September 17, 2021

What’s the Difference Between 1031s and QOZs?

HUDSONPOINT Team
Written by: HUDSONPOINT Team
1031 Tax Exchange, QOZ, Savings

What’s the Difference Between 1031s and QOZs?

Before 2017, real estate investors had limited options to defer paying taxes, and a majority used 1031 like-kind exchanges to swap real estate assets without triggering taxable gains. Then Congress passed the Tax Cuts and Jobs Act in December 2017, presenting the real estate market with a new tax-saving opportunity: the creation of Qualified Opportunity Zones (QOZs).

Congress established Opportunity Zones to encourage long-term investments, especially in low-income urban and rural areas. The intention was to boost economic development and job creation in these distressed areas.

difference between 1031s and QOZs

In many ways, the tax advantages of both Qualified Opportunity Zones and 1031 exchanges are similar. However, investors need to understand the key differences to minimize taxes best.

 

A Quick Overview of Opportunity Funds and the 1031 Exchange

1031 Exchanges (or like-kind exchanges) enable investors to defer paying capital gains tax on a property sale by reinvesting proceeds into a replacement property. This process is sometimes called “swapping.” A 1031 Exchange allows an investor to preserve the gross equity earned from a real estate investment, which increases their buying power.

Qualified Opportunity Zones (“QOZs”) are economic investment vehicles that provide tax incentives to real estate investors who roll over their capital gains to invest in the growth and revitalization of underserved communities. Investors use qualified Opportunity Funds (“QOFs”) to facilitate investments in opportunity zones that help improve these regions while also providing investors with specific tax advantages.

 

How are Opportunity Zones and 1031 Exchanges Similar?

  • Both are instruments instituted into the United States tax code to spur economic growth.
  • Both provide opportunities for investors to defer and/or avoid taxes for capital gains and impose a 180-day limitation on the time taxpayers have to complete the investment.
  • Both allow investors to extend deferral across multiple sales, given that they keep rolling the net proceeds into other qualified investments. (Although, under current law, QOF tax benefits go away after 2026).

 

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How are Opportunity Zones and 1031 Exchanges Different?

While certain similarities may help real estate investors feel as if they can really “go either way” when it comes to choosing which investment vehicle is most tax-efficient, there are some big differences between the two as well that should be considered.

difference between 1031s and QOZs

 

The Bottom Line

1031 exchange was once the only tax-deferring instrument available. With the arrival of QOZs under the Tax Cuts and Jobs Act of 2017, investors now have a new option. And while both vehicles are comparable in that 1031 exchanges and investments in Qualified Opportunity Zones provide tax incentives for real estate investors, essential differences separate the two investment vehicles.

 

Common 1031 exchanges may be more suitable for real estate investors who understand what they want to buy, want to control and manage their own property, or want to invest in a simple triple net lease site. Conversely, opportunity zones may work for someone who thinks development provides a greater potential return on investment or wants to defer gain realized on a non-real estate investment. Additionally, QOFs could help investors interested in investing in a portfolio of properties rather than one or two.

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IRC Section 1031 is complex tax language, therefore you should consult your tax or professional for details regarding your situation.  There are material risks associated with investing in real estate securities including illiquidity, vacancies, general market conditions and competition, lack of operating history, interest rate risks, general risks of owning/operating commercial and multifamily properties, financing risks, potential adverse tax consequences, general economic risks, development risks and long hold periods. There is a risk of loss of the entire investment principal. 

It is not intended and should not be construed or relied upon as legal or tax advice. No tax benefits are guaranteed as a result of investing in a Qualified Opportunity Fund. Potential investors should consult their tax advisers with respect to the U.S. federal income tax consequences of an investment in a Qualified Opportunity Fund.

This is for informational and educational purposes only and should not be construed as investment advice or an offer or solicitation of any products or services. Opinions are subject to change with market conditions. The views and strategies may not be suitable for all investors and are not intended to be relied on for legal or tax advice.

Securities offered through National Securities Corporation Member FINRA/SIPC

 

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