Of course, we are big believers in the tax benefits of a 1031 exchange when selling real property with a gain. Having thus said, if a property owner opts to forgo a 1031 exchange or misses a deadline resulting in a failed exchange, there is another alternative: investing the sales proceeds into a Qualified Opportunity Fund (“QOF”). This tax-saving vehicle is not just a 1031 alternative, but available to anyone selling an asset which will result in a capital gain; for example, the sale of a business, stock or bond. A taxpayer with capital gains can defer capital gains tax if they sell their appreciated assets and, within six months, roll over the profits into a QOF.
Reduce tax liability by 15%: When you sell an appreciated asset and invest the proceeds in a QOF, the capital gains tax is deferred until December 2026, at which time you will owe only 85% of the tax you would have paid if you hadn’t invested in a QOF; the 15% is forgiven (stepped up cost basis).
Pay no tax on new capital gains: Now that you have invested in a QOF and deferred the payment of the capital gains tax, what about the real estate purchased in the fund? The money invested will go into real estate development projects to be held for a minimum of 10 years. And if held for 10 years, any capital gain upon sale is tax free (100% stepped up cost basis).
The Tax Cuts and Jobs Act passed in 2017, allowed states to designate Qualified Opportunity Zones; areas needing economic development. A taxpayer may defer taxes by investing unrealized capital gains in a Qualified Opportunity Fund, which in turn invests in real estate located in Qualified Opportunity Zones. To be eligible, within 180 days of a sale you would need to roll-over the gain (just the gain, not your cost basis) into a QOF and the QOF must use that cash to purchase Qualified Opportunity Zone Property. There is no dollar limit on the amount of gain that can be deferred or excluded under this program.
To obtain more information on the tax benefits of investment capital gains into a Qualified Opportunity Fund click here (coming soon).