Using a 1031 exchange can be a great way to defer capital gains taxes on the sale of income property under the right circumstances.
But 1031s can and do fall apart sometimes. One of the most frequent hurtles is the 45-day identification requirement: You have to identify the actual property that you will exchange into within 45-days. Suitable inventory may be hard to find though. Others reasons for a blown 1031 exchange can include additional financing requirements, and taking possession of the sale proceeds.
Have no fear, there is a back-up plan for a blown 1031 exchange: The Opportunity Zone Fund.
Created by the Tax Cuts & Jobs Act in 2017, Opportunity Zone Funds allow for the reinvestment of any capital gain up to 180 days after receipt into Qualified Opportunity Zones. The taxes on those gains will be both reduced and deferred (delayed). Unlike a 1031 exchange which requires all proceeds to be reinvested, just the gains need to be reinvested in a OZF. The basis can be reinvested elsewhere.
Recently, some new clients called me after selling their rental property and picking up their check from the escrow company. They wanted to know how to minimize taxes on their capital gains. (Ideally, you want to make this call before selling and picking up the check, but I digress.) Since they had already taken possession of the proceeds, the 1031 exchange option was already off the table. For them, the best option was investing the gains into an Opportunity Zone Fund. This will result in the taxes on the gains being deferred until 2027 and a reduction of the eventual capital gains taxes they pay.
If you'd like to hear more about how Opportunity Zone Funds can be a back-up plan for a 1031 exchange, schedule a call.