Opportunity Zones: Today, Tomorrow and Beyond

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The Opportunity Zone (OZ) program, created in 2017 and originally scheduled to end after 2028, has been revised and made permanent through the One Big Beautiful Bill Act (OBBBA). The program allows taxpayers to defer federal tax on capital gains by investing in Qualified Opportunity Funds (QOFs), which develop businesses in OZs.

OBBBA introduces several changes: increased tax benefits for investors, a sharper focus on the lowest income communities, added incentives for rural investments and new reporting and disclosure requirements. Although many of these changes are not yet in effect, making the OZ program permanent positions it to become a lasting part of America’s investment landscape.

What Are OZs? History and Key Definitions

OZ Investor Benefits

Under the original rules still in effect, taxpayers with capital gains can defer federal tax on those gains (until December 31, 2026, unless the investment is sold earlier) by contributing the gain amount to a QOF within 180 days of realizing it. For gains recognized via a partnership or S corporation, the taxpayer can choose one of three starting points for the 180-day period:

• The date the underlying entity recognized the gain.
• The last day of the entity’s tax year (generally December 31).
• The un-extended due date of the entity’s tax return (usually March 15).

These options allow taxpayers with Schedule K-1 gains to defer tax on a prior year’s gain by investing in a QOF as late as the following September 15.

In addition to the immediate deferral, there is a potentially more powerful exclusion benefit: if the QOF investment is held for at least 10 years, all gain on the investment may be excluded from federal tax (provided it is sold before 2048). This exclusion applies if the taxpayer disposes of their interest in the QOF or if the QOF sells its assets when structured as a partnership or S corporation. The exclusion does not apply if the QOF is a C corporation.

QOFs and QOZBs

QOFs and Qualified Opportunity Zone Businesses (QOZBs) must meet several structural and operational requirements to qualify for the program’s tax benefits. At a high level, the rules focus on where assets are located, how property is used and improved and whether the underlying business is actively operating within an OZ. Key requirements include:

• QOF asset requirements: At least 90% of a QOF’s assets must consist of either:
• Equity in an underlying QOZB.
• Qualified Opportunity Zone Business Property (QOZBP).
• QOZB requirements:
• At least 70% of tangible property must be QOZBP.
• At least 50% of gross income must come from the active conduct of trade or business in one or more OZs.
• QOZBP definition: Tangible property used in a trade or business that:
• Was purchased after December 31, 2017.
• Either is originally used in the OZ by the QOF or QOZB or is substantially improved.
• Is used in the OZ during the QOF’s or QOZB’s holding period.
• Substantial improvement: Requires additions to the property’s basis equal to the original basis (a 100% basis increase).
  
  
• Leased property: Tangible property used in-zone may qualify as QOZBP without original use or substantial improvement requirements.

Originally Designated OZs

Original OZs were designated by state governors and territory governments and certified by the Treasury Department. The designation process relied on specific eligibility criteria and statutory limitations.

Designation Criteria

A tract had to qualify as a low-income community, meaning either:

• The poverty rate is at least 20%.
• The median family income does not exceed 80% of the statewide median family income.
• Note: For tracts within a metropolitan area, the threshold was 80% of the greater of the statewide median or the metropolitan area median.

Limitations and Exceptions

• The number of tracts designated as OZs was generally limited to 25% of the total low-income communities in the state (although a minimum of 25 OZs per state was permitted).
• Up to 5% of OZs per state could be for tracts that were contiguous to an approved low-income OZ, provided the contiguous tract’s median family income did not exceed 125% of the contiguous low-income community.
• Every low-income community in Puerto Rico was certified by law as an OZ.

Scope and Expiration

There are over 8,700 OZs across all 50 states, Washington D.C., Puerto Rico and the Virgin Islands. The original OZs will expire on December 31, 2028.

OZ Reporting

QOFs file Form 8996 annually to certify they meet the required 90% investment standard or calculate and pay a penalty and to report certain details about their QOZBP and QOZB interests. QOZBs have no specific reporting requirements, although QOFs require significant details from these entities. Investors file Form 8997 annually to report investments in, holdings of and dispositions of interests in QOFs.

What Changes Now? Almost Nothing

Significant changes were made to the OZ program earlier this year in the OBBBA, but almost none are in effect yet. Most will take effect in 2027, although one provision applies immediately and benefits existing OZs in rural areas.

Effective July 4, 2025, investments in certain rural OZs will generally require only half the capital improvements required for non-rural OZs. For QOZBP in rural OZs, “substantial improvement” now means 50% of the property’s original basis. The Internal Revenue Service (IRS) released the list of qualifying rural tracts in Notice 2025-50 on September 30, 2025.

What Changes in 2027?

New OZ Investor Benefits

Starting January 1, 2027, QOF investors may defer gains for five years, provided the investment isn’t sold and no other inclusion events occur. After five years, a 10% basis step-up applies, so only 90% of the original gain is taxed. For new rural QOFs, the step-up is 30%, leaving only 70% of the gain taxed.

If held 10 years, up to 30 years of gain may be excluded. If sold earlier, all gain may be excluded; otherwise, the taxpayer may step up the basis to fair market value at year 30.

Rural Qualified Opportunity Zones (QOZs)

A new type of rural QOF was created, requiring at least 90% of its assets in either:

• QOZBP, substantially all of which was used in a rural OZ for most of the fund’s holding period.
• Equity in a QOZB where substantially all tangible property is QOZBP used almost entirely in a rural OZ.

Rural area is defined as any area that is not a city or town with a population of more than 50,000, nor an urbanized area contiguous or adjacent to such cities or towns.

New Decennial OZ Designations

New OZs will be designated every 10 years, with the next on July 1, 2026. These designations take effect January 1 the following year and last 10 years (January 1, 2027 through December 31, 2036 for upcoming OZs).

