New Law Extends and Amends Qualified Opportunity Zone Tax Incentives

At a Glance

• The governors of each state will designate new qualified opportunity zones (QOZs) on July 1, 2026. The new zones will go into effect on January 1, 2027, and will expire 10 years later. Zone designations will be updated every 10 years thereafter.
• Capital gains invested in qualified opportunity funds (QOFs), as well as the new qualified rural opportunity funds (QROFs), after 2026 may be deferred until five years after the investment is made.
• Capital gains invested in QOFs after 2026 are eligible for a 10% step-up in basis, and QROFs are eligible for a 30% step-up in basis after the QOF or QROF investment has been held for at least five years.
• Although the law made many improvements to the QOZ program, it did not make changes to reduce the complexity of structuring QOF investments. It remains important to establish a proper investment structure prior to acquiring property and to consider timing and leasing issues very carefully.

Background

The qualified opportunity zone (QOZ) tax incentive program, originally adopted in the Tax Cuts and Jobs Act of 2017 (TCJA), has been a popular incentive for investors in designated economically distressed zones. Under the TCJA, the incentives were only available for investments in qualified opportunity funds (QOFs) made before 2027.¹

H.R. 1, An Act to Provide for Reconciliation Pursuant to Title II of H. Con. Res. 14 (also known as the One Big Beautiful Bill Act) extends the QOZ program indefinitely and makes several important changes to the incentive, most of which are effective for QOF investments made after 2026.

New QOZ Designations

The governors of each state will designate new QOZs on July 1, 2026. The new zones will go into effect on January 1, 2027, and will expire 10 years later. Zone designations will be updated every 10 years thereafter.

Special Rules for Rural QOZ Investments

The new law adds the concept of a qualified rural opportunity fund (QROF), which is similar to a QOF, but at least 90% of its assets must be held in rural QOZ properties or businesses. A QOZ is considered rural unless it is in: (a) a city or town with a population greater than 50,000; or (b) an urbanized area contiguous and adjacent to such a city or town.

After 2026, capital gains invested in QROFs will be eligible for a more generous step-up in basis after five years than applies to nonrural funds.

Furthermore, the substantial improvement requirement is relaxed for property located in rural QOZs. Rural property is considered substantially improved if the improvements cost more than 50% of the property’s adjusted basis. Unlike many of the law’s other provisions, the relaxation of the substantial improvement requirement for property in rural QOZs is effective immediately. The substantial improvement test for nonrural property will continue to require that the improvements cost more than 100% of the property’s adjusted basis.

Other than these two notable differences, the rules for QROFs are generally the same as those that apply to QOFs, such that the deferral, gain exclusion and new reporting requirements discussed below apply similarly to QROFs.

Deferral of Capital Gains

Capital gains invested in QOFs after 2026 may be deferred until five years after the investment is made. If the investment is sold or exchanged sooner, the deferral ends on the date of such sale or exchange. The QOZ program continues to require that a taxpayer invest capital gains and make a deferral election with respect to that gain in order to access the other benefits (discussed below) of the QOZ program. The law does not extend the deferred realization date for any capital gains invested in QOZs prior to 2027, which remains December 31, 2026.

Step-up in Basis

Capital gains invested in QOFs after 2026 are eligible for a 10% step-up in basis, and QROFs are eligible for a 30% step-up in basis after the QOF or QROF investment has been held for at least five years.

Gain Exclusion

Similar to the original QOZ program, after an investment in a QOF is held for at least 10 years, any gain from a disposition of the investment may be excluded from income. However, under the new law, for post-2026 QOF investments, the investor’s basis will be the fair market value on the thirtieth anniversary of the investment if the QOF interests are retained beyond the 30-year period.

New Statutory Reporting Requirements

New Sections 6039K and 6039L adopt reporting requirements for QOFs and QOZ businesses (the operating companies or real estate partnerships that QOFs typically invest in) for taxable years beginning after July 4, 2025. QOF returns will be required to include the total value of the QOF's assets, information regarding the partnerships or corporations in which the QOF invests, the number of employees they have, and information regarding dispositions of QOF interests by investors. QOFs are also required to provide statements to investors who dispose of QOF interests. Moreover, under to-be-issued regulations, QOZ businesses will be required to provide information statements to their QOF owners.

For failure to file, QOFs will be subject to penalties of up to $10,000 per return or $50,000 per return for QOFs with assets in excess of $10 million (increased to $50,000 or $250,000 in the case of intentional disregard).

Careful Structuring

Although the law made many improvements to the QOZ program, it did not make changes to reduce the complexity of structuring QOF investments. It remains important to establish a proper investment structure prior to acquiring property, to consider timing and leasing issues very carefully.

For More Information

For further information, you may contact the author.

Summer associate James Burnett contributed to this update.