Opportunity Fund
|1031 Exchange / DSTs
|Full Tax Benefit Timeline
|10-year holding period
|Triple Net Leasing
|Capital Gain Eligibility
|Any type of gain. Can be invested into a QOF that holds real estate and/or operating business(es).
|Like-kind exchange. Must be a gain from real estate. Can only be invested into another real estate investment property.
|Tax benefit applies only to the gain. Can reinvest full or partial gain.
|Entire sales proceeds (principal and gain) must be rolled over for the full benefit.
|Investment Strategy / Risk
Ground-up construction, redevelopment, or early-stage business.
|Varies (Traditional 1031).Stable Cash Flow (DST).
|Timeline For Investment
|45-Day Rule & 180-Day Rule
|None. Funds and investors self-certify.
|Requires the employment of a Qualified Intermediary.
|Limited to 8,764 census tracts, most of which are “low-income”
|No geographic restriction
Table Of Contents: Opportunity Zones Explained
- Chapter 1: Opportunity Zones Explained — The basics of the OZ program.
- Chapter 2: Opportunity Zone Tax Benefits — How the OZ tax break works.
- Chapter 3: A Brief History Of Opportunity Zones — Policy background on the OZ legislation.
- Chapter 4: Where Opportunity Zones Are Located — Includes the map of Opportunity Zones.
- Chapter 5: Two Ways To Invest In OZs — Active vs. passive options for investing.
- Chapter 6: How To Invest In Opportunity Zone Funds — QOF investments for passive LP investors.
- Chapter 7: How To Start Your Own OZ Fund — How to create a self-managed OZ fund.
- Chapter 8: Opportunity Zones vs. 1031 Exchanges — Two popular tax deferral programs.
- Appendix: The Best Opportunity Zone Resources To Learn More — Recommended links.