How Missoula investors can use Opportunity Zones and 1031 Exchanges to Their Advantage
Which one works best for your particular situation?
Much ink has been spilled in the last year regarding the possibilities that Opportunity Zone investments bring to investors across the country. Missoula, Kalispell, Bozeman and other cities throughout Montana have designated Opportunity Zones that open up possibilities to investors that were not available 18 months ago.
The IRC Section 1031 exchange has been an important driver of commercial real estate investment for almost 70 years. It originated in the 1950s as a way to incentivize the sale of farm land into more productive uses and has remained a centerpiece of many investors’ strategies to minimize their tax exposure ever since.
However, there is some confusion out there as to what an opportunity zone can mean for an investor and how that stacks up against a 1031 exchange. Both provide favorable tax treatment and deferral of capital gains. In practice, the two are very different in terms of mechanics, benefits and restrictions on each. To find out which one might work best for your situation, read on.
A 1031 exchange (1031x) of like kind property (real estate for real estate) permits deferral of capital gains and recapture tax. One of the more attractive features of a 1031x is that such gains can be deferred indefinitely if desired by the investor. However, there are strict requirements on how the disposition proceeds are used, how they are tracked and when they are re-invested. It also provides some challenges for members of a partnership who do not necessarily want to stick together on an exchange. More on 1031 exchanges can be found here.
QUALIFIED OPPORTUNITY FUNDS (QOF)
Section 1400Z-2 of the 2017 Tax Cut and Jobs Act allows for the creation of Qualified Opportunity Fund investments. Such QOF investments provide another useful, albeit different, avenue for deferring capital gains from a wide variety of assets, not just from real estate. Appreciated stock and business interests are also open to deferral through QOF investments which provides a chance for some investors to re-balance their portfolio without creating major tax events in the short term. If done properly, a QOF investment also provides a means to reduce the taxable gain by up to 15% going into the deal and 100% of the gain going out of the deal if the property is held for 10 years or more.
Although QOFs provide flexibility not available in a 1031 exchange in some instances, there are other tradeoffs associated with them that may or may not fit your specific needs. For instance, a QOF requires additional investment (“substantial improvement) into a given property that is not required in a 1031 exchange. Additionally, QOFs are limited geographically to designated census tracts and locks an investor into a given property for 10 years if they want to realize the full benefit of an opportunity zone investment.
More on QOFs can be found here.
The chart below (Source: CCIM Institute) provides a breakdown of the pluses and minuses of deferral options.
Sterling CRE does not provide tax, legal or accounting advice. We strongly encourage you to consult your attorney, CPA or tax counsel for advice specific to your situation. In conjunction with those advisors, we help you find and close on properties suitable for 1031 exchanges or QOFs in Missoula, Flathead and throughout western Montana. You’re invited to contact commercial real estate advisors Matt Mellott or Claire Matten today to discuss your investment goals and to discover which deferral strategy works best for you.