In order to make a tax free like kind exchange, replacement property must be identified within 45 days of the sale of the old property and the replacement property must be acquired within 180 days of the sale. As you might expect, these timelines can be challenging to meet.
Taxpayers can also defer gain by investing in a Qualified Opportunity Zone (QOZ) investment. The QOZ rules also require that the investment (in a Qualified Opportunity Fund (QOF)) be made within 180 days of the date of sale of their property. However, unlike a 1031 exchange, there is no tracing rule so an investor can use funds from any source (including debt) to invest in the QOF. Also, the investor only needs to invest an amount equal to the amount of gain that they want to defer, unlike a 1031 exchange where they must reinvest all of the proceeds (gain and return of capital) to avoid recognizing gain.
Consequently, if an investor is unable to identify replacement property within 45 days, they could obtain return of the proceeds held by the 1031 qualified intermediary (QI) and invest them into a QOF. Even if an investor is able to identify a property within 45 days, the deal might not close, or might not be able to be closed within 180 days. While the investor may not be able to obtain return of their funds from the QI prior to the 180th day, they may be able to borrow funds to bridge a QOF investment.
The benefits of a QOZ investment are a little different than, and in some respects, not as good as those of a like kind exchange, and in some respects better. An investment in a qualified opportunity fund has two benefits 1) deferral of gain but only until December 2026 (there are legislative proposals to extend this date), and 2) no tax on the gain from a subsequent sale if the held for 10 years. By contrast, in a 1031 exchange, while the gain can be deferred indefinitely, upon a sale event, that gain will be taxable.
Bottom Line: If your like kind exchange fails or is going to fail, keep in mind a QOZ investment to help mitigate the tax consequences.
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