A New Option to the 1031
For those looking into a 1031 exchange, a Qualified Opportunity Fund is a new option to consider
There’s now something brand-new to consider. You should know that you can sell that investment property and invest the capital gains in a Qualified Opportunity Fund. The Tax Cuts and Jobs Act that passed on Dec. 22, 2017 created Opportunity Zones.
You invest in these Opportunity Zones through a Qualified Opportunity Fund. We mention all of this because some real estate investors may wind up switching from using 1031 exchanges and investing in these Qualified Opportunity Funds.
Avoid paying taxes altogether
There are some huge benefits with a Qualified Opportunity Fund that differ greatly from 1031 exchanges for real estate investors. For one, with a 1031 exchange you defer the payment of real estate taxes, but in Qualified Opportunity Funds you get to avoid paying taxes altogether.
The tax rules that will govern these Qualified Opportunity Funds are still being finalized as we end 2018, and Opportunity Zones (the Treasury has certified 8,700 Opportunity Zones, which is 12 percent of U.S. Census tracts) and investing in Qualified Opportunity Funds won’t be for everyone. But, let’s say you’re planning on selling an investment property that went up in value extensively over the year.
If you sell that property, you have to transfer all of the funds from the sold property to the new property.
The Opportunity Zone rules only require you to invest the capital gains from the sale of the old property. So, if your sale nets you $500,000 and half of that came from capital gains, you’d end up with $250,000 in your pocket and $250,000 to invest in an Opportunity Zone.
Only Capital Gain Is Taxed
Next, once you invest in an Opportunity Zone, the tax rules appear to give you the ability to avoid paying tax on any new capital gains you make from the new investment in the Opportunity Zones. In some cases, if you continue your investment, you don’t pay taxes on gains for 10 years or more. Furthermore, if you don’t happen to be a real estate investor and you have capital gains from other investments, you are not restricted to capital gains from the sale of real estate; those capital gains can come into play from the sale of other assets that give you a capital gain.
In addition, if you have real estate, you might end up avoiding a tax bill on the recapture of any depreciation you took while owning the new Opportunity Zone property. So, in real estate terms, you can keep some of your non capital gains cash from the sale of your old property, you can invest your capital gains from that sale, you can delay paying tax on those capital gains, you can avoid paying taxes on future gains that you might make on your investments in the Opportunity Zones, and you might avoid paying tax on any depreciation you take on the Opportunity Zone property investment.
It almost sounds too good to be true. And, all these benefits may still get throttled back. The rules and regulations that came out recently were around 70 pages long. All in all, if you have money and have capital gains, the tax law gives you the ability to put that money to use in certain designated areas and you can make money with the money that’s invested there and not pay taxes for 10 or more years.
And just in case this wasn’t a sweet enough deal, the IRS rules allow you to increase your cost basis by up to 15 percent. That means that on your old investment, you can exclude taxes up to 15 percent on the old investment.
We’ll continue to watch the development of Opportunity Zones and Opportunity Funds, and let you know what happens.
What Are Opportunity Zones?
- Created by the Tax Cuts & Jobs Act of December 2017
- Big changes to 1031 exchange
- US Treasury has certified 12% of US Census Tracts
- Only Capital Gains from old property has to be invested
- Detailed rules are still in process in December 2018