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Taxes / Capital Gains
Tax-Smart Strategies for Capital Gains in 2023.
By Kayla James
Updated July 5th. 2023 09:00 am ET.
1031 Exchanges: Deferring and/or Eliminating Capital Gain Taxes.
Using 1031 exchange and qualified opportunity zones to revest the proceeds from the sale of an appreciated asset can defer and sometimes eliminate taxes. Federal capital gain taxes can siphon of up to 23.8% of the gain for investments held more than a year and as much as 40.8% for investments held for less than a year.
Named after the section of the Internal Revenue Service Code, Section 1031 exchange enables taxpayers to defer capital gains taxes the sale of an asset by reinvesting the proceeds into a like-kind asset of equal or greater value. The asset class is usually real property and real property interest like oil and gas mineral property.
Section 1031 exchanges are attractive to investors who are looking to maintain or expand their investment portfolio without triggering capital gains tax.
Key Requirements for a Valid 1031 Exchange.
There are some key requirements for a valid 1031 exchange. most important the class of asset in question must be held for investment purposes or for productive use in a trade or business. The structural variable the code is the timing requirements for the exchange. Under the IRS code, the entire exchange must be completed within 180 calendar days of the sale of the original property.
Given the complexity of a 1031 execution, there would be no wonder why it is advised for investors to seek knowledgeable counsel from a qualified intermediary.
With a qualified intermediary the asset can be identified within 45 days of the sale of the original property. the placement from the proceeds from the original sale is placed in an escrow account until the exchange is complete. The processing includes all relevant paperwork and payment of fees. Managing is important ensuring that the process is done within the proper time frame 180 calendar days of the original sale.
Failure to comply with any of any1031 requirements can result in pay the capital gain tax on the original sale or invalidation of the exchange. Learn more: Master section 1031podcast
Qualified Opportunity Zone Investing.
Unavoidable tax consequences is that the Section 1031 does not allow an investor to keep some of the proceeds of the original sale for alternative purposes. The entire amount of the original sale must be reinvested, or the shortfall amount will be treated as taxable "boot". However, there is the opportunity to investing the capital gains from the appreciated asset.
Qualified Opportunity Zones are economically distressed communities, defined by individual census tract, nominated by states governors, and certified by the Secretary of the Treasury under the authority to the Internal Revenue Service. In the United States there are 8,764 Qualified Opportunity Zones. The cause for QOZ is to spur private and public investment.
Unlike the 1031 exchange, there is no "like-kind" requirement, so whether your appreciated asset is investment real estate, an art collection a cryptocurrency investment, a stock or bond portfolio, or a cattle ranch any appreciated can be sold, and the proceeds that the portion of the proceeds that represents the investment's capital gain can then be reinvested into a Qualified Opportunity Zone. By making a QOZ investment, the taxpayer can defer payment on the original asset until Dec. 31 2026. (the current date of the program's expiration), or until the subsequent sale of the QOZ investment, whichever comes first.
Investors are also incentivized to hold the QOZ investment for at least 10 years at which time any capital gains taxes on the QOZ itself entirely eliminated. However, Appreciation on the investment of an Qualified Opportunity Zone is not guaranteed. It is wise to work with an experienced advisor to do the necessary due diligence before selecting an QOZ fund
Diversification, Capital Gains, and Ordinary Income All in One.
The most common and easy accessible way for investors to invest in oil and gas is by purchasing stock from major oil companies. Companies include: Occidental, Marathon, ConocoPhillips, EOG, and Kinder Morgan. These investments as well, will generate both capital gains and ordinary income. If these investments have been under a structured tax shelter there is immense upside potential.
there are also other ways of investing in Oil and Gas achieving the similar results. Directly investing in the energy sector removing exposure of the stock market and simultaneously locking in the tax benefits of a section 1031 exchange or a Qualified Opportunity Zone investment. Sence the passing of the TCJA. a number of funds have been created with the expressed goal of eligibility for tax-smart strategies and diversivation into the oil and gas sector.
In the interest of new and/or existing oil and gas wells are a corresponding interest in mineral rights. Since the wells in question constitute real property, they retain eligibility for section
1031 exchange, and with some of these properties in question located in QOZ. Their status as potential QOZ investment are in tact. These funds are inherently speculative, therefore it is well advised to consult with an experience advisor before venturing. If you are an investor who is interested in investing in the oil and gas industry with the section 1031 there are still great benefits in doing so. This is becuase many funds are structured where you can write-off up to 90 percent of the amount of the investment against ordinary income. There are many states in the US. that allow similar deductions. The actual amount of the deduction permitted is dependent on a number of factors.
