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When Congress passed the Tax Cuts and Jobs Act (TCJA) at the end of 2017, they created a type of tax incentive not yet seen at the federal level: Qualified Opportunity Zones (QOZs). When taxpayers invest capital gains into economically depressed land tracts known as “opportunity zones,” they can defer their gains and direct those deferred tax dollars to other personal or business ventures.
But opportunity zones won’t be around forever, at least not at the federal level; the program is set to expire at the end of 2026. Taxpayers can only defer their original gains until December 31, 2026, at which time all original gains will be taxed, even if your clients continue to hold onto their QOZ investments.
If the original gain can only be deferred until the 2026 tax year, is QOZ investment worth the effort?
Maybe! In fact, QOZ investment provides other benefits beyond just a three- or four-year deferral of the original gain. But QOZ investment isn’t the only option, either.
If your clients’ gains are from sales of real property, they should compare QOZ investment with another type of incentive that might be better for them: like-kind exchanges.
Let’s discuss how QOZ investment and like-kind exchanges differ to help you determine which tax incentive program is best for your clients.
We’ve already taken deep dives into both the QOZ program and like-kind exchanges under Section 1031, but let’s recap what these two programs can offer your clients.
| QOZ Investment | Like-Kind Exchanges (Section 1031) |
| If taxpayers invest capital gains into a QOZ, they can receive one or more of the following tax incentives: A 10% step-up in basis of the original gain if they (a) invest by December 31, 2021, and (b) hold their QOZ investment for at least five years A deferral of the original gain until December 31, 2026, if they hold their QOZ investment until that date A permanent exclusion of QOZ investment gains (i.e., on appreciation arising from their QOZ investment) | Like-kind exchanges allow taxpayers to defer gains on sales of real property if they purchase replacement property that is (1) of like kind and (2) of equal or greater value to the relinquished property. |
So, which is the better choice for your clients?
The two incentive programs are quite different, but they provide the taxpayer with the same type of incentive: a tax deferral. However, QOZ investment only offers tax deferrals through December 31, 2026, while like-kind exchanges can help your clients defer their gains for decades, if not indefinitely. This might make like-kind exchanges appear to be the clear winner, but in many cases, QOZ investment still comes out on top.
The QOZ incentive is available to all taxpayers, not just real estate owners. All capital gains, no matter their source, can be invested into QOZs, including sales of the following types of assets:
To receive the QOZ investment benefits, your client may invest cash or assets into the QOZ. For example, if your client recognized a capital gain from selling stock and bonds, they can invest cash into the QOZ, or they can direct another asset that they own — perhaps a building, machinery or land — into the QOZ, as long as the fair value of that asset is at least the amount of the realized gain.
Like-kind exchanges allow taxpayers to invest only in real estate.
Both businesses and individuals can participate in the QOZ program, but only business entities can perform like-kind exchanges.
To participate in the QOZ program, taxpayers must only invest gains from the sale of capital assets. To defer 100% of the gain from sales of real estate using like-kind exchanges, the taxpayer must typically invest all the proceeds, not just the gain. Let’s look at an example:
| QOZ Investment | Like-Kind Exchanges (Section 1031) |
| Your client sells a building they own outright for $1M that has a basis of $600K. To defer taxes on their $400K gain, they must invest $400K into an opportunity zone. | Your client sells a building they own outright for $1M that has a basis of $600K. To defer taxes on their $400K gain, they must purchase property that is of equal or lesser value than the $1M property they sold. |
If your clients invest their original gains before the end of 2021, they may be able to exclude 10% of that gain permanently. If they hold onto that investment until the end of 2026 (i.e., for at least five years), they can raise the basis of their original investment by 10%, effectively eliminating 10% of the original gain.
But even if your client cannot make their investment before the end of the year, they may still be eligible for a gain exclusion on their QOZ investment. While the original gain will be fully taxable on December 31, 2026, they will be able to exclude the gain on the appreciation that occurs within the QOZ investment fund. To exclude that gain on appreciation, they must hold onto their investment for at least 10 years.
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Absolutely not. Like-kind exchanges are still beneficial, and we anticipate they will continue to play a significant role in the real estate investment market. Here’s why:
Section 1031 is a permanent fixture of our tax code. The QOZ program expires at the end of 2026.
Like-kind exchanges require a good amount of planning and knowledge about the tax law, but they’ve been around for decades; players in the industry know how they work. You can easily find a lawyer or exchange coordinator to help you, as well as a CPA who knows how like-kind exchanges should be reported. QOZ investment, on the other hand, is still quite new, and much of the legal and tax requirements of the program are not fully fleshed out by the IRS.
For the taxpayer to reap the benefits of QOZ investment, they must hold their qualifying investment in a Qualified Opportunity Fund (QOF) for between 5 and 10 years. It is the QOF’s job to ensure it is following QOZ protocols. Program qualifications are quite strict, and there is little the taxpayer can do if their QOF is noncompliant with the program.
Comparatively, taxpayers who use like-kind exchanges can more easily ensure their own successes. If your client uses an experienced exchange coordinator and purchases their replacement property in a timely manner, they are at lower risk of losing their tax benefits because of someone else’s mistake.
Like-kind exchanges can defer taxes for decades, if not permanently. Those original gains can be deferred again and again if your client continues to make qualifying Section 1031 exchanges. In most cases, if they bequeath those real estate assets at death, the basis in their assets will be stepped up to fair value, excluding those gains permanently.
With QOZ investment as an option, your clients have even more tax incentives to consider. If you want to see how either QOZ investment or like-kind exchanges would play out on their tax return, use our Corvee Tax Planning software. We have a QOZ strategy and a like-kind exchange strategy in our tax planning software that can tell you how much your clients will save if they pursue one or both of these tax incentives.
See how Corvee allows your firm to break free of the tax prep cycle and begin making the profits you deserve.
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