Opportunity Zone vs 1031 Exchange: Invest Now or Wait for OZ 2.0?

1031 exchange or opportunity zone fund: what does each defer?

A 1031 exchange can defer all of the gain on investment or business real property, with no end date, if you put all the net proceeds into replacement real property and replace any debt paid off. A Delaware statutory trust (DST) is not a third route: it is one kind of replacement property for a 1031 exchange. An opportunity zone fund defers only the gain you invest, from almost any capital sale, and only for a set time.

Sources: Form 8824 instructions; Notice 2026-40, section 4.02; Public Law 119-21, section 70421.

In a 1031 exchange you must not receive the sale cash: a qualified intermediary, engaged before closing, holds it and acquires the replacement for you. If you receive the money or can draw on it, the sale is taxed (26 CFR 1.1031(k)-1(f) and (g)(4)). Within 45 days, name the replacements in a signed, written document sent to the intermediary or the seller: up to three properties of any value, or more if their total value is no more than twice the value of what you sold (26 CFR 1.1031(k)-1(c)).

A case is simple when one person sells one property and buys one replacement. It needs professional judgment when the gain sits inside a partnership or comes on a K-1, when a sale falls near year-end, or when a state is involved. A CPA can compare both routes on your numbers before the deadlines run. Gather the closing statement, the K-1 that shows the gain, and any earlier Forms 8824.

Can I do a 1031 exchange into a syndication or a fund?

No. An interest in a partnership is not real property for section 1031, so you cannot exchange a property for units in a syndication, a fund or an LLC taxed as a partnership (26 CFR 1.1031(a)-3(a)(5); Form 8824 instructions). The only exception is a partnership with a valid election under section 761(a) to be left out of the partnership tax rules, which is rare for a syndication. Stock and certificates of trust or beneficial interests are not real property either.

A Delaware statutory trust (DST) is the main exception people use. In Revenue Ruling 2004-86, the IRS held that a taxpayer can exchange real property for an interest in a DST without recognizing gain, if the trust is an investment trust and the other section 1031 rules are met. The ruling's trust had tight limits: the trustee could not take new money, buy other property, renegotiate the lease or the loan, or make more than minor changes to the building. Whether a given DST qualifies depends on its trust agreement and how it is run. Reporting a DST each year is covered in Delaware statutory trust tax reporting.

My syndication is selling: can I exchange my share?

Usually not on your own. The partnership owns the property, so the partnership decides whether to sell or exchange, and an exchange at that level covers every partner.

Some partners ask the partnership to deed them a share of the property before the sale, so each can exchange separately. Whether that works depends on whether each partner then holds the property for investment, as section 1031 requires (26 U.S.C. 1031(a)), and the statute sets no fixed holding period. It needs a lawyer and a tax review before the deal closes, not after.

If the partnership sells and passes the gain through on your K-1, section 1031 no longer applies to you, but a qualifying gain can go into an opportunity zone fund within the 180-day periods below. What to do with a final K-1 is covered in Your final fund tax form.

Which gains can go into an opportunity zone fund?

Capital gains and qualified 1231 gains can go in. Wages, option income taxed as pay, and other ordinary income cannot (Opportunity zones FAQ, Q11 and Q29).

• Gain on a rental or business property (qualified 1231 gain) can go in, except the part taxed as ordinary income because of earlier depreciation. For a building depreciated evenly each year (straight-line), that part is usually zero, so most or all of a building's gain qualifies. Equipment, furniture and other personal property are different: their depreciation is usually taxed as ordinary income (26 CFR 1.1400Z2(a)-1(b)(11)(iii); Form 4797 instructions).
• Selling a business. Capital gain on shares can go into an opportunity zone fund, never into a 1031 exchange. In an asset sale, the real estate can be exchanged, capital or qualified 1231 gain on assets such as goodwill can go into a fund, and ordinary income, such as on inventory or recaptured depreciation, can go into neither; see Selling your business.
• Futures and straddles. Gain from section 1256 contracts and from positions in a straddle is generally not eligible. Exceptions cover net gain from section 1256 contracts that were never part of a straddle, and some identified straddles (26 CFR 1.1400Z2(a)-1(b)(11)(vi)).
• Related buyers. Gain from a sale to a related person is not eligible.
• Only the gain. You need to invest only the amount of the gain, not the whole sale price. You can also invest part of the gain and defer only that part (FAQ, Q13). Money you invest beyond your eligible gain is a separate, non-qualifying investment with no opportunity zone benefits (26 CFR 1.1400Z2(a)-1(c)(6)).

