Rolling over gains using a Qualified Opportunity Fund (“QOF”) is a unique mechanism in several ways:
- Gains from any source can be rolled over, not just from real estate (this includes stocks and business sales).
- When an investor holds their interest in the QOF for 10 years, upon sale the appreciation in that interest is not taxed. That means an investor can invest $100k, that grows to $250k over 10 years, and the $150k gain is not taxed.
- The gain from the initial sale is deferred until 2026, and there is a 15% step up in basis (10% if held for five years and an additional 5% if held for seven years).
Looking at those points in more detail, investing in a QOF is different from rolling over gains using s1031 in both the source of gains and the end result upon sale.
- To roll over into a QOF, the gain can be from any source, not just real estate. 1031 exchanges are only available to those selling investment real property. This is particularly significant for those with gains in the stock market or from sale of a business.
- In a 1031 when the upleg property is eventually sold capital gains will be due at that time (providing the investor does not do another 1031, assuming 1031 exchanges are still allowed in future). In a QOF investment capital gains tax on the original gain is deferred to 2026 and the investor gets a 15% stepped up basis (providing they invested in 2019, otherwise there is a 10% step up if held for five years). Most significantly, at the sale after 10 years the investor’s gains on the fund investment are not taxed.
- A 1031 exchange is from one investment property to another investment property of greater or equal value. Finding such a property can be difficult and the time frames to identify and close are tight (45 days and 180 days respectively). A QOF investment involves rolling over gains from any source into the fund within 180 days. Any portion of the gain may be rolled over, there is no requirement to invest the whole gain to satisfy a ‘greater or equal’ test as there is in a 1031.
From an investor’s perspective there are several things to consider when choosing between a 1031 and a QOZ investment. If the investor has gains from anything other than real estate then 1031 is not an option, whereas a QOZ fund is open to any source of gains. If the investor is experienced in owning investment property and wishes to grow and manage his or her portfolio over several decades and to keep any proceeds on sale of those investments within the portfolio, then a 1031 is a good option. If the investor wants a tax-free sale after 10 years, where the proceeds can be taken for the investor to use as they please, then a QOZ investment is more favorable.