The Tax Cuts and Jobs Act, signed into law on December 22, 2017 (the TCJA), authorized the opportunity zone tax incentive program (the OZ Program) to encourage investment in low-income community businesses. Under the OZ Program, individual and corporate taxpayers were eligible to defer paying tax on gains from the sale of stock, business assets, or any other property (“Old Gain”) by reinvesting the proceeds into certain low-income communities designated as “qualified opportunity zones.” Under the TCJA, the taxpayer was required to realize and reinvest the gain into a “qualified opportunity fund” (a QOF) no later than December 31, 2026 in order to obtain any deferral and exclusion benefits from the OZ Program. Such an investment allowed the taxpayer to defer recognition of the Old Gain for federal income tax purposes until December 31, 2026. The primary benefit of such reinvestment was the ability to avoid tax on any gain resulting from the reinvestment (“Future Gain”) if the reinvestment in the QOF was held for a designated time period. Prior to the enactment of the One Big Beautiful Bill Act, which was signed into law on July 4, 2025 (the OBBBA), the future of the OZ Program after 2026 was unclear. Thankfully, the OBBBA provides for the permanent renewal and expansion of the OZ Program.
For gain recognized on or before December 31, 2026, the OBBBA leaves the existing OZ Program unchanged. A detailed discussion of the benefits and requirements of the TCJA OZ Program can be found here. The below discussion focuses on the new aspects of the opportunity zone implemented by the OBBBA, which are available for gain recognized, and investments made in QOFs, on or after January 1, 2027. Except to the extent addressed below, we expect the existing provisions of the program, described at the foregoing link, to be applicable to the new, permanent OZ Program.
- Permanent Extension of the OZ Program: Under the TCJA, a taxpayer’s ability to participate in the OZ Program will end December 31, 2026. Under the OBBBA, the OZ Program will continue indefinitely.
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Identification of Opportunity Zones:
- Timing: Under the TCJA, opportunity zones were determined during the period immediately following enactment of the TCJA. Under the OBBBA, opportunity zones for the next round of investment will be identified on July 1, 2026. Taxpayers who recognize gain on or after January 1, 2027 will have the opportunity to reinvest this gain into one of the opportunity zones designated on July 1, 2026. The opportunity zone designations will survive for a ten-year period. At the expiration of the ten-year period, the process will repeat (i.e., on July 1, 2036, new opportunity zones will be identified and the gain recognition and investment period with respect to those opportunity zones will begin on January 1, 2038).
- Definition: Under the TCJA, a “low-income community” is a census tract that: (A) has a poverty rate of at least 20% or (B) (i) if not located in a metropolitan area, has a median family income that does not exceed 80% of the statewide median family income or (ii) if located in a metropolitan area, has a median family income that does not exceed 80% of the metropolitan area median family income. Under the OBBBA, a “low-income community” is a census tract that: (A) (i) if not located in a metropolitan area, has a median family income that does not exceed 70% of the statewide median family income or (ii) if located in a metropolitan area, has a median family income that does not exceed 70% of the metropolitan area median family income, or (B) (i) has a poverty rate of at least 20% and (ii) (1) if not located in a metropolitan area, has a median family income that does not exceed 125% of the statewide median family income or (ii) if located in a metropolitan area, has a median family income that does not exceed 125% of the metropolitan area median family income.
- Repeal of Rule for Contiguous Census Tracts: Under the TCJA, a census tract could be designated as an opportunity zone, even if it was not a low-income community, if the census tract was contiguous with a low-income community. This “contiguous tract” provision has been repealed under the OBBBA.
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Gain Deferral:
- Timing: Under the TCJA, a taxpayer who recognized gain on or after January 1, 2018 and invested such gain into a QOF in a timely manner was eligible to defer paying tax on that gain until the earlier of (i) the date on which the taxpayer’s investment in the QOF is sold or exchanged or (ii) December 31, 2026. Under the OBBBA, if a taxpayer invests gain into a QOF in a timely manner, the taxpayer can defer paying tax on that gain until the earlier of (i) the date on which the taxpayer’s investment in the QOF is sold or exchanged or (ii) the fifth anniversary of the date of the taxpayer’s investment in the QOF. Accordingly, under the TCJA, an investor in the OZ Program in 2018 could benefit from almost 8 years of deferral, but an investor in 2025 would benefit from only 1 year of deferral. By contrast, under the OBBBA, the maximum deferral timeline is 5 years, but this 5-year benefit is available regardless of when the investment is made.
