How 1031 Exchanges Interact with Opportunity Zones
Can Investors Use Both Strategies Together?
1031 exchanges and Opportunity Zones are two of the most powerful tax tools available to real estate investors — but they operate under very different IRS rules. Many investors assume they must choose one or the other, but in certain situations, these strategies can work together.
Here’s what you need to know.
What a 1031 Exchange Does
A 1031 exchange allows investors to defer capital gains taxes by reinvesting sale proceeds into like-kind real estate.Key benefits include:Full tax deferralAbility to reinvest 100% of equityPortfolio growth through leverageBut it requires:Strict 45-day identification180-day closingReinvestment into real property
What an Opportunity Zone Offers
Opportunity Zones (OZs) provide tax incentives for investing capital gains into designated communities.Benefits include:Deferral of capital gains until 2026Partial reduction of the deferred gain (if held long enough)No tax on the new investment’s appreciation if held 10+ yearsBut:OZ funds require investment through a Qualified Opportunity Fund (QOF)The asset must meet substantial improvement or original use rules
How the Two Strategies Can Work Together
Here’s the part most investors don’t know:
You can 1031 into a property located inside an Opportunity Zone.
This does not give OZ tax benefits — but you still receive 1031 deferral.
You cannot place 1031 proceeds directly into a QOF.
Why? Because QOFs must receive cash from a taxable sale, not proceeds from a 1031 exchange.However…
You can do a 1031 exchange now, and later sell the replacement property and invest that gain into a QOF.
This two-step strategy allows:Short-term deferral via 1031Long-term tax elimination via Opportunity Zone investmentIt’s not common — but when timed correctly, it can be powerful.
When the Strategies Conflict
A 1031 exchange cannot be used to reinvest directly into:A QOFA partnership interestA fund structure that doesn’t hold direct real estateThis is the biggest misconception among investors.Additionally, Opportunity Zone rules require:Substantial improvementCompliance reportingInvestment through a QOF structureThese do not align with 1031 requirements.
While you can’t directly place 1031 funds into an Opportunity Zone Fund, investors can use both strategies in sequence — or invest in Opportunity Zone real estate directly through a traditional 1031 exchange.
Thinking about using both tax strategies? We can help you analyze whether a 1031 exchange, an Opportunity Zone investment, or a combined approach is the best fit for your goals.
