The section 1031 regulations require a qualified intermediary.
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Why do I need a qualified intermediary for a Section 1031 transaction but not to place an investment in an QOF?
If I’m rolling over gains from real estate, is there a benefit to do it into a QOF compared to a 1031 exchange?
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The short answer is that 1400z is a different section of the code than section 1031 and has different requirements and benefits. There are pros and cons to both 1031 and QOF investment options. 180 days to reinvest the proceeds in a QOF, and the flexibility to invest as much or little of the gain as you like is certainly one of the QOF advantages. The chance for a step-up in basis of the fair market value without having to die is another.
It’s the law. Section 1400z that covers Opportunity Zones does not require an intermediary. Section 1031 is an evolved law that has been clarified by court cases and revenue rulings. These cases have allowed for delayed exchanges if money is held by an intermediary.
There are a number of differences between the 1031 and QOF programs. As you have stated, the need for a qualified intermediary and needing to place your proceeds in escrow is just one of the differences. Please be aware that there are differences that favor each side differently, and the geographic restrictions of QOF's, substantial improvement requirements and end date to the deferral are some of the items to be aware of before prioritizing a QOF instead of 1031.
You don't need a QOF, because the OZ program's tax benefits apply upon the sale of any asset for capital gains, not just real estate. Applying to be a qualified intermediary would be onerous for those selling publicly traded securities or fund interests. QOF and 1031 are different programs with different pros and cons. A full description is too long to provide here, but a comparison could be found here: https://www.linkedin.com/pulse/opportunity-zone-investments-replace-section-1031-matthew-e-/
Which is more beneficial for a particular investor depends on the specifics of each case and the priorities and goals of the investor. There are significant differences between the two, but there is no one-answer-fit-all solution.
The use of a qualified intermediary is mandated in the safe harbor rules set out in Treasury Regulation 1.1031(k)-(1(g)(4). The rules stipulate that a reciprocal trade or actual exchange must take place in each transaction. This means the exchange must assign their interest in both the relinquished property and the replacement property to the qualified intermediary. The qualified intermediary actually acts as a principal in the transactions which is how a reciprocal trade is created even when the replacement property is being purchased from someone other than the buyer of the relinquished property. The objective of Opportunity Zones is to give tax breaks to spur economic growth and development in lower-income areas. One of the ways the rules incentivize investors is by keeping the requirements as minimal as possible, hence the rules do not require the use of a qualified intermediary when making an investment in a QOF. The benefit of using a QOF over a 1031 exchange depends on your objectives. With a QOF, only the gain needs to be reinvested. However, the investment in the QOF would need to be held for at least five years to receive any reduction in taxes. It is also worth noting the tax deferral with a QOF is temporary and taxes on the gain will be due in 2026 when the Opportunity Zone provisions expire. With a 1031 exchange, while you will need to reinvest the net sales proceeds, you will benefit from 100% tax deferral on the sale and you may be able to defer taxes permanently. I recommend you discuss the benefits of each of these tax deferral strategies with a tax attorney and your CPA to help you determine which strategy best aligns with your goals.
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