1031 with DST and QOZ fund

[Strongsilence-CPA]

I don't understand this 1031 completely.

Client 1031 was done with an exchange service provider.  Client's investment property relinquished and deferred gain went to two DSTs. He took 400K cash into his personal account, then invested that into 2 Qualified Opportunity Zone Funds (within 180 days).  I have read the only recognized capital gains are allowed to be invested into QOZ funds.  So that means F8949 is required to report the gain.  What is the amount of the gain?

QOZ funds are not* allowed to be included in a 1031. So, the problem seems to be that the deferred gain calculation must allocate the gain to the 4 investments. But if QOZ funds are not a part of the deferred gain / 1031 then how is the gain on only the QOZ funds calculated?

*  A QOZ fund is not an investment into the underlying real estate.  Therefore, it cannot be a 1031 exchange.

[sjrcpa · Accepted solution]

The $400K your client received is boot. He recognizes gain up to the $400K. Then that gain can be deferred into the QOZ fund.

[Strongsilence-CPA]

oh boy.

The 400K was taken personally and contributed within the 180-day requirement.

[qbteachmt]

"The 400K was taken personally"

He touched it. He had control of it outside of the 1031 exchange, so it is no longer sheltered funds.

"and contributed within the 180-day requirement."

Which rule is this? The one for 1031, which no longer applies to money outside of the exchange service's escrow function?

[sjrcpa]

"and contributed within the 180-day requirement."

Which rule is this?

The rule for deferring gain into a QOZ fund.

[BobKamman]

@sjrcpa is on the right track.  It would be helpful to have some numbers here.  Let's say the property sold for $1 million, with a basis of $100K, so a $900K gain. The two DST's (apparently Delaware Statutory Trust must replace Daylight Savings Time in our vocabulary) cost $600K.  So, $500K gain rolled over and basis of those two items is $100K.  The other $400K is "boot" that would be taxable gain, had it not gone into the QOZ property.  

[Strongsilence-CPA]

Those numbers do illustrate my client 1031 and explain it to me.

1. 100% of the gain rolled over is transferred to the new basis - for the two DSTs only.

2.  All the cash used to purchase the QOZ is deferred gain because it has gone into the QOZ funds. 

3. The 400K is then reported as the deferred gain on the Form 8949.

Point 2 is interesting. $400K is taxed because it is boot and means it is capital gain eligible for the QOZ deferral provision.

[Strongsilence-CPA]

BUT CALIFORNIA, the entire 400K is recognized gain for California.

Qualified Opportunity Zone Funds

The TCJA established Opportunity Zones. IRC Sections 1400Z-1 and 1400Z-2 provide a temporary deferral of inclusion of gross income for capital gains reinvested in a qualified opportunity fund, and exclude capital gains from the sale or exchange of an investment in such funds. California does not conform to the deferral and exclusion of capital gains reinvested or invested in federal opportunity zone funds under IRC Sections 1400Z-1 and 1400Z-2, and has no similar provisions. If, for California purposes, gains from investment in qualified opportunity zone property had been included in income during previous taxable year, do not include the gain in the current year income.

[Strongsilence-CPA]

Finally, Form 8824.  I need to NOT list the 400K as cash received so that 0 gain is reported.

[qbteachmt]

I'm so glad you brought the specific State into the discussion. I was going to ask for that info next. I only one client using QOZ, but it's across a couple of States, so I had to help them understand how to do their segregation.