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Can my 1031 funds automatically qualify for an Opportunity Zone investment?

I recently missed out on the 45-day deadline for the 1031 exchange I was working on. Do my 1031 funds automatically qualify for this OZ investment? If so, what do I need to do to make the change?


Answers
  • John Wegmann
    July 31, 2019

    Qualified Opportunity Fund (QOF) investments can provide a viable remedy, and perhaps the only salvation, for "botched" 1031 exchanges. In the process of implementing the QOF investment, there are several pluses, minuses and caveats to consider. Whereas in a Section 1031 you must invest the entire proceeds realized in a sale to achieve a complete gain deferral, with a QOF you need only invest the amount which is treated as capital gain. This raises the point that with a Section 1031 exchange you are able to defer depreciation recapture (which does retain its character), but going the QOF route does require recognition of recapture as ordinary income such that only the portion of gain that comprises capital gain may be deferred via the QOF mechanism. Whereas in the case of Section 1031 exchange, you have no geographical limitations but strict restrictions on what constitutes like kind property, the QOF route has fewer investment restrictions but does require that the QOF have its trade or business located in a Qualified Opportunity Zone. Finally, while Section 1031 allows for investment in triple-net (NNN) leased real estate, NNN-leased property does not qualify for purposes of a QOF. In addition, you will no longer need the services of a Qualified Intermediary (QI) to hold the funds in escrow. The QOF option also provides a longer reinvestment period than Section 1031, in that it gives you 180 days including the date the gain is realized. However, it's likely that the Section 1031 disposition comprises Section 1231 property, in which case the proposed regulations provide that the 180-day period by which gain must be reinvested in a qualified opportunity fund with respect to any section 1231 capital gain begins on the last day of the taxpayer's taxable year, not the date of the sale giving rise to the gain. This rule follows the logic that net capital gain from Section 1231 property is determinable only as of the last day of the year. While the foregoing explanation is designed to cover main issues, it is not intended to cover each and every detail which may affect your specific transaction. In terms of what procedures you are required to follow, compliance requirements are quite complex, especially if you go about to create your own QOF, such that I highly recommend you seek legal/tax counsel customized to your specific transaction.

  • Brian Keida
    April 28, 2019

    They do not automatically qualify. You will need to check on page 3, question 26 of the Form 1065 that you are electing to be a Qualified Opportunity Fund. You then complete Form 8996 when filing your tax return. You will then need to make sure you are following all of the rules to be an OZ fund.

  • Paul Wassgren
    April 02, 2019

    Any gain from a prior investment can be invested in a Qualified Opportunity Fund (QOF) and accrue the tax benefits. You can also invest the original principal from your prior investment, but it would not benefit from the tax deferrals and reductions under the QOZ tax regime. With respect to your 1031 exchange proceeds, some of that will be gain and some will be original basis/principal. You must invest the gain portion into a QOF within 180 days of the prior sale. Please be sure to consult with a tax advisor or attorney familiar with the QOZ rules.

  • Adam Yormack
    April 03, 2019

    The window on OZ capital gain eligible money is longer than 1031. Therefore, yes, the money is eligible.

  • Peter McNeil
    April 02, 2019