Long story short, the two tax programs are not necessarily alternatives to each other and are not even necessarily mutually exclusive.
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Why are QOFs a beneficial alternative to 1031 exchanges for real estate investors?
What are the different requirements between OZs and 1031?
Answers
The biggest one is that for a QOF, you only need to reinvest your gain or part of it, instead of the total proceeds. There are other differences as to holding periods, but it is a case-by-case analysis.
1031 exchanges have several advantages over deferring gains on an Opportunity Zone investment. The deferred gain will be avoided if the owner dies due to a step-up in basis. However, an investor in an OZ fund will not get a step-up in basis and the investment goes to heirs with the lower basis. An exchange can be the direct purchase of real estate; the OZ investment must be made into a fund. An exchange can be real estate anywhere inside the U.S.; the OZ investment is limited to areas designated economically disadvantaged. Because the investment must be improved, to qualify as an OZ investment, the OZ investments are generally development deals that will not create cash flow in the first 2 to 4 years. The OZ investment is of great use when: The capital gain is not related to real estate and does not qualify for an exchange, such as the sale of a business or stock portfolio; the taxpayer only wants to invest the gain portion and not the entire value of asset sold; there is no need to do an identification. OZ investment is a great solution when the 45 day identification period of 1013 exchanges is blown. It is also a good solution when a gain is recognized inside of a passthrough entity and some of the investors want a deferred gain and the others just want all cash and to pay the tax. If the owner dies and the heirs do not sell until the original 10 year period has elapsed, step-up is on all the gain and not just the gain prior to death.
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