Opportunity Zone Loophole?

Question

Forgive my ignorance here. I'm just getting started in investing, so this topic may be old hat for a lot of you.

I'm wondering if I were to do a 1031 exchange to a property in an opportunity zone, would I never have to pay capital gains tax on either property (if I sold the second property)? Happy to clarify my thinking if this doesn't make sense.

Also, if anyone knows any advantages/disadvantages of refinancing a home in an opportunity zone, I would love to hear those!

Aaron H. · Answer

There's quite a bit of nuance to how capital gains work for OZ investments. Short version, these kind of exchanges really just mean you're deferring your taxes, not avoiding them entirely.

Straight from the IRS:

"...investors can defer tax on any prior gains invested in a Qualified Opportunity Fund (QOF) until the earlier of the date on which the investment in a QOF is sold or exchanged, or December 31, 2026.   If the QOF investment is held for longer than 5 years, there is a 10% exclusion of the deferred gain.  If held for more than 7 years, the 10% becomes 15%.  Second, if the investor holds the investment in the Opportunity Fund for at least ten years, the investor is eligible for an increase in basis of the QOF investment equal to its fair market value on the date that the QOF investment is sold or exchanged."

In theory you can keep 1031 exchanging things to keep deferring taxes until you die (continuing to increase your basis in the next thing you buy), but in practice that can be tough to pull off...

Note also that there are other rules surrounding what property qualifies, what counts as a "qualified opportunity fund," and whether you have to make additional investments into improvements in the property to qualify.

Bill B. · Answer

A few stumbling blocks....

The improvements have to be greater than the purchase price.

You can’t live in it (or your 1031 exchanged property) it has to be an investment property.

I THINK you have to hold the new property for 10 years to avoid paying taxes on the new gain but you still owe some taxes on the old gain depending how long you hold it.

I also BELIEVE, some of the best features are no longer available because there’s an expiration for some of the benefits not that is before you’d get to them if you bought today.

Dave Peterson · Answer

Thanks Aaron! I guess I don't have a strong enough understanding of the Opportunity Zone rules and benefits to ask what I'm asking. I was under the impression that if you buy in an opportunity zone, make improvements to the property and then sell it, you don't have to pay ANY capital gains tax. It sounds like that isn't exactly accurate (or at least it's not quite that simple), but I was using it as the basis for the following potential plan.1. I own a home. I want to exchange it for an investment property I found in an opportunity zone.2. I do a 1031 exchange, and defer taxes.3. I move into the OZ house and make improvements to it.4. I sell the OZ house after a few years, rather than doing another 1031 exchange.5. I pay no capital gains on either the first or second property.All that to say, I think I'd better keep it simple this go-around. :) Thanks again for your help!