Part III · Structures · No. 13

Opportunity zones

A regime enacted in 2017, and made permanent in 2025, offering capital-gains deferral and tax-free post-investment appreciation for investment in designated low-income census tracts. Deferred gain on original-program investments is recognized at the end of 2026; a redesigned, rolling version applies to investments made from 2027.

What the structure is

The Qualified Opportunity Zone regime was enacted as part of the Tax Cuts and Jobs Act of 2017 at §§1400Z-1 and 1400Z-2. Roughly 8,700 low-income (and certain contiguous) census tracts were designated as Qualified Opportunity Zones in 2018. A taxpayer who realizes capital gain (including §1231 gain) may, generally within 180 days, invest an amount up to the gain in a Qualified Opportunity Fund (QOF) and elect to defer the gain. The QOF invests in qualifying property within designated zones. The One Big Beautiful Bill Act (Pub. L. 119-21, §70421, signed 4 July 2025) made the program permanent and restructured it for investments made after 31 December 2026.

The tax problem it addresses

Three tax benefits:

• Deferral. Under the original rules, deferred gain is recognized on the earlier of disposition of the QOF interest or 31 December 2026 — so all pre-2027 deferrals come into income in 2026 (reported on 2026 returns filed in 2027). Under the OBBBA rules, gain invested after 31 December 2026 is deferred until the earlier of disposition or five years after the investment date — a rolling deferral period.
• Basis increase after five years. Under the original rules, investments held 5 years before 31 December 2026 received a 10% basis step-up and 7-year investments an additional 5%; the 7-year increase required investment by the end of 2019 and the 5-year increase by the end of 2021. Under the OBBBA rules, investments made after 2026 and held five years receive a 10% basis increase in the deferred gain — 30% for investments in a new "qualified rural opportunity fund".
• Tax-free appreciation after 10-year hold. A QOF interest held at least 10 years can, by election, take a basis equal to fair market value on sale — eliminating tax on appreciation during the QOF holding period. For investments made after 2026, the OBBBA caps this at 30 years: basis is fair market value at sale, or, for interests held longer, fair market value on the 30th anniversary of the investment.

Mechanics

• Taxpayer realizes capital gain on any property (real estate, securities, art, business sale).
• Generally within 180 days, invests an amount up to the gain in a QOF and elects deferral (Form 8949; investor reporting on Form 8997).
• QOF holds at least 90% of assets in qualified opportunity-zone property (real or business property in a designated zone).
• Original gain is deferred — to 31 December 2026 for pre-2027 investments, or up to five years for investments made after 2026 — or recognized earlier on disposition. Deferred gain keeps its original character when recognized.
• After 10-year hold, election under §1400Z-2(c) steps basis to FMV; sale produces no further taxable gain on the QOF investment.

The applicable statutes and authorities

• 26 U.S.C. §§1400Z-1, 1400Z-2.
• Treas. Reg. §§1.1400Z2(a)-1 through §1.1400Z2(f)-1.
• Rev. Proc. 2018-16 (designation of OZs).
• One Big Beautiful Bill Act, Pub. L. 119-21, §70421 (permanent program, decennial zone designations, rolling deferral, rural funds, reporting).
• Rev. Rul. 2018-29 (land and original use); Notice 2020-39 and Notice 2021-10 (pandemic relief).

Substance and audit risk

• 90% asset test. The QOF must hold at least 90% of assets in qualifying opportunity-zone property, tested semiannually with penalties for failure.
• Substantial improvement test. Pre-existing buildings acquired by QOF must be substantially improved (basis additions exceeding pre-acquisition basis) within 30 months.
• Working-capital safe harbor. A QOF subsidiary may hold cash as working capital for up to 31 months under defined business plans.
• 10-year exit mechanics. The 10-year basis step-up election is at sale; the underlying investment must remain qualified throughout. The Service has provided guidance on permissible exit structures (Treas. Reg. §1.1400Z2(c)-1).

Cost and complexity

QOF formation and ongoing compliance is administratively heavier than a typical real-estate LLC. Annual Form 8996 filing, semiannual asset testing, working-capital documentation, and exit-planning analysis add cost. Most retail OZ investors enter through institutional fund offerings rather than self-formed QOFs.

Common combinations

• QOF for art-sale proceeds. Sale of appreciated art produces collectibles gain taxed at up to 28%; investment in a QOF defers the gain (which keeps its 28% character when recognized) and can produce tax-free appreciation on the QOF investment itself.
• QOF for business-sale proceeds. Founder sale of operating business gain deferred through QOF investment.
• QOF for real-estate gain. Sale of appreciated real property invested in QOF holding new real-estate development.
• QOF combined with §1031 timing. Real-property gain that does not qualify for §1031 (or for which §1031 timing is unworkable) may qualify for QOF deferral.

Recent developments

Deferred gain on all original-program investments is included in income on 31 December 2026; holders of 2018–2026 vintage QOF interests should plan for the 2026 tax liability (payable with 2026 returns in 2027) even though the QOF investment itself may be illiquid. Gain realized and invested during 2026 under the old rules obtains deferral only until that same date, though the 10-year exclusion remains available.

The One Big Beautiful Bill Act (4 July 2025) made the program permanent. Governors designate a new set of zones every ten years, with the first new designations taking effect 1 January 2027; the low-income-community definition was tightened and non-low-income contiguous tracts can no longer be designated. Investments made after 31 December 2026 receive the rolling five-year deferral, the 10% (or 30% rural) basis increase, and the 10-year exclusion capped at 30 years. The Act also added expanded QOF and investor reporting with new penalties (§6726). Treasury and IRS guidance on the new rules is still developing as of October 2026.

Litigated OZ authority remains limited; compliance with the semiannual 90% asset test, the substantial-improvement test, and working-capital documentation is the principal exposure.

Reviewed October 2026