Whether it’s due to more 1031 transactions failing lately or an increased awareness of the advantages of Opportunity Zones, Four Points Funding has seen a significant increase of 1031 investors asking about OZs as an alternative to 1031s. 1031 exchanges offer Real Estate Investors the chance to defer capital gains tax by rolling their investments forward into a “like kind” exchange. One deal rolls into another deal, which rolls into a larger deal and so on. Until Opportunity Zones, there were few tax advantaged ways out of 1031s, other than dying.
The transition from 1031 to OZ is extremely simple, though, and maintains significant tax advantages. Investors sell their investment property and realize their gains instead of rolling the investment forward into a 1031. They then have 180 days to invest some or all of their capital gains into a qualified Opportunity Fund (QOF). In doing so, they defer taxes on those gains until 2026, they reduce the 2026 tax bill by 10% if invested before the end of 2021 and, most importantly, can eliminate taxes on gains made within the OZ if held in a qualified manner for 10+ years.
This straightforward path of escaping the 1031 hamster wheel is drawing investors for a number of reasons:
Perhaps the most important benefit of this transition from 1031 to OZ, is that investors only roll forward capital gains. In a 1031 exchange investors are required to leave in their original principal and their gains, and even roll forward their debt. With an OZ Fund, investors keep their original basis to do with as they please, and receive a tax deferral on the portion of the gains they invest in an OZ fund, resulting in instant liquidity. In uncertain times, liquidity is king for investors.
1031 exchanges provide investors with a 45 day window to identify replacement property and investors must complete the “like kind” exchange within 180 days. If something happens with one of the properties identified and the investor is past the 45 day deadline, the options are to go forward with the deal (even if the investor doesn't like it) or risk ruining 1031 benefits.
By contrast, Opportunity Zone investors are given 180 days to identify an Opportunity Zone Fund investment that suits them. Gains realized from a partnership and 1231 gains have special timing that can allow investor clocks to start on January 1, granting even more time.
In April of 2020 the government announced a one time deadline extension for currently pending 1031 exchanges. If an investor has taken the first step of a like-kind exchange by selling the old property, and either the 45-day or the 180-day deadline falls between April 1 and July 15, the deadline has been extended to July 15, 2020.
If an investor’s 45 day clock expired and they were unable or unwilling to roll their 1031 dollars forward, they can still take advantage of Opportunity Zone benefits as long as they are within 180 days of realizing their gains.
During 1031 transactions, funds are required to be held by an intermediary. During this time, investor capital is not available for any other use. Opportunity Zones, on the other hand, have no qualified intermediary and investors are free to utilize their capital gains during their 180 day investor window.
1031 investments must roll forward into like-kind properties, and often this means rolling investments from one property to another larger property. In times of uncertainty, single asset investment constitutes a higher degree of risk than a multi-asset fund. 1031 investors are increasingly opting into diverse funds to avoid rolling forward into potentially riskier 1031 investments.
1031 exchanges remain a powerful tool for real estate investors, and certainly not all 1031 investors will convert to Opportunity Zones. In a market fraught with volatility, however, many are looking at Opportunity Zone Fund investments as an alternative to 1031 exchanges.
Here at Four Points Funding, we are seeing a number of 1031 deals falling through. Investors are wary of rushing into new 1031 purchases in volatile markets. Lenders being inundated by PPP applications has created complications in securing debt, especially for commercial and hospitality projects which are now perceived as higher risk. As a result, many people have been forced to realize gains over the last few months, whether they wanted to or not. For investors reconsidering their allocation strategy, and potentially dealing with falling apart 1031 exchanges, Opportunity Zones are an outstanding option.
Contact Four Points Funding to learn more about how Opportunity Zone tax deferral, reduction and forgiveness compare to 1031s.