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1031 Exchange vs. OZ Investing

1031 Exchange vs. OZ Investing

Private Credit
August 29, 2023

Investors consistently aim to optimize gains while minimizing tax impacts.

Typically, real estate investors utilized the 1031exchange to defer capital gains tax by reinvesting in other properties. However, a newer option has emerged: Qualified Opportunity Zones (QOZs).

Qualified Opportunity Zones (QOZs) were established in 2017under the Tax Cuts & Jobs Act, targeting economically distressed regions to incentivize private investments for economic growth. Investors in QOZs gain tax advantages, including deferred capital gains tax and potential elimination of tax on investment appreciation.

QOZs and 1031 exchanges offer differing tax benefits that significantly impact investment choices. In terms of tax deferral, 1031exchanges involve reinvesting in "like-kind" properties within a specific timeframe, while QOZs defer taxes until 2026 by investing gains in a QOZ fund. QOZs offer more investment flexibility as they lack strict like-kind requirements, enabling diversification.

Another difference lies in reinvestment amounts. 1031exchanges mandate reinvesting the entire sale proceeds, whereas QOZs require only the capital gain to be reinvested, allowing more funds for other purposes. Moreover, in QOZs, investors can reset the depreciable tax basis, offering potential tax benefits from depreciation expenses.

The main allure of QOZs is potential tax elimination on gains from the QOZ investment itself. If held for a decade, investors may owe no capital gains tax upon sale, making QOZs attractive for substantial returns.

Both QOZs and 1031 exchanges provide tax-advantaged strategies. While 1031 exchanges were popular, QOZs offer an innovative and flexible approach to potentially defer or eliminate capital gains taxes. Sound financial assessment and consultation with tax experts are essential before investing in either. By leveraging these opportunities, investors can take significant steps toward building substantial wealth.

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