Posts tagged 1031 Exchange
Opportunities Abound in Local Opportunity Zones

Congress made several significant changes to the individual income tax when it passed the Tax Cuts and Jobs Act of 2017. The creation of the Opportunity Zone program is among these changes. This law, codified in the Internal Revenue Code, creates tax breaks and incentives for those who invest their money into designated “opportunity” zones. In short, the Opportunity Zone program is an economic development tool designed to spur economic development and job creation in distressed communities. An Opportunity Zone is a designated economically-distressed area where new investments, under certain conditions, may be eligible for preferential tax treatment. Our local officials in Chelan and Douglas County proactively sought the designation of a large number of properties within each of the counties as Opportunity Zones, which requests were ultimately approved by Governor Inslee among a total of 139 census tracts approved as Opportunity Zones in 36 counties within Washington. You can find these properties through this mapping feature.

In order to invest within an Opportunity Zone and qualify for these new tax breaks, an investor must first form a Qualified Opportunity Fund (“QOF”), which can be either a partnership (including limited liability companies) or a corporation. This fund is the vehicle which then makes the investments in the eligible property located in an Opportunity Zone. The tax benefits for these investments are reminiscent of the benefits associated with 1031 exchanges, but with the potential for even more advantageous tax breaks.


Deferring Tax on Capital Gains

Investors into Opportunity Zones can defer tax on prior capital gains invested into a QOF until the earlier of the date on which the investment in the QOF is sold, or December 31, 2026.

  • If the QOF is held for longer than five years, there is a 10% exclusion on the deferred gain

  • If the QOF is held for longer than seven years, there is an additional 5% (for a total of 15%) exclusion on capital gain

  • If the investor holds the investment in the QOF for at least ten years, the investor is eligible for an increase in basis of the QOF investment equal to its fair market value – meaning that there would be no capital gains tax levied at all.


Requirements

In order to take advantage of the deferral, there are a few requirements.

  • The 180-Day Window. The investment into the QOF must be made within 180 days of the sale of other property. An investor cannot utilize the Opportunity Zone program if they already have the cash and simply want to invest. There has to be a triggering sale of property with capital gains and then a reinvestment of those funds within the 180-day window.

  • The Fund. The fund has to be set up in accordance with the Internal Revenue Code and the recently released proposed regulations. As noted above, the fund can be a partnership tax entity or a corporation. The QOF must designate a fund manager.

  • The Investment. The QOF must use at least 90% of the funds it receives to invest in qualifying property within an Opportunity Zone. The investment must improve existing property and/or consist of a new build. The investment can also be made into a new or existing business that is located within an Opportunity Zone.

  • The December 31, 2026 Window. The capital gains exclusion incentives are based on the length of time that the investment is held and time-capped as of the end of 2026. An investor can still invest in 2019 in order to hit the seven year window of time for exclusion of capital gains.


Conclusion

The tax breaks associated with the investment into Opportunity Zones could have a lasting impact on many taxpayers. An investor does not need to create their own fund and there are many funds all over the country, which are currently formed and trying to raise capital. If you are a property or business owner that has been considering a sale that would trigger capital gains, now may be a great time to sell and reinvest those funds into a QOF fund. On the flip side, if you are a property or business owner located in an Opportunity Zone, you should consider leveraging these tax incentives to get new investors. The Opportunity Zone regulations are complex. Investors considering the Opportunity Zone Program should consult with their attorney and tax adviser to ensure full compliance with the rules and regulations in order to achieve the maximum tax benefits contemplated under the Act.

Email Lindsey J. Weidenbach or Michelle A. Green at JDSA Law for assistance or call (509) 662-3685.

1031 Exchange: Is It Right For Me?

With the housing market booming and the economy picking up speed, we are seeing a resurgence in 1031 exchanges. 

A 1031 exchange allows you (the “exchangor”) to defer paying taxes on investment property when it is sold, so long as those proceeds are reinvested into other property of “like kind.”  Tax deference is often advantageous, however, the pros should be weighed against the cons — prior to diving into a 1031 exchange — to ensure the 1031 exchange is right for you. 

The first question: 

Can I benefit from a 1031 exchange? 

You benefit from a 1031 exchange if you are selling investment property, or property that is used in a trade or business, and want to purchase new investment property to replace it. If this is the situation, you can sell the old property and purchase the new property without paying taxes on the sale.  This tax deference is the main benefit of a 1031 exchange. 


If the properties qualify, and are of like kind, the next question: 

What is your basis in the relinquished property, and are the current capital gains rates favorable to a sale? 

If you have a high basis in the property (basis being the difference between the price you purchased the property for and its current fair market value), then you might not want to defer taxes.  It may be more tax efficient to pay the capital gains now, while rates are reasonable, on a high basis.  However, if you have a low basis in the property, it is almost always more advantageous to defer the taxes and go with a 1031 exchange.

In order for your property to qualify as 1031 property for sale (the “relinquished property”), you must have held it for five or more years as an investment or in a trade or business.  Once you sell the relinquished property, you have 45 days to identify new property to purchase (the “replacement property”) which also has to be intended for investment, or for a trade or business purpose.  After the replacement property is identified, it must be purchased within 180 days (around 6 months) from the relinquished property's date of sale.  This is the most common type of 1031 exchange, and is referred to as a forward, delayed 1031 exchange

There are many other types of exchanges and different iterations of the same pattern. For instance:

  • You can sell multiple properties and/or purchase multiple properties.

  • You can first purchase the replacement property and then sell the relinquished property — this is called a reverse, delayed 1031 exchange.

  • If you know exactly what properties you want to sell and purchase, you can sell and purchase simultaneously (or close to simultaneously) through a title company, which is referred to as a simultaneous 1031 exchange.

  • You can sell one property, purchase another and build improvements on it, which is called a construction 1031 exchange.

  • A 1031 exchange even works for large items of equipment.


Before we continue, let’s discuss the requirements: 

What are the requirements of a 1031 exchange?  

  • The primary principal of the exchange is: the exchangor cannot have control over, or access to, the funds during the exchange. If you have access to the funds, the exchange fails and does not qualify for tax deference.

  • A 1031 exchange has to be facilitated by a qualified facilitator, which is defined in the Internal Revenue Code very specifically, but generally means anyone who is a true third party, not related to or an agent of the person performing the exchange (the exchangor).

  • If you’re thinking of selling property that would qualify for a 1031 exchange, contact a qualified facilitator first, to make sure your specific property sale qualifies and to make sure tax deference is right for you, based on the property’s basis and current capital gains rates.

  • The facilitator must be assigned the Purchase and Sale Agreement and must receive the proceeds of the sale of the relinquished property, and will hold the funds in trust until the exchange is complete.

  • If you have already sold the relinquished property, it is too late and you will not qualify for an exchange.

Once you have engaged the facilitator and sold the relinquished property, the facilitator will enter into an agreement to purchase the replacement property, keeping in mind the two time limitations discussed above, and will use the proceeds from the sale of the relinquished property to purchase the replacement property.  The replacement property is deeded directly to the exchangor. Any remaining proceeds are reimbursed to the exchangor, and will be taxable income.


These exchanges are highly technical.  Any misstep of the Internal Revenue Code regulations can lead the disqualification of your exchange.  JDSA has a focused, real estate legal team and regularly acts as a 1031 exchange facilitator.