Alternative investments 101.

Despite their structural differences, both strategies offer several shared benefits:

• Capital gains deferral: Investors may defer taxes on realized capital gains by reinvesting proceeds under the rules of either program.
• Real estate exposure: Although OZ funds can include investments in businesses, both strategies are commonly used to reinvest in real estate, which can provide diversification benefits relative to public equity and fixed income markets.
• Economic development incentives: Both approaches encourage reinvestment into the economy. 1031 Exchanges support continued investment in commercial and investment real estate, while OZs target underserved communities that have been identified by federal and state governments.

Eligible types of capital gains

• 1031 Exchange: Only capital gains from real estate sales are eligible. The replacement property must be “like-kind,” which generally means it must also be real estate used for investment or business purposes.
• Opportunity Zones: Capital gains from the sale of any capital asset, including real estate, stocks, or business interests, can be reinvested. Under the new legislation, investors may also contribute limited amounts of ordinary income to OZ funds, capped annually at $10,000.

Timing and duration of deferral

• 1031 Exchange: Tax deferral can be maintained indefinitely as long as proceeds are reinvested into qualifying like-kind properties within specified timeframes and requirements.
• Opportunity Zones: Capital gains reinvested into a OZ fund may be deferred until December 31, 2026, or until the investment is sold, whichever occurs first. Beginning in 2027, a new OZ designation cycle will take effect, offering a permanent version of the program.

Tax treatment of gains

• 1031 Exchange: The original basis carries forward indefinitely. Taxes are owed when a property is eventually sold for cash.
• Opportunity Zones: If the investment is held for at least 10 years, any appreciation on the OZ investment itself is permanently excluded from capital gains tax. Additionally, the new legislation introduces a 10 percent step-up in basis after a five-year holding period, and a 30 percent step-up for investments made in rural OZs.

Geographic and investment flexibility

• 1031 Exchange: Investors have broad geographic flexibility and can select from any qualifying real estate across the United States.
• Opportunity Zones: Investments must be made within designated OZs. Under the revised legislation, eligible tracts must have median incomes at or below 70 percent of the area median income, and those with median incomes exceeding 125 percent are excluded. At least one-third of new zones must be located in rural areas. Investors may invest in real estate or qualified operating businesses, providing a broader range of opportunities.

Regulatory and policy considerations

• 1031 Exchange: The Biden administration had proposed a cap of $500,000 per year on the amount of gain that may be deferred through 1031 Exchanges. This proposal has not been enacted into law as of 2025 but remains under discussion.
• Opportunity Zones: The One Big Beautiful Bill makes the OZ program permanent, establishes a new decennial designation process beginning in 2026, and introduces stronger transparency requirements, including annual reporting on community impact and fund-level investment data.

The recent legislative updates to the Opportunity Zone program introduce new opportunities, particularly for investors with longer time horizons and a desire to align investment goals with economic development priorities. Financial professionals should evaluate the nature of the capital gain, the client’s liquidity needs, investment preferences, and time horizon when determining the most appropriate strategy. As the regulatory environment continues to evolve, staying informed will be essential to providing effective guidance.

At their core, BDCs are closed-end investment funds that raise capital from investors and deploy it into private U.S. businesses, typically those that are too small or too early-stage to access traditional capital markets. They provide capital in the form of debt, equity, or hybrid instruments and are often actively involved in advising or supporting the businesses in their portfolios.

Created by Congress in 1980 through an amendment to the Investment Company Act of 1940, BDCs were designed to increase capital access for small and developing businesses. To qualify as a BDC, at least 70% of a fund’s assets must be invested in U.S.-based “eligible portfolio companies” valued at less than $250 million. BDCs can be publicly traded, privately offered, or non-traded but publicly registered, each with distinct characteristics in terms of liquidity, transparency, and accessibility. For clients seeking income and diversification, BDCs may offer an attractive value proposition:

Income potential: BDCs typically invest in debt instruments that pay regular interest, which can support consistent investor distributions. Yields may range from 5-10% depending on market conditions and fund structure.

Tax efficiency: Like real estate investment trusts (REITs), most BDCs avoid entity-level taxation by distributing at least 90% of their taxable income to shareholders, resulting in pass-through treatment. However, distributions are generally taxed as ordinary income.

Portfolio diversification: BDCs offer exposure to private credit and equity markets that are otherwise difficult to access for most retail clients.

When evaluating BDCs for clients, consider the following:

Liquidity constraints: Publicly traded BDCs are accessible via major exchanges, but non-traded BDCs are illiquid and may impose restrictions on redemptions. Advisors should ensure that client goals and time horizons align with the fund’s structure.

Credit risk: BDC portfolios are largely comprised of small or mid-sized companies, many of which carry higher credit risk than larger, publicly traded firms. Economic downturns can disproportionately impact these businesses.

Fee structure: Management and incentive fees for BDCs can be relatively high, especially in the non-traded space. It is important to evaluate whether a fund’s net return justifies its cost and compare fee terms across offerings.

Transparency and reporting: Public BDCs must file regular disclosures with the Securities and Exchange Commission (SEC). Non-traded BDCs may be less transparent, although those that are publicly registered will still be subject to SEC reporting standards.

Incorporating BDCs into a diversified investment strategy can provide clients with exposure to private credit markets and potential income streams. However, it’s important to balance these opportunities with a comprehensive understanding of the associated risks and structural considerations.