Legal Blog

Time to Rethink Deferment of Capital Gains

The IRS recently issued Notice 2020-23, which provides some relief via extending deadlines for certain capital gain deferment strategies.  For taxpayers who recognize capital gains, there are a couple of tax deferment strategies.  Specifically, a like-kind exchange (under IRC Section 1031) or an investment in “Qualified Opportunity Zone Property” (under IRC Section 1400Z-2).  Much has been written about both topics, and this post will not rehash those rules, but below is a quick summary along with some recent extensions by the IRS.

  • Like-Kind Exchange.
    • General Summary. Capital gain can be deferred by investing such gain into qualifying replacement property subject to the rules of Section 1031. “Deferral” means that such capital gain is then recognized on the subsequent sale of such replacement property (absent further planning). The rules are complex; however, most commonly, like-kind exchanges involve real estate.
    • Time Periods to Observe. Generally, There are certain time periods that must be observed to qualify for a like-kind exchange: generally replacement property must be identified within 45 days of the initial sale and the purchase of replacement property must be completed within 180 days of the initial sale. In addition to these time periods, there are a myriad of other rules, which is beyond the scope of this quick post.
    • Coronavirus Relief. If the end date of either the 45-day identification period or the 180-day replacement period falls on a date between April 15 and July 15, then such end date has now been extended to July 15. Beware of the complexities.  For instance, even if the identification period is extended, the day-count for the replacement period nonetheless starts from the initial sale. So, this extension may seem of little benefit to taxpayers who need to line up financing or other details of their replacement property, which have been delayed as a result of the Coronavirus.  It is yet to be seen if the IRS will return with further relief for the 180-day replacement period.
  • “Qualified Opportunity Zone Property”
    • General Summary. Capital gains can be deferred by investing such capital gains into “Qualified Opportunity Zone Property” (“QOZ Property”).  The gains are deferred until December 31, 2026, and any appreciation on such new investment could ultimately be eliminated if held for 10 years.  This is a six-year deferral of current gain combined with a Roth-IRA type exclusion of gain on additional appreciation.  Again, the rules are complex, and formalities must be observed, including making an election on the appropriate tax return.  What qualifies as QOZ Property (generally speaking) includes real estate located within, and businesses that operate within, a mandated Qualified Opportunity Zone.  Understanding this area is complex, but it does provide entrepreneurs or investors into entrepreneurial companies (such as angel investors or VCs) an opportunity to invest or start new companies with strategies to defer and/or eliminate future taxation.
    • Time Periods to Observe. The taxpayer must invest their capital gain in QOZ property within 180 days after they recognized such capital gain to qualify for such deferment.
    • Coronavirus Relief. If the end date of the 180-day period for investing such capital gains falls on a date between April 15 and July 15, then such end date has now been extended to July 15. This gives taxpayers some time to consider whether they can benefit from these rules or structure an investment into QOZ Property.

In summary, the IRS has granted these extensions that will help taxpayers within these particular situations.  However, the rules are complex, and July 15 will come quickly.  Therefore, the sooner taxpayers can navigate these complex rules the better their chances of maximizing their benefits.

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