The IRS FAQ and the regulation still limit eligible gains to those taxed before January 1, 2027. Public Law 119-21 removed that limit, as Notice 2026-40, section 4.02(2) confirms.

My gain came on a fund K-1: when does my 180-day window start?

Generally on the last day of the partnership's tax year, which is December 31 for a calendar-year fund. The day the K-1 arrives does not matter (FAQ, Q23).

If the partnership did not defer all of its gain itself, you may instead choose either of these starts (26 CFR 1.1400Z2(a)-1(c)(8)(iii)):

The same choices apply to S corporation shareholders and to beneficiaries of estates and non-grantor trusts. If the partnership made its own deferral election, that gain never reaches your K-1 as taxable gain, and there is nothing for you to defer.

I have a gain this year: invest now or wait for January 1, 2027?

An old-rule investment, made by December 31, 2026, has its deferred gain included no later than the return for the year that includes December 31, 2026 (Notice 2026-40, section 4.01(1)). For a gain from this year, that is the same return, so nothing is deferred.

It still keeps the 10-year benefit: hold it 10 years and you can elect no tax on the fund's growth (Notice 2026-40, section 4.01(3)). If the zone's designation has ended, the regulation keeps that election only for a sale made by December 31, 2047 (26 CFR 1.1400Z2(c)-1(c)).

A gain from this year that is invested on or after January 1, 2027, still within its 180 days, gets the new rules (Notice 2026-40, section 4.02(2)). That works when:

• the gain came late in the year, so the 180 days reach into the new year;
• the gain came on a K-1, so the 180 days can start on December 31 or the partnership's March 15 due date; or
• the gain is reported on the installment method, is net gain from section 1256 contracts, or is a capital gain dividend from a mutual fund or REIT, because those 180 days can start on December 31 (26 CFR 1.1400Z2(a)-1(b)(7)(ii), (b)(11)(vi)(B) and (b)(11)(viii)(B)).

The 180 days begin on the day the gain is realized. Any other gain realized on or before July 5, 2026 has 180 days that end by December 31, 2026, so the new rules cannot apply to it.

If you will invest after your return is due, file an extension and elect the deferral on the return filed after you invest, or on an amended return (FAQ, Q16). An extension does not extend the time to pay (IRS).

A fund's property bought after December 31, 2026 generally must be in zones designated under the new law (Notice 2026-40, section 5.01); how a fund qualifies is covered in Setting up a qualified opportunity fund.

Opportunity zone 2.0: what do the rules give from January 1, 2027?

For an investment made on or after January 1, 2027, the new rules give 5 years of deferral, a basis increase at 5 years, and no tax on the fund's growth after 10 years (Public Law 119-21, section 70421(c); Notice 2026-40, sections 4.02 and 5.02). Regulations for these rules have not been issued; Notice 2026-40 is transitional guidance, so details may change.

The amount taxed at the 5-year date is the deferred gain, or the investment's value if lower, minus your basis. A qualified rural opportunity fund is one whose assets are, under the law's test, property in zones made up entirely of rural areas.

The tax at the 5-year date is due even if the fund pays you no cash.

Depreciation recapture and death: how do the routes compare?

Depreciation recapture is the part of a sale gain that comes from depreciation deducted earlier. The two routes treat it, and death, very differently.

1031 exchange. The deferred gain, including the part from depreciation, moves into the replacement property through a lower basis (Form 8824 instructions, Part III). If you still hold the replacement at death, your heirs' basis is generally its fair market value on the date of death (26 U.S.C. 1014(a)), so the deferred gain is generally not taxed to anyone.

Opportunity zone fund. When the deferred gain is later included, it keeps its original character, such as long-term capital gain or qualified 1231 gain (Form 8949 instructions; 26 CFR 1.1400Z2(a)-1(c)(1)). Ordinary recapture was never deferred, so it was taxed in the sale year. Death is not an inclusion event, but the deferred gain does not go away: the heir reports it when the investment is sold or the 5-year date arrives. The heir's basis is zero plus any increases already earned, not the value at death (26 CFR 1.1400Z2(b)-1(c)(4) and (g)(6)). What heirs do next is covered in Inheriting a fund interest.

