4A — May 10 - 23, 2019 — M id A tlantic
Real Estate Journal
www.marejournal.com
T ax A dvantage I nvestment S ource
By John V. Maggi, Congress Asset Exchange & Freyr Energy LLC 1031 Like-Kind Exchange vs Qualified Opportunity Zone - Which is best for me? L
ike -Kind 1031 Ex - changes and Qualified Opportunity Zones are valuable investor tools – un- derstanding their use and benefits can produce profit- able results. DISCUSSION Section 1031 Like-Kind Exchanges: Exchanges are allowed for business use or investment real estate only and have established, well understood rules that allow capital gains tax to be delayed indefinitely. They can be done regularly, say, every year or two. The
investor must fully commit to the exchange with all aspects of transaction; that is, they must re-invest all of their equity, debt and gain, with no cash out, into another real property for maximum ben- efit. Exchanges require the use of a Qualified Intermedi- ary (QI) and have been used extensively in the real estate industry and been part of the U.S. tax code since the 1920’s. Qualified Opportunity Zone (QOZ) Investment: The Tax Cuts and Jobs Act (TCJA) of 2017 created the QOZ tax incentive which encourages
investment in economically distressed communities. In- vestment in a Qualified Oppor- tunity Fund (QOF) can serve to defer, reduce, and in some cases, eliminate capital gains taxes. Any type of capital gain can be “rolled-over” (within 180 days) into a QOF, including in- vestments that formerly, but no longer, qualify for Exchange tax deferral (e.g., “personal prop- erty” such as autos, aircraft, artwork, etc.) – investments in stocks, bonds, commodities, etc. also qualify. A reduced capital gains tax is delayed for up to 7 years (until 2026). Maximum
tax benefits are achieved after 10+ years with the effective elimination of all capital gains taxes and ordinary income from depreciation recapture for qualifying investment in a QOF partnership. Importantly, only the gain component is required to be rolled-over into the QOF… and principal cash may be re- turned to the investor with no tax due. No QI is required for the capital gain roll-over into the QOF. ISSUES Exchanges: Because both the transac- tions for the sale of old and the
purchase of the new real estate must be completed within the mandatory 180-day exchange period, timing problems often exist for exchanges. Timing issues can sometimes be elimi- nated or mitigated via the use of a Special Purpose Entity (SPE) strategy that allows for greater transaction flexibility, with the exchange being accom- plished over a much longer pe- riod of time. The SPE strategy may also have additional cash flow and financial reporting benefits. QOF Investment: Because QOF investments will be made in property that is not in traditionally preferred locations, care must be exercised - invest- ing solely for tax benefits can backfire. Importantly, investors should remember that the full amount of the deferred capital gains tax will be due no later than 2026 – this “phantom” in- come could create a situation where there is no cash avail- able from the investment and the deferred tax is now due. Also, the investment rate of return may be lower because of the tax savings. WHAT TO DO: Generally, for real estate, an exchange is preferable for the immediately avail- able long-term tax deferral. However, if the investor cannot identify suitable new replacement property by the 45th day of the exchange period, they may want to consider terminating the ex- change and pursuing a QOF investment. They would be required to then, within the next 135 days, roll-over only their gain into a QOF. Also, for investors with gains from personal property sales that no longer qualify for Exchange tax deferral (or other non-real property investments too), a QOF should be given consider- ation. JohnMaggi is president of Congress Asset Ex- change, LLC a Qualified Intermediary company that creates andmanages Special Purpose Entities (SPE’s). John is also a partner and a founding member of Freyr Energy LLC, a developer of solar energy power generation facilities within Quali- fied Opportunity Zones (QOZ’s).
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