Like-Kind Exchanges Versus Opportunity Zone Investments

CHARLOTTE, NC—As investors and developers ease into 2019, Opportunity Zones (OZ) and Like-Kind Exchanges (LKE) are being seriously examined as capital movements are determined. The similarities and differences between OZ benefits and LKE benefits can be significant and deserve more attention as investors and developers weigh the pros and cons as they contemplate projects and next steps for this new year.

The Opportunity Zone, part of the 2017 Tax Cuts and Jobs Act, is designed to attract investment capital into economically distressed areas. If the Opportunity Zone concept succeeds, the effects could transform specific blighted areas. In return for their investments, investors receive several tax benefits, which vary depending on the amount of time the capital remains invested in a Qualified Opportunity Zone.

A tax-deferred transaction, otherwise known as a like-kind exchange or 1031 exchange, allows for the disposal of an asset and the acquisition of yet another similar asset without generating a capital gains tax liability from the sale of the first asset. Like-kind exchanges only applies to the exchange of a business or investment property for another property.

“Like-kind exchanges are one of the last remaining real estate tax benefits left out there. They’ve been around for a while and only apply to real estate. These exchanges are perfect for a business owner looking to sell his business and invest in yet another business or a real estate investor looking to sell a rental property and buy a similar rental property,” says Palmer McArthur, Partner, Moore & Van Allen PLLC.

Opportunity Zone funds, on the other hand, not only offer investors an ability to defer and reduce their original capital gains tax bill but they also get a chance to eliminate any capital gains taxes earned from that specific investment under certain conditions, McArthur tells GlobeSt.com.

When engaging in a like-kind exchange, investors must reinvest both the capital gains and principal from the sale of an appreciated asset within 180 days of sale. Technically a like-kind exchange is simply a swap of one property for another and not a traditional sale that would culminate into a taxable event.

“However, locating an investor who wants to swap properties is not always practical and as a result the IRS allows for a like-kind exchange, where someone sells their property and buys another property of a “like kind” within 180 days of sale or by the date of their next tax bill through a qualified intermediary,” explains McArthur.

On the other hand, Opportunity Zone funds requires an investor to reinvest only their capital gains within 180 days to qualify for the tax benefits. Investors can also invest directly within an Opportunity Zone without having to go through an intermediary. To qualify for Opportunity Zone tax advantages, investors are simply required to indicate they rolled their capital gain into an Opportunity Zone fund on their tax returns. Its also important to note that since these investments do not require an intermediary, the buying and selling process for Opportunity Zones is more streamlined thus reducing an investor’s transaction expenses.

Under a like-kind exchange, an investor’s capital gains will eventually be fully taxed upon the final disposition. What this means is if their last asset, acquired in a like-kind exchange, significantly appreciates, that asset could incur a sizable tax bill.

If Opportunity Zone investors, on the other hand, hold their investment for at least 10 years and then sell, they do not owe federal taxes on that capital gain. There is currently no limit on how long an individual may keep an Opportunity Zone investment which means that investors can steadily build up the property’s appreciation and not owe federal taxes when they sell it in 10 years or more.

“The tax incentives associated with Opportunity Zone investments will continue to be compelling,” says McArthur. “Like-kind exchange investors will continue to enjoy the benefits of that transaction as well. I don’t think people will purchase property without thinking it’s a sound investment decision.”