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.
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§ 1031 Like Kind Exchanges |
§ 1400Z-1 Qualified Opportunity Zones |
Relinquished Property – Character and Use |
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Must be real property
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No personal property, even property used in or on real property as part of business
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Any property that generates capital gain
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Can be real or personal, tangible or intangible property
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Replacement Property – Character and Use |
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Must be real property
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No personal property, even property used in or on real property as part of business
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Tangible property used in a trade or business located in a Qualified Opportunity Zone
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Can be real or personal property
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Does replacement property have to be “like-kind” to relinquished property? |
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Yes
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All real property is like-kind to other real property
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Identification requirements for replacement property? |
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Replacement property must be identified in 45 days, with limit on number of properties
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No separate “identification” requirement, but must be in a Qualified Opportunity Zone
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Acquisition of replacement property |
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Must invest in Qualified Opportunity Fund within 180 days
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Qualified Opportunity Fund must meet 90% Asset Test
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Proceeds that must be rolled over into qualifying investment |
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Entire proceeds from sale
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Only the gain from the sale
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Taxpayer vs. Property Analysis |
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Taxpayer selling property must also acquire replacement property, creating issues when partners don’t all want to engage in like-kind exchange
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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
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Partnership or LLC interests |
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Allowed, as long as meet the requirements of Qualified Opportunity Zone Partnership Interest
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Stock in corporations |
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Allowed, as long as meet the requirements of Qualified Opportunity Zone Stock
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Additional Capital Requirements |
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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.
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Timing of inclusion of deferred gain |
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Upon sale of replacement property (unless further deferred in another like-kind exchange)
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Earlier of: sale or exchange of Opportunity Zone Fund investment or 12/31/26
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Reduction in deferred gain inclusion through basis step-up |
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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
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Timing of inclusion of gain over and above deferred gain |
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Upon sale of replacement property (unless further deferred in another like-kind exchange)
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Upon sale of opportunity zone fund unless held for more than 10 years, in which case there would be no gain
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Related parties |
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Not prohibited, but 2 year holding period after exchange required
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Sale to related party cannot be deferred
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