Hope you enjoy the latest edition of our CRS newsletter!
Quote of the Month:

“Real estate is an imperishable asset, ever increasing in value. It is the most solid security that human ingenuity has devised. It is the basis of all security and about the only indestructible security.” 

x - Russell Sage, American Financier and Politician
Opportunity Zones and 1031 Exchanges . . .
What’s a Real Estate Investor to Do?

In the world of real estate investing, 1031 Exchanges have long been a popular tax incentive allowing sellers to defer capital gains on the sale of a property by reinvesting them back into the market. Within the last year, a new type of incentive has emerged as a result of the 2017 Tax Cuts and Jobs Act (TCJA) - Opportunity Zones. To encourage growth and job creation within economically distressed communities, the TCJA allowed state governors to nominate locations that were then certified by the US Treasury to be designated as Qualified Opportunity Zones. Under this new strategy, those who invest in one of over 8,700 of these designated areas through a Qualified Opportunity Fund have a new way to defer and potentially eliminate part of their capital gains tax liability, depending on how long they hold the investment and how they use the property.

As with all things tax-related, specific rules governing how a taxpayer can take advantage of investing in an Opportunity Zone are quite complicated. The IRS published a list of Opportunity Zone Frequently Asked Questions to help explain the initial set of regulations sent last year. This April, the US Treasury released a second round of proposed regulation s to clarify many more taxpayer-friendly aspects of Opportunity Zone investments. The 169-page document provides significant guidance and details on the requirements necessary to benefit from the newest strategy.
Why Invest in an Opportunity Zone?

The biggest draw of an Opportunity Zone investment is that it can be made using capital gains that are not exclusively from real property held for investment. The sale of a business, personal property or stocks can’t be used for a 1031 Exchange, but are eligible to be put into a Qualified Opportunity Fund that invests in an Opportunity Zone.

However, the primary intent of the Opportunity Zone incentive is to have the capital infused into economically depressed areas long enough to make a difference in the community. Therefore, incentives for excluding, rather than just deferring, tax liability only take effect after a property is held for at least 5 years, at which time 10% of the tax liability will be excluded. After 7 years, that number jumps to 15%. If it’s held for 10 years, all of the new gains can be permanently excluded. For example, if you invested in a property worth $1M and its value increases to $2.5M within the 10 years it’s held, you will get a permanent tax exclusion on the $1.5M profit.

The Opportunity Zone incentive will run out at the end of 2026, so you do have a limited time in which you can defer your tax gains. The upside is that until then you get full access to the capital you would otherwise have to pay in taxes to invest and grow your money. The downside is that the deferred portion of the original tax will be due by April 15, 2027, even if the new gain is excluded. 

If you can hold on to an Opportunity Zone investment for 10 years, another huge benefit comes when the property eventually is sold. At that time you will be eligible for an increase in basis (the amount of the original investment) of the investment equal to its fair market value. Since taxpayers are taxed on the difference between their basis and the sale price, this effectively means the transaction will be tax free.

According to a Zillow study reported in the World Property Journal, sale prices on properties in Opportunity Zones have risen by 20% just since last spring, indicating a strong interest in these types of properties. To get the full benefit of the tax deferral, you have about 2.5 years left to decide whether to make an investment in an Opportunity Zone.

Why Invest in a 1031 Exchange?

Unlike investing in an Opportunity Zone, a 1031 Exchange can be used as a tax incentive only if you have capital gains resulting from the sale of real property held for investment. However, since becoming part of the tax code in 1921, 1031 Exchanges have long been a great tool to foster economic growth and development. A 1031 Exchange has no time restrictions on how long it needs to be held, so a 1031 exchanger has the option to reinvest more times within a same 10-year period as someone investing in Opportunity Zones, potentially getting a better overall return on investment. In fact, the 1031 Exchange incentive can be a permanent tax deferral vehicle, as long as the investor continues to meet the reinvestment requirements. Some additional advantages could be:

  • Flexibility – you can choose to not take full tax deferral if you want to reduce your debt, mortgage, etc. Opportunity Zones rules don’t allow for this.
  • Step-up in Basis – if you continue to do 1031 exchanges throughout your lifetime, the full tax deferral can be passed on to your heirs - and the value will be stepped up to the full present day fair market value. 
  • Real Estate Tax Deductions - 1031 Exchange investors benefit from deductions such as mortgage interest, depreciation benefits, etc. Since an Opportunity Zone investor invests into a fund rather than real property, they don’t get those benefits.
  • Opportunity to Refinance – 1031 investors can refinance to pull money out of their new investment after the exchange is complete. The IRS hasn’t addressed Opportunity Zone refinancing options yet.
  • Timing/Payment of Taxes – If an Opportunity Zone investor doesn’t have the cash to pay the deferred taxes due by the end of 2016, they may need to sell other assets to pay them. 1031 investors potentially have more control over the timing of the taxes they owe.

So What’s Best for Me?

Depending on an investor’s particular financial situation, 1031 Exchanges and investments in Opportunity Zones are both exciting opportunities to maximize their return on investment and save on capital gains. However, they are both complicated strategies with different sets of investment rules that must be followed. You should consult with your tax professional to review your options carefully and discuss how you could potentially combine both strategies before deciding what is best for you.
Experience the CRS difference in cost segregation services:

Our in-house professionals include construction engineers and accredited appraisers with extensive technical experience in tangible asset appraisal and real estate tax accounting. This allows CRS to offer real value by providing detailed, IRS-compliant cost segregation studies to clients owning all types of commercial property.
When you choose CRS you get:

  • A detailed cost segregation study following IRS guidelines
  • A company that truly understands the mechanical, electrical, HVAC and other assets in your building that qualify for accelerated depreciation
  • A company whose primary business is cost segregation
Call or email CRS for a complimentary, risk-free cost segregation proposal
and see how you can reduce federal and state income taxes,
optimize depreciation deductions and increase cash flow.

Contact:  Rob Rahner
Email:   rob@CRScostseg.com
Phone:   732.548.3855
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