- Amount of Includible Gain: Under both the TCJA and the OBBBA, on the applicable inclusion date, the taxpayer must include in income the difference between (A) the lesser of (i) the amount of gain deferred or (ii) the fair market value of the taxpayer’s QOF investment, determined as of the inclusion date, and (B) the taxpayer’s basis in the QOF investment.
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Basis and Basis Adjustments:
- Default Rule: Under both the TCJA and the OBBBA, the taxpayer’s basis in the QOF is $0, increased by any deferred gain recognized and by any basis adjustments described below.
- Basis Adjustments: Under the TCJA, the taxpayer’s basis in the QOF investment was increased by an amount equal to (i) 10%, if the taxpayer holds the QOF investment for at least five years or (ii) 15%, if the taxpayer holds the QOF investment for at least seven years. Under the OBBBA, if the taxpayer holds the QOF investment for at least 5 years, the taxpayer’s basis is increased by an amount equal to (i) 30% of the gain deferred, if the QOF is a “qualified rural opportunity fund” (a QROF) or (ii) 10% of the gain deferred, for all other QOFs.
- Qualified Rural Opportunity Fund: The OBBBA created the new QROF concept, which provides greater tax benefits for an investment in a QOF that qualifies as a QROF. A QROF is a QOF that invests at least 90% of its assets, directly or indirectly, in businesses located in an opportunity zone composed entirely of a rural area. A rural area is any area other than (i) a city or town with a population over 50,000 and (ii) any urbanized area contiguous and adjacent to a city or town described in (i).
- Substantial Improvement: In order for an existing structure to qualify as qualified opportunity zone business property under the TCJA, the QOF must “substantially improve” the property. Specifically, during a 30-month period a QOF (or its subsidiary) must make additions to its basis with respect to the property in the hands of the QOF (or subsidiary) that exceed its basis in the property at the beginning of the 30-month period. Under the OBBBA, this rule continues; however, for existing structures owned by a QROF (or a subsidiary thereof), the QROF (or its subsidiary) must make additions to its basis in the property during the 30-month period of at least 50% of the QROF’s (or its subsidiary’s) basis in the property (rather than 100% of the QOF’s (or its subsidiary’s) basis in the property, as is applicable for non-QROF properties).
- Gain Exclusion: Under the TCJA, if a taxpayer holds his, her, or its QOF investment for at least 10 years, the taxpayer can elect to adjust the basis of the QOF investment to its fair market value as of the date of the sale or exchange of that investment. As a result, if a taxpayer holds the QOF investment for at least 10 years, all gain (other than deferred gain) from the subsequent sale or exchange of that investment is excluded from taxable income. However, the election to adjust basis is available only if the taxpayer sells or exchanges the investment on or before December 31, 2047. As a result, if a taxpayer who invested in a QOF under the TCJA OZ Program does not sell his, her, or its QOF investment before June 30, 2048, the taxpayer is not eligible to exclude any Future Gain from the sale of the investment. Under the OBBBA, if a taxpayer holds his, her, or its QOF investment for at least 10 years, then (i) if the investment is sold before the 30th anniversary of the date the investment was made, the taxpayer’s basis is increased to the fair market value of the investment as of the date of the sale or exchange of the investment; and (ii) for investments that are not sold within this 30-year window, the taxpayer’s basis is increased to the fair market value of the investment as of the 30th anniversary of the date the investment was made. Accordingly, the OBBBA changes remove the penalty for holding onto a QOF (or QROF) investment beyond a set date – even if a taxpayer does not sell or exchange his, her, or its investment within 30 years, the taxpayer gets to exclude an amount equal to the Future Gain resulting from the investment as of its 30th anniversary if and when the taxpayer eventually sells or exchanges the investment.
