Section 1031 Exchanges vs. Qualified Opportunity Zone Funds: Which is Better?
By: Ernie Neve
To avoid immediately paying capital gains tax on your profit, you have options:
· Deferring the capital gains tax using a Section 1031 exchange
· Deferring the capital gains tax using a qualified opportunity zone fund
With a Section 1031 exchange, you sell your property and invest all the proceeds in
another like-kind replacement property of equal or greater value.
With a qualified opportunity fund, you don’t acquire another property. Instead, you invest in a corporation, partnership, or LLC that pools money from investors to invest in property in areas designated by the government as qualified opportunity zones. Most qualified opportunity funds invest in real estate.
Which is better? It depends on your goals. There is no one right answer for everybody.
A Section 1031 exchange is preferable to a qualified opportunity fund investment if your goal is to hold the replacement property until death, when your estate will transfer it to your heirs. They’ll get the property with a basis stepped up to current market value, and then they can sell the property immediately, likely tax-free.
In contrast, your investment in a qualified opportunity fund requires that you pay your deferred capital gains tax with your 2026 tax return. That’s the bad news (only four years of tax deferral).
The good news: if you hold the qualified opportunity fund for 10 years or more, there’s zero tax on the appreciation.
In contrast, if you sell your Section 1031 replacement property, you pay capital gains tax on the difference between the original property’s basis and the replacement property’s sale amount.
And if you’re looking to avoid the headaches and responsibilities that come with ownership of commercial or rental property, the qualified opportunity fund does that for you.
If you’re looking for liquidity, the qualified opportunity fund gives you that because you need to invest only the capital gains to defer the taxes. With the 1031 exchange, you must invest the entire sales proceeds in the replacement property to avoid any capital gains tax.
Of course, you want your investment to perform. Make sure to do your due diligence, whatever your choice.
If you want to discuss Section 1031 exchanges or opportunity funds, please call me on my direct line at 610-278-8400.