Investors continually seek ways to enhance their investment strategies and capitalize on available opportunities. In the realm of real estate investment, two prevalent methods that can potentially enhance investment prospects are 1031 exchanges and Opportunity Zone Funds.
While these investment tools do share commonalities, their distinct contrasts indicate that choosing a straightforward path between the two will not always be easy. As we look at a comparison of 1031 exchanges vs. Opportunity Zone Funds, we will aim to empower you to form your own conclusion and gain a clearer insight into which aligns better with your investment strategy.
1031 Exchange vs Opportunity Zone Fund: Which Is Best?
Both 1031 exchanges and Opportunity Zone Funds are tax-advantaged real estate investment tools that allow investors to defer capital gains taxes from the sale of an investment property. They also lend themselves to portfolio diversification and wealth accumulation, making them both great options for investors depending on their financial strategy.
However, when comparing 1031 exchanges vs. Opportunity Zone Funds, there are key distinctions to understand, as aside from these similarities, they are extremely different avenues to similar end goals.
What Is a 1031 Exchange?
When investors sell real estate under normal circumstances, they must pay income taxes on the profits from the sale to the IRS and potentially a state government. These taxes can be as much as 33% of the profits (the difference between the sale price and the original purchase price) of the sale , which can dampen profitability.
However, 1031 exchanges allow investors to defer these taxes by taking the proceeds from the sale of the relinquished property and investing them into a new property(s). This means the investor can hold on to their capital as it is reinvested into the new property(s). It’s worth noting that the new property must be considered a “like-kind” property—one used for investment purposes.
1031 exchanges are outlined in section 1031 of the Internal Revenue Code1. While they can be powerful tools with many benefits for real estate investors, they are heavily regulated, and those engaging in 1031 exchanges are beholden to strict rules and timelines.
Other important factors of 1031 exchanges include:
- 45-day window: After selling the original property, investors have 45 days to identify the replacement property(s).
- 180-day window: After selling the original property, investors have 180 days to complete the 1031 exchange process.
- Qualified intermediaries (QI): Investors are not allowed to hold on to funds from the relinquished property sale during the 1031 exchange process and must allocate those funds to a QI.
- Increased flexibility: 1031 exchanges don’t have to be a one-to-one swap. They also allow investors to swap one property for multiple and vice versa, which means they can expand or consolidate their real estate holdings.
What Is an Opportunity Zone Fund?
Opportunity Zones are economically challenged communities designated by a state to be eligible for private investments through a tax incentive program introduced in the Tax Cuts and Jobs Act of 2017. They are an alternate strategy to a 1031 exchange and the primary aim of this initiative is to foster economic development and job creation within these underserved areas through private investment.
When investors purchase properties in Opportunity Zones Funds, they can defer, reduce, or potentially eliminate capital gains taxes depending on how long the property is held for investment. At the onset of an Opportunity Zone Fund investment, there are 180 days from the sale of the original property or asset to invest the capital gains into a qualified opportunity fund (QOF).
- Five-Year Holding Period: The first level of Opportunity Zone Fund tax benefits allows investors to defer paying taxes on up to 10% of the original capital gains.
- Seven-Year Holding Period: After seven years of holding a QOF, investors can defer an additional 5% of the original capital gains, bringing the total deferral to 15%.
- Ten-Year Holding Period: After holding the Opportunity Zone Fund investment and QOF funds for at least 10 years, investors can exclude any capital gains realized from the appreciation of the funds within the QOF from their taxable income.
Both of these tax tools have their advantages and disadvantages. Although Opportunity Zone Funds can allow investors to defer or eliminate capital gains taxes while potentially improving economically distressed areas, they are restricted to particular locations that may not be profitable long-term, which carries a high level of risk.
On the other hand, 1031 exchanges allow for potentially indefinite deferral of capital gains taxes while allowing investors to swap, consolidate, or even expand their real estate holdings. However, they are complex beasts that require strict adherence to guidelines and narrow timelines.
Moreover, there is always a level of risk associated with any investment. That’s why investors should always seek counsel from a qualified financial advisor before commending a 1031 exchange or Opportunity Zone Fund.
Canyon View Capital Wants to be Your 1031 Exchange Partner
Understanding the advantages and disadvantages of 1031 exchanges vs. Opportunity Zone Funds is a significant first step toward your next investment goal. Canyon View Capital could be a powerful partner if you decide that a 1031 exchange aligns with your investment strategy.
At CVC, our leadership boasts over 40 years of experience in real estate investing and tax-advantaged portfolio investment. Leveraging this expertise, we assist investors keen on 1031 exchanges in reaping the tax benefits while delving into multifamily real estate. Our approach relieves them from the burden of property management by seamlessly exchanging into one of our properties in America’s Heartland as tenants in common.
Still need more information on 1031 exchanges vs Opportunity Zone Funds?
At Canyon View Capital, we will walk you through every step of your investment when using your 1031 exchange as a vehicle, and our staff will always answer your questions honestly, completely, and promptly. For more on investing using a 1031 exchange, contact Canyon View Capital.
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Gary Rauscher, President
When Gary joined CVC in 2007, he brought more than a decade of in-depth accounting and tax experience, first as a CPA, and later as the CFO for a venture capital fund. As President, Gary manages all property refinances, acquisitions, and dispositions. He works directly with banks, brokers, attorneys, and lenders to ensure a successful close for each CVC property. His knowledge of our funds’ complexity makes him a respected executive sounding board and an invaluable financial advisor.