The Tax Reform Act created a new method of deferring taxes on capital gains that is more flexible and multifaceted than the traditional 1031 exchange. Investors in this new program can now defer capital gains on the sale of ANY asset (not just real estate), pay lower taxes on those deferred gains, and pay no capital gains taxes on any increase in the new investment’s value if they hold the asset for a minimum of ten years.
How it Works
Like a 1031 exchange, investors must reinvest capital gains within 180 days. The investments must go into an Opportunity Fund, which invests in real estate or businesses located in specific geographic districts within each of the 50 states. Large parts of the U.S. are eligible, including many commercial, industrial, and residential areas.
Investments held through Opportunity Funds enjoy a tax deferral until December 31, 2026, or the date of a sale, whichever is earlier. The original capital gains tax is reduced by 10% after 5 years, and by 15% after 7 years. After 10 years, investors pay no capital gains on the new investment’s increase in value.
1031 Exchanges Compared to Opportunity Funds
Unlike Section 1031, tax benefits through a qualified Opportunity Fund are available for capital gains from the sale of ANY asset, not just like-kind real estate. Only capital gains must be reinvested. You do not have to invest your entire previous basis into an Opportunity Fund to avoid taxable “boot.”
With a 1031 Exchange, capital gains are deferred only until sale of the new property, when all taxes are due. There is no automatic step up in basis except for your heirs upon your death. Nor are capital gains and depreciation recapture eliminated if your new investment is held for 10 years.
Additional Tax Benefits
Investors may combine Opportunity Fund tax breaks with the newly modified expensing and depreciation rules to create passive losses that can be used to offset other income.
Download our white paper for more detail about how Opportunity Funds compare to 1031 Exchanges.