1031 Exchange vs. Opportunity Zones: What Multifamily Investors Need to Know

Are you planning on selling shares of stock, real estate, or a business? Multifamily investors seeking tax advantages have two key options: 1031 exchanges and Opportunity Zones (OZs). Understanding the advantages and limitations of both strategies enables investors to be well-equipped to make informed decisions to maximize returns and minimize tax burden.

What is an Opportunity Zone?

The Opportunity Zone program — introduced  as part of the Tax Cuts and Jobs Act of 2017 — aims to ignite economic growth by encouraging investments in distressed regions. OZs offer tax benefits to investors if they timely invest those gain amounts (within 180 days of realization) in a Qualified Opportunity Fund (QOF). Practically speaking, a QOF is the investment vehicle used to fund a project within the OZ. Roers Companies’ focus is on uncovering the hidden gems within these zones: prime locations, ripe for growth and development. Whether your capital gains stem from a business sale, real estate transaction, or stock trade, Roers Cos. can accommodate both long-term and short-term gains. By channeling investments into a QOF, these advantages enhance the overall investment appeal. 

Opportunity Zone Investment Timeline Example

Benefits of Investing in a QOF 

Temporary Deferral of Taxes on Previously Earned Capital Gains

OZ investors may defer tax on the invested gain amounts until the earlier of (i) December 31, 2026 or (ii) when the asset is disposed of. Simply put, the gain will reflect on an investor’s 2026 tax return and he or she would pay it in 2027; all in all, they would have a three-year deferral to make that tax payment. 

Permanent Exclusion of Taxable Income on New Gains

Where an investor holds his or her interest in the QOF for 10 years or more and after such 10-year holding period has been surpassed, the investor may be able to permanently exclude from U.S. federal income tax any gain earned from the QOF investment, which includes depreciation recapture. In short, as long as Roers Cos. holds for 10 years, which is our commitment to our investors on OZ projects, the appreciation or the gain on the backside when Roers Cos. sells a project comes out completely tax-free.

Enhanced Returns

By investing in a multifamily real estate project that is part of an OZ, investors can potentially benefit from these enhanced returns while also enjoying the tax benefits associated with QOFs.

Depreciation Benefits

The depreciation deduction allows for investors to offset passive income received from the investment, thereby substantially reducing the amount of income investor is required to recognize.

What is a 1031 Exchange?

A 1031 exchange, named after the relevant section of the U.S. tax code, is a strategy for real estate investors to defer capital gains taxes. When you sell a property that has increased in value (appreciated), you typically owe capital gains tax on the profit. A 1031 exchange allows you to postpone that tax bill. To qualify for the deferral, you need to reinvest the proceeds from the sale into a “like-kind” property within the indicated timeframe. In simpler terms, properties are like-kind if they’re the same nature or character, even if they differ in grade or quality. For multifamily investors, this means exchanging real estate for real estate, such as retail for an apartment building, single-family homes for commercial real estate, etc.  

1031 Exchange vs. Opportunity Zones

It’s important to understand the differences between a 1031 exchange and an OZ investment, and when to utilize each. A 1031 exchange allows for the transfer of real estate assets without immediate tax consequences, as long as the proceeds are reinvested into another property within the allotted timeline. This deferral strategy is ideal for those looking to upgrade their real estate portfolio without incurring immediate hefty taxes. It is crucial to reinvest the full amount of the realized proceeds to avoid any tax implications. Failure to do so may result in taxable gain on the uninvested portion. 

One of the challenges with 1031 exchanges is the tight timeframe to identify new projects, leading to rushed decisions that may not be optimal. Unlike the rigid 45-day window of a 1031 exchange, the OZ program offers more flexibility. You have 180 days versus the short window of time with a 1031. With an OZ, you also have the choice to defer your entire gain or only a portion, allowing you to tailor your tax strategy to suit your needs. 

An advantage of investing in an OZ compared to a 1031 exchange is the flexibility when selling the property. With a 1031 exchange, you are often pressured to reinvest in another property to avoid a larger tax burden. This creates a cycle of constantly searching for new investments, and sometimes buying just to avoid paying taxes. On the other hand, with an OZ investment, although you pay taxes on the original investment after three years, you will walk away from the future sale gains in 10 years completely tax-free.  

By investing in an OZ, you break free from the real estate cycle’s constraints. Some even seek to exit their 1031 cycle by selling properties that have undergone multiple exchanges and reinvesting the gains into an OZ. While acknowledging the tax implications, this strategy helps alleviate the burden of deferral and leads to a tax-free step-up upon sale. These nuances distinguish the OZ approach.

If you’ve recently sold a stock, business, real estate or triggered a capital gain, let’s talk about OZ investments. These are great projects as standalones, and when you add the tax benefits, OZs can be a home run for your portfolio. If you have questions about these market insights or current investment opportunities with Roers Cos., contact our investor relations team or take a closer look at the investment hub on our website: roerscompanies.com/opportunity-zones

NOT TAX ADVICE: This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.

NO OFFER OF SECURITIES; DISCLOSURE OF INTERESTS: Under no circumstances should any material or information contained herein be used or considered as an offer to sell or a solicitation of any offer to buy an interest in any investment. Any such offer or solicitation will be made only by means of the  confidential Private Placement Memorandum relating to the particular investment. Access to information about investments with projects undertaken by Roers Companies LLC, Roers Companies Project Holdings LLC, or any of their respective affiliates is limited to investors who either qualify as accredited investors within the meaning of the Securities Act of 1933, as amended, or those investors who are generally are sophisticated in financial matters, such that they are capable of evaluating the merits and risks of prospective investments.

Investment outcomes vary. Past success does not guarantee future results.