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Information Reporting: Many critics of the TCJA OZ Program identified the lack of
required reporting as a shortcoming of that program. The sole reporting required under the TCJA is
the filing of Form 8996, Qualified Opportunity Fund, which requires a QOF to provide the IRS with
information regarding the value of the QOF’s assets and qualified opportunity zone property.
- Under the OBBBA, the reporting requirements for QOFs have been expanded. Specifically, on an annual basis, the QOF (or QROF) must file a return setting forth (i) its name, address, and TIN; (ii) whether it is a corporation or property; (iii) the value of its total assets as of each relevant testing date; (iv) the value of its “qualified opportunity zone property” as of each relevant testing date; (v) with respect to each investment in qualified opportunity zone stock or a qualified opportunity zone partnership interest: (A) the name, address, and TIN of such corporation or partnership; (B) the NAICS code of such corporation or partnership; (C) the census tract in which the qualified opportunity zone business property of such corporation or partnership is located; (D) the amount of the investment made by the QOF (or QROF) into such corporation or partnership; (E) the value of any tangible property owned by the corporation or partnership; (F) the value of any tangible property leased by the corporation or partnership; (G) the approximate number of residential units (if any) for any real property held by such corporation or partnership; and (H) the approximate number of average monthly full-time equivalent employees of such corporation or partnership; (vi) with respect to any qualified opportunity zone business property held directly by the QOF (or QROF): (A) the NAICS code that applies to the trades or businesses in which the property is used; (B) the census tract where the property is located; (C) whether the property is owned or leased; (D) the aggregate value of such property as of each testing date; and (E) with respect to real property, the number of residential units, if any; (vii) the approximate number of average monthly full-time equivalent employees of the trades or business of the QOF (or QROF) in which qualified opportunity zone business property is used; and (viii) with respect to any holder who disposes of an investment in the QOF (or QROF) during the year: (A) the name, address, and TIN of such holder; (B) the date the investment was acquired by the holder; and (C) the date the investment was disposed of by the holder.
- The QOF (or QROF) also must provide each of its investors with a written statement setting forth the name, address, and phone number of the person at the QOF (or QROF) responsible for filing the foregoing return and any information required to be shown on the QOF (or QROF) return under subclause (viii) above, if that information is included with respect to the recipient investor.
- The information provided by these reporting requirements will no doubt be valuable to the IRS and Congress in evaluating whether the OZ Program is achieving the results that it intended to accomplish. But it will add another layer of administrative burden and compliance cost to be considered by those looking to participate in the program when weighing the tradeoffs between the benefits and burdens of such participation.
- A penalty of $500 per day applies for failing to file the foregoing return in a timely manner, not to exceed $10,000 for any one return ($50,000 in the case of QOFs (or QROFs) with gross assets in excess of $10,000,000). If the failure to file the return in a timely manner is due to intentional disregard, the $500 per day amount is increased to $2,500, and the limits on the aggregate amount of the penalty are increased to $250,000 for QOFs (or QROFs) with gross assets in excess of $10,000,000 and $50,000 for all other QOFs (or QROFs). All penalty amounts are indexed for inflation.
- Be Mindful of the Effective Date Rules: As discussed above, the OBBBA changes to the TCJA OZ Program rules are generally effective for gain recognized, and investments made in QOFs, on or after January 1, 2027. This effective date means that the reinvestment of Old Gain resulting from any sale made before January 1, 2027 will qualify for deferral only until the end of 2026, as it will be subject to the TCJA OZ Program rules. Furthermore, the 10% basis step-up (30% for investments in QROFs) with respect to that Old Gain will not apply to an investment in a QOF occurring before 2027; no basis step-up will be available for such investments. As a result of the OBBBA effective date rules, taxpayers have an incentive to defer their gain recognition event (and subsequent QOF investment) until after January 1, 2027 in order to maximize the tax benefits that are available under the OZ Program rules as revised by the OBBBA.