Tax Breaks: 1031 vs. Opportunity Zones

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The specific tax breaks offered by 1031 exchanges and Opportunity Zone investments also differ in significant ways. The NAIOP Commercial Real Estate Development Association compares and contrasts how capital gains taxes are treated in a 1031 vs. Opportunity Zones:3 Deferral of capital gains tax Capital gains can theoretically be deferred indefinitely by using a 1031 exchange, when funds are rolled over from one replacement property to another, time after time. When an investor passes away, the property basis is stepped-up to fair market value, which means the heirs may pay no capital gains tax whatsoever. However, Opportunity Zones have a hard deadline of December 31, 2026 after which the tax on capital gains tax must be paid. Unlike a 1031, rollovers are not an option when investing in Opportunity Zones. Reduction of capital gains tax Although a 1031 exchange can indefinitely defer capital gains tax, the process can’t reduce the capital gains tax. On the other hand, Opportunity Zones can. If an OZ investment is held for at least five years, the capital gains tax liability is reduced by 10%. Any additional gains from the investment are also free from capital gains tax, provided the investment is held for at least 10 years. Capital gains tax at disposition If an investor is still alive when the final 1031 property is sold, all capital gains associated with the 1031 exchange are taxed. But, if the investor dies before the property is liquidated, the basis is stepped-up to fair market value, essentially eliminating capital gains tax liability for the heirs. Opportunity Zone investments offer a similar potential benefit, provided the OZ investment is held for at least 10 years. If the property is sold after 10 years, the basis is stepped-up to full market value, which entirely eliminates any capital gain on appreciation. However, the initial capital gains taxes that were deferred by investing in an Opportunity Zone are still due after 2026, either from the investor or heirs.

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