Tax Planning for Capital Gains

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Did you know that you pay capital gains taxes when you sell an investment property? Did you also know that you could offset or defer the taxes in certain situations?

There are two ways to defer the capital gains tax: a Section 1031 like-kind exchange or a qualified opportunity zone fund.

A Section 1031 exchange means you ‘exchange’ one property for another. In actuality, you sell one property and quickly invest the funds in another like-kind property to replace it. The property must be worth at least as much as the property you sold.

A qualified opportunity fund doesn’t require you to buy another property. Instead, you take the funds earned from selling the initial property and invest them in a company (LLC, partnership, or corporation) that pools money from investors and invests in real estate the government designates as qualified opportunity zones.

How do you decide?

Here’s a significant difference. The 1031 exchange allows you to defer the taxes virtually forever. If you keep the property upon your passing, your heirs inherit it, and they get the stepped-up value, meaning they only pay taxes on the capital gains earned between the value on the date of your death and when they sell it. If they sell it immediately, they pay little to no taxes.

A qualified opportunity fund, however, is only a 4-year tax deferral. After that, you’d pay taxes on your 2026 tax return, meaning it only buys you a little time. But, if you hold the fund for at least ten years, you don’t pay taxes on the appreciation.

With a 1031 exchange, you pay capital gains taxes on the capital gains or the difference between the property’s basis and the new property’s sales price.

Another consideration is the qualified opportunity fund doesn’t require you to own and manage a property. Plus, it’s a more liquid opportunity than investing funds in another property.

There are many factors to consider. Contact us today to discuss this further if you’re considering either option with your real estate investment.