Low-income communities are now defined as census tracts where either:

• Median family income does not exceed 70% of statewide median family income for non-metropolitan areas (for tracts within a metropolitan area, 80% of the greater of the statewide or metropolitan median).
• Poverty rate is at least 20% and median family income does not exceed 125% of state median family income (for tracts within a metropolitan area, not in excess of 125% of the metropolitan median family income).

The original program’s poverty test did not include the “not in excess of 125%” requirement and the income threshold for non-metropolitan tracts was 80%.

In addition, the provision allowing contiguous tracts that were not low-income to be designated as OZs has been repealed. All low-income tracts in Puerto Rico are also no longer automatically designated by statute, though qualifying tracts may still be selected through the decennial process.

Altogether, these changes are estimated to reduce the total number of OZs by 20% to 25%. By narrowing eligibility to the most in-need communities, the program’s geographic scope has also become more limited. (See this map of eligible low-income tracts under the new rules, from the Economic Innovation Group, on which many early estimates of newly designated OZs are based.)

OZ Reporting and Penalties

OBBBA added new, detailed reporting requirements for QOFs (and rural QOFs) and, for the first time, specific reporting requirements for QOZBs (and rural QOZBs). New QOF reporting requirements for both interests in QOZBs and directly held QOZBP include: the applicable industry code, the number of residential units (if any) and the average monthly full-time equivalent employees. QOZBs must provide written statements to QOFs with the information needed to complete the new reporting.

QOFs must also report the name, address and tax identification number of anyone who disposed of a QOF interest during the year, including the date(s) acquired and disposed and the amount disposed. A copy of this statement must be provided to the disposing investor, along with QOF contact information.

New penalties apply for failing to submit a complete and accurate return, including the new disclosure requirements, for QOFs and rural QOFs. The penalty is $500 per day, up to $10,000 per return ($50,000 for funds with gross assets in excess of $10 million). If failure was due to intentional disregard, the daily penalty is $2,500, up to $50,000 ($250,000 for large funds).

What Did Not Change?

Many proposed adjustments to the OZ program did not make it into the final bill. One would have allowed the investment of non-capital gains, which would have significantly expanded the program’s utility but at a substantial revenue cost to the government.

Another widely supported change would have permitted more flexible investment structures. Excluding disregarded entities, only two structures remain permitted: (1) direct, where the investor invests in a QOF that directly owns QOZBP; and (2) indirect, where the investor invests in a QOF that, in turn, invests in one or more QOZBs. Fund-of-fund QOFs and other complex structures remain prohibited.

Many housing advocates wanted the program more directly tied to affordable housing, noting that most residential development to date has been market-rate, with minimal below-market units. (See New York University Furman Center’s 2024 State of the City report, which notes a focus on market-rate housing among new OZ developments.) Others sought to condition certain tax benefits on measurable outcomes such as job creation. Conversely, industry and real estate groups pushed for simpler program administration.

Ultimately, none of these changes were adopted. Although the program is now more targeted to low-income communities and reporting now captures job creation and residential real estate, the legislation added no outcome-based conditions to the tax benefits and did not address affordable housing. Meanwhile, QOFs, QOZBs and their advisors must now compile and report more detailed information, with significant penalties for noncompliance.

What Questions Remain?

A number of issues still need clarification, particularly around the 2027–2028 transition period when two sets of designated OZs will be active.

Gains Recognized in 2026

Taxpayer gains recognized in 2026 will often be investible in 2027. It seems clear that such gains may be invested in the newly designated OZs and qualify for the new benefits. But can they be invested in original OZs (that are not re-designated) and still qualify for a five-year deferral? The likely answer is no, since the original program generally would not have permitted deferral for investments made in 2027 or 2028, but guidance is needed. Even without a five-year deferral, such investments should still qualify under the original OZ rules and be eligible for exclusion after a 10-year holding period.

Investments in Original OZs (2027/2028)

Will gains from 2027 or 2028 be investible in the original OZs and qualify for the new benefits? The intention was likely to limit the tax benefit to investments in the newly designated OZs. However, the statute as written could allow qualifying investments in the original OZs to receive the new benefits. Regulatory guidance — or potentially a statutory amendment — may be required.

OZ Expiration Issues

What happens when OZs expire? No guidance currently exists for this issue, which affects both the original zones in 2028 and all future designations. Key questions include: Can a QOF or QOZB make additional investments after a zone’s expiration? What if the property is not acquired before that date? Must substantial improvement be completed — or merely begun — before expiration? Guidance on these and other related matters will be necessary as the original OZs approach their 2028 expiration.

So, What Does This Mean Now?

While the OZ program is now permanent and more attractive to investors, the major changes will not take effect until 2027. Although some additional investments in rural OZs may occur in the near term, overall OZ investments are likely to slow until the more advantageous tax benefits begin in 2026.

Currently, we are waiting for IRS guidance on the significant transition and zone expiration issues facing QOZs in 2027 and 2028. QOZs and QOZBs in contiguous or other OZs unlikely to be re-designated should revisit investment and business plans now to prepare for potential changes when the zones expire in 2028.

2027 is expected to be the start of a surge in OZ investments, as many investors will defer investing 2026 gains to take advantage of greater tax benefits. Potential OZ investors and entrepreneurs should use the intervening period to consult with their advisors and evaluate whether OZs may benefit their plans.

Contact Us

Our professionals can provide guidance tailored to your specific situation. For more information on Opportunity Zones or to discuss how these changes may affect your investments, please contact your PKF O’Connor Davies client service team or:

Christopher Johnson, JD, LLM, CPA, MBA
Partner
cjohnson@pkfod.com