Real Estate Journal — Tax Issues & Accounting — July 12 - 25, 2019 — 7A
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Tax Issues & Accounting By Bruce Johnson, Capstan Tax Strategies Compare & Contrast: 1031 Exchanges and OZs: Both options can be good investment vehicles for CRE
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ntil recently, tax- payers who wanted to defer recognition
property selection, restrictive timelines, etc. On the other hand, contrib- uting to a pooled fund of this nature means that underlying assets are illiquid — extract- ing oneself from an QOZ in- vestment may be more chal- lenging than simply cashing out of a straightforward 1031 exchange. QOZs have two major limi- tations — they are finite in number and geographically limited. Rapidly gentrifying areas are going fast — with potential for overinvestment continued on page 14A
appreciated assets (stocks, bonds, etc.). However, a sale to a related party is not a permissible source of gain. In another contrast, only capital gains from the sale have to be reinvested into the QOF. A taxpayer certainly may invest the principal or other mon- ies, but only the capital gains portion will be eligible for the tax advantages. Investments in QOFs must be in cash, and there is no “middleman” required. In one sense, QOFs have a little more flexibility than 1031 exchanges — as noted
earlier, the QOF can invest not only in real estate but also in operating businesses with personal property, in company stock, in capital resources like factory equipment, etc. In this sense, QOZ investments may have more potential for diversification, and they may become useful resources for start-up operations in need of capital. QOZ investments are also attractive to the pas- sive investor. Since these pooled funds are diversified and professionally managed, the individual investor doesn’t have to concern himself with
Qualified Opportunity Zone Investments Enacted by the TCJA, Quali- fied Opportunity Zones (QOZs) are 8,700-plus federally-des- ignated Census tracts in low- income communities nation- wide. Interested investors may defer capital gains tax by reinvesting capital gains into a Qualified Opportunity Fund (QOF) that will be used to acquire property and/or businesses located in an ap- proved QOZ. The gains to be reinvested may stem from the sale of real estate (similar to a 1031), or from the sale of other
o f c a p i t a l gains when selling real estate had one opt i on — the 1031 e x c h a n g e . However, the Tax Cuts and Jobs Act of
Bruce Johnson
2017 introduced the Qualified Opportunity Zone, a new op- tion that has many investors and developers intrigued. Both of these vehicles defer capital gains tax, increase buying power and encourage reinvest- ment, but as the saying goes, the devil is in the details, and the thoughtful investor will familiarize himself with all the nuances before determining which strategy might be most suitable. The 1031 Consider a taxpayer who owns a property that has greatly appreciated in value. The taxpayer would like to sell, but fears the sizeable associated capital gains tax. For almost 100 years, the 1031 exchange has been a viable solution: the taxpayer may sell the property in question— the relinquished property — and fully reinvest the proceeds into a replacement property, in the process deferring capital gains tax on the sale. While a suitable replacement property is being located, a qualified in- termediary holds on to the pro- ceeds from the relinquished property. 1031 exchanges are essen- tially “swaps” of “like-kind” real property. Under the new rules instituted in the Tax Cuts and Jobs Act of 2017 (TCJA), real estate sales are the only permissible starting point, and both the principal and the capital gains portions of the sale must be reinvested in the replacement property in order to defer the entire gain. The properties must be held for investment purposes or be a trade/business — an exchange can’t involve land being developed or properties purchased for resale, for ex- ample. There is no geographic restriction on 1031 property, and the exchange may even take place between related parties. Furthermore, the investor is under no obligation to improve the replacement property in any way.
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