Qualified opportunity zones (QOZs) are economically distressed areas that have been designated by state and federal governments to stimulate economic development and job creation. These zones were created under the 2017 Tax Cuts and Jobs Act (TCJA) with the goal of encouraging long-term private investment in low-income communities across the United States. These benefits can be realized when gains are reinvested in a qualified opportunity fund (QOF): a corporation or partnership established specifically to invest in QOZ projects.
Key Takeaways
- The One Big Beautiful Bill Act provides for new QOZ designations every ten years starting on January 1, 2027
- Tax benefits have been modified for investments made after December 31, 2026.
- The QOZ program is designed to potentially defer and reduce taxes on capital gains.
The Law Prior to the Bill
The ability to make new QOZ investments was originally set to expire on December 31, 2026. These tax benefits included:
- Temporary Deferral of Capital Gains – If a capital gain is generated when assets are sold and that capital gain is reinvested into a QOF within 180 days of the sale, taxes on that gain don’t need to be paid in the year of sale. The tax on that gain is deferred until December 31, 2026, or when the QOF investment is sold, whichever comes first.
- Reduction of the Deferred Gain (Up to 15%) – If a QOF investment is held long enough prior to reaching the mandatory gain recognition date of December 31, 2026, part of the deferred gain is permanently excluded through basis step-ups, as follows:
- If the investment is held for at least five years (before recognition of gain on Dec 31, 2026), 10% of the deferred gain is excluded.
- If the investment is held for at least seven years (before recognition of gain on Dec 31, 2026), an additional 5% of the deferred gain is excluded, leading to a potential total exclusion of 15%.
- Permanent Exclusion of Capital Gain (After 10 Years) – If a QOF investment is held for 10 years or more, the taxpayer can choose to elect to step up the basis to the fair market value (FMV).
Any appreciation in a QOF investment is completely tax-free when it’s sold. This benefit is available for investments held and sold any time before December 31, 2047.
New Legislation
The One Big Beautiful Bill Act (OBBBA) makes the QOZ program permanent with certain modifications and enhancements. However, it doesn’t change the December 31, 2026, deadline for mandatory recognition of capital gains. Any qualifying investments made in 2025 or 2026 would be subject to that deadline.
Permanent Extension
Under the TCJA, the original QOZ program was set to expire for contributions made after December 31, 2026. The OBBBA provides for new QOZ designations every ten years starting on January 1, 2027.
Tax Benefits Modified
For investments made after December 31, 2026:
- The deferral period now ends at the earlier of (1) five years after the investment in the QOF is made or (2) the date the investment is sold. The gain to be included at the end of the deferral period is the lesser of (1) amount of gain excluded by investment in the QOF, or (2) the FMV of the investment as of the end of the deferral period over the tax basis (see below on tax basis increases).
- At the five-year mark of holding the investment, a 10% basis increase will be applied (except for qualified rural opportunity funds discussed below).
- The 10-year basis step-up to FMV remains a part of the QOZ program. If a QOF is sold before being held for 30 years, the FMV of the investment on the date of the sale is used (basis is stepped up to FMV, thereby eliminating any gain). If a QOF is sold after being held for 30 years, the FMV on the 30th anniversary is used.
Qualified Rural Opportunity Funds (QROFs)
A QROF is similar to a QOF except that the investment needs to be in a QOZ in a “rural area.” These are further defined to mean any area other than (1) a city or town with a population of greater than 50,000 or (2) any urbanized area adjacent to such a city or town. Investors in QROFs recognize a basis step-up held for at least five years of 30%. The same five-year deferral period and 10-year basis step-up noted above apply to QROF investments.
The QOZ program is designed to defer and potentially eliminate taxes on capital gains while also aiming to support underserved communities. While additional information will be needed from the Department of Treasury (especially in determining which census tracts qualify as “rural areas”), now’s a good time to review if investing in the permanent QOZ program can be beneficial.
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