What is the difference between QOZ and 1031?
Qualified Opportunity Zones (QOZs) were implemented as part of the Tax Cuts and Jobs Act of 2017. QOZ funds allow investors to defer and eliminate capital gains taxes from any source, not just real estate. If an investor realizes gains from the sale of a business, stocks or private property, they could invest it in a QOZ fund. If they are selling real estate, their options expand to include a 1031 exchange or QOZ fund. Origin offers both strategies, including our QOZ Fund III, and we can help investors weigh the benefits and characteristics of both options.
- You can defer the capital gains indefinitely
- 1031s work great for selling a stabilized real estate property and getting into a different stabilized real estate property.
- 1031s can work for development deals but they are very complicated
- Typically you have to invest all of the proceeds from a 1031 deal into the new 1031 deal
- Usually the exit strategy is death whereby the heirs inherit a stepped up basis in the properties
| 1031 Like-Kind Exchange | Opportunity Fund Investment | |
| Fund Opportunity | Property held for investment purposes (not homes) | Investments in Qualified Opportunity Zone assets (business or real estate) |
| Investment Vehicle | Third-party custodian | Qualified Opportunity Fund |
| Source of Capital Gain | Must be from a business real estate sale | Can be from sale of any asset |
| Timeline | Identify replacement property within 45 days of sale; all proceeds from prior sale must be reinvested within 180 days | Reinvest eligible capital gains within 180 days of realization |
| Eligible Property | Property held for investment purposes anywhere in the U.S. | Property in designated Opportunity Zones |
| Amount to Invest | All proceeds from property sale for full tax deferral | Any amount of capital gains |
| Deferral of Invested Capital Gain | Until final sale; multiple rollovers possible | No later than 12/31/2026; 10% lower basis if investment held 5 years |
| Tax on Appreciation | No tax until final sale; Appreciation calculated from original basis | Tax-free after 10 years |
| Hold Period | Indefinite | Minimum of 10 years for full tax benefits |
| Estate Planning Considerations | Heirs owe no capital gains tax | Heirs responsible for deferred capital gains tax, but not on appreciation |
The significant difference between the two options is that the 1031 exchange is a deferral program with unlimited duration. The QOZ program has a limited deferral period, but it affords tax-free profits after a minimum 10-year hold. The determination of which program is better will vary based on each individual investor’s objective. If an investor’s primary goal is to defer taxes indefinitely and never access the investment capital, the 1031 exchange would be the preferable solution; however, if an investor wishes to realize the profits on an investment at some point in their lifetime, a QOZ Fund is the better option.
Because the taxes deferred in a 1031 exchange can roll on indefinitely, the 1031 exchange option can be a valuable estate planning tool. If an investor is willing to hold onto investment property for life, the taxable gains disappear; the investor’s heirs receive a step-up in basis to the property’s fair market value on the date of death, erasing any previous appreciation in the value. Those heirs can sell then the asset immediately without a capital gain.
Under the QOZ program, there’s no escaping the taxman on December 31, 2026, and any person who inherits an interest in a QOZ Fund prior to that date will assume the original tax basis in the investment (no step-up upon death) and be obligated to pay the tax; however, if the heir holds the QOZ Fund interest until a date that is at least 10 years from the original investment, their tax basis will receive a step-up to the investment’s fair market value upon disposition.
You can also watch this video to learn more.