Opportunity Zone Loophole?

[Dave Peterson]

Forgive my ignorance here. I'm just getting started in investing, so this topic may be old hat for a lot of you.

I'm wondering if I were to do a 1031 exchange to a property in an opportunity zone, would I never have to pay capital gains tax on either property (if I sold the second property)?  Happy to clarify my thinking if this doesn't make sense.

Also, if anyone knows any advantages/disadvantages of refinancing a home in an opportunity zone, I would love to hear those!

[Aaron H.]

There's quite a bit of nuance to how capital gains work for OZ investments. Short version, these kind of exchanges really just mean you're deferring your taxes, not avoiding them entirely.

Straight from the IRS:

"...investors can defer tax on any prior gains invested in a Qualified Opportunity Fund (QOF) until the earlier of the date on which the investment in a QOF is sold or exchanged, or December 31, 2026. If the QOF investment is held for longer than 5 years, there is a 10% exclusion of the deferred gain. If held for more than 7 years, the 10% becomes 15%. Second, if the investor holds the investment in the Opportunity Fund for at least ten years, the investor is eligible for an increase in basis of the QOF investment equal to its fair market value on the date that the QOF investment is sold or exchanged."

In theory you can keep 1031 exchanging things to keep deferring taxes until you die (continuing to increase your basis in the next thing you buy), but in practice that can be tough to pull off...

Note also that there are other rules surrounding what property qualifies, what counts as a "qualified opportunity fund," and whether you have to make additional investments into improvements in the property to qualify.