Does my state follow each route?

States differ, so check the state where the property is and the state where you live. California, for example, follows section 1031 but not the opportunity zone rules.

• California and 1031. If you exchange California property for property outside California, you must file Form FTB 3840 for the year of the exchange and each later year until the California-source deferred gain is recognized. This applies whether or not you live in California. If you file neither the form nor a California return, the Franchise Tax Board may assess the deferred gain (2025 FTB 3840 instructions).
• California and opportunity zones. California does not follow the deferral or the exclusion for opportunity zone funds. A California taxpayer reports the whole gain on the state return in the year of sale (2025 Schedule D (540) instructions).

What do I file in the year I choose?

Each route has its own forms, and missing one can cost the deferral.

What if the exchange fails or the deadline passes?

If a 1031 exchange fails, the gain is generally taxed in the year of the sale. If a qualified intermediary holds the cash into the next year, the gain may be reported when the cash is paid out (26 CFR 1.1031(k)-1(j)(2)). If a deferred exchange misses the 45 days or 180 days limits, it is not a like-kind exchange, and any gain may be taxable in the year you transferred the property (Form 8824 instructions). An opportunity zone investment made after day 180 is not a qualifying investment.

A large gain taxed in one year can also bring a penalty for paying too little estimated tax during the year; see Estimated tax in a big bonus year. Claiming a deferral that does not qualify can add an accuracy-related penalty of 20% of the underpayment (IRS).

Example

Illustrative only, in US dollars; no tax is computed.

A K-1 gain invested under the new rules

Maria is a limited partner in a calendar-year real estate syndication. The syndication sells its building in November and does not defer the gain itself. Her K-1 shows $600,000 of qualified 1231 gain.

• Her 180 days start on December 31, the last day of the partnership's year, so they run to about June 28, 2027.
• She invests $600,000 in a qualified opportunity fund in May 2027. Because that is on or after January 1, 2027, the new rules apply.
• On her return for the year of the sale, filed on extension or amended after she invests, she reports the gain, enters the deferral on Form 4797, line 2, elects it on Form 8949 in a code O row and a code Z row, and files Form 8997.
• If she holds 5 years, her basis rises by 10%, or $60,000. In the year that includes the 5-year date in May, she reports $540,000 of deferred gain, still as 1231 gain, if the investment is worth at least $600,000.

Had she chosen the partnership's 180 days and invested in December under the old rules, the $600,000 would be included on her return for the same year, with no deferral.

A rental sold by its owner

Sam sells a rental he owns directly for $1,500,000, with a $700,000 gain and a $400,000 mortgage paid off at closing.

• 1031 route: to defer all of the gain, he buys replacement real property worth at least $1,500,000, such as a qualifying DST interest, within the deadlines, puts in all $1,100,000 of cash, and replaces the $400,000 of debt with new debt or more cash. If he keeps $100,000 of cash, $100,000 of gain is taxed now; that taxed gain may itself be eligible for an opportunity zone fund.
• Opportunity zone route: he invests up to $700,000, the gain, within 180 days of the sale and keeps the rest of the proceeds. If he invests on or after January 1, 2027, the deferred gain, less the 10% basis increase, is taxed at the 5-year date unless he sells sooner. Only depreciation taxed as ordinary income is left out; for a rental building depreciated on the straight-line method, that is usually none.

Different for you?

• You already hold an opportunity zone fund and your deferred gain comes due: see Opportunity zone deferred gain coming due.
• You need to report a DST after the exchange: see Delaware statutory trust tax reporting.
• You are forming your own opportunity zone fund for the gain: see Setting up a qualified opportunity fund.
• You live in Canada and are exchanging a US rental: see Exchanging a US rental property.
• Your syndication sold and sent a final K-1: see Your final fund tax form.
• You are selling a rental you own directly and want the general rules: see Rental property taxes.
• You are selling your business: see Selling your business.
• Part of the sale gain is your carried interest: see The carried interest three-year rule.
• Your gain is on startup stock: see QSBS through a venture fund.
• You want both routes compared on your numbers before the 180 days run out, or the gain is inside a partnership you manage: see hedge fund and real estate fund tax.
• You want your own return prepared for the sale year: see individual tax.