The 2017 Tax Cuts and Jobs Act created new tax incentives for investing in the U.S. Among these is an opportunity to defer capital gains tax by reinvesting such gains in qualified opportunity funds (QOFs). QOFs are created to invest in specifically designated economically distressed communities throughout the U.S. Section 1031 of the Internal Revenue Code of 1986, as amended (the Code), can also be used for deferral of the recognition of gain on a sale of property (commonly known as 1031 exchanges).
This article discusses certain of the major differences between these two tax incentives and certain key considerations and restrictions that should be taken into account when determining the best way to utilize them.
The recently enacted statute allows taxpayers to defer their tax on capital gain by reinvesting sale proceeds up to the amount of their capital gain in a QOF. The type of asset sold is irrelevant, as long as the sale produces capital gains. A taxpayer is able to defer the capital gain tax by reinvesting in a QOF, and may receive additional benefits, including permanent exclusion of some of the gain if the investment is held for a specified period. However, there are certain requirements that a QOF must meet, and the deferral of the gain terminates in 2026, at which point the deferred gain must be recognized. In addition, many open questions remain with respect to investments in QOFs and the structuring of the QOFs.
As an alternative, 1031 exchanges can be used to defer gain on the sale of real property exchanged for other real property. The 1031 exchanges are limited to sales and purchases of real property; and while 1031 exchanges only offer the deferral of the gain, without the possibility of exclusion, if used consecutively, indefinite deferral is available.
The chart below offers a comparison of certain key requirements and benefits of an investment in QOFs and a 1031 exchange.
The QOF rules were recently enacted, and guidance is limited. Regulations were issued in proposed form, and are subject to change. There are many open questions relating to investments in QOFs, and until further guidance is issued, there may be some risk with respect to achieving desired benefits.
This summary is not intended to be all inclusive and is meant solely as a guide to some key considerations.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.