Qualified Opportunity Zone (QOZ)

A qualified opportunity zone is a population census tract that is a low-income community and has been designated as such under Internal Revenue Code section 1400Z-1, whose own heading is "Designation." The tax consequences do not attach to the zone; they attach to an investment in a qualified opportunity fund, which Internal Revenue Code section 1400Z-2(d)(1) creates and which the IRS describes as an investment vehicle organized as a corporation or a partnership for the purpose of investing in qualified opportunity zone property, other than another such fund, and holding at least 90 percent of its assets in that property. The distinction matters practically as well as legally: nobody buys a zone, and the location of the fund's assets, not the investor's, is what the requirements test. The IRS uses the short form "opportunity zone" on its own landing page while the statute uses the longer defined term.

What the incentive actually consists of. A taxpayer who realizes a capital gain may elect under section 1400Z-2(a) to defer it to the extent they invest a corresponding amount in a qualified opportunity fund within 180 days of the sale or exchange. The deferred gain comes back into income at a date the statute fixes. Separately, section 1400Z-2(c) allows an investor who has held the fund investment for at least ten years to elect to treat its basis as its fair market value, which removes tax on the fund investment's own appreciation. The second election is the larger benefit and it is independent of the first: it applies to growth inside the fund, not to the gain that was deferred.

Permanence, and the ten-year cycle. Public Law 119-21, in a section headed "Permanent renewal and enhancement of opportunity zones," added section 1400Z-1(c)(2)(C), which defines the "decennial determination date" as "July 1, 2026, and each July 1 of the year that is 10 years after the preceding decennial determination date." That change took effect on enactment. So designation is now a recurring process rather than a one-off, and each round runs on its own ten-year designation period. Rev. Proc. 2026-14 sets out the 2026 round's calendar: a 90-day nomination period running from July 1, 2026, extendable by 30 days, then a consideration period at Treasury, with any tract certified under that procedure carrying a designation period from January 1, 2027 through December 31, 2036. Eligibility for that round is measured from the 2020 to 2024 American Community Survey five-year data and the 2020 Decennial Census of Island Areas. Whether any tract has in fact been designated for 2027 is not something this page asserts; as of late August 2026 the nomination window had not closed.

The existing zones have an end date, and Puerto Rico's is a year earlier. The IRS states in Notice 2026-40, describing the prior statute, that the designation period for zones certified in the original round ends on December 31, 2028, and on December 31, 2027 for zones deemed certified in Puerto Rico. Rev. Proc. 2026-14 says the same. The earlier Puerto Rico date follows from those zones having been deemed designated a calendar year earlier than the 2018 certifications. Public Law 119-21 repealed the Puerto Rico blanket rule with effect from December 31, 2026, which is why the current Code text still shows it.

The single most important date for anyone already invested. The 2025 amendments to section 1400Z-2 apply only to amounts invested in qualified opportunity funds after December 31, 2026. An investment made before then therefore continues under the prior rules, including the prior inclusion date. The IRS states in Notice 2026-40 that where gain was deferred for a qualifying investment made on or before December 31, 2026, it must be included in gross income in the taxable year that includes the earlier of an inclusion event or December 31, 2026, and that taxpayers holding such an investment through that date "are required to include in income in the taxable year that includes that date the amount of remaining deferred gain." The notice adds that the amount so included "may not be deferred" by a further election. The IRS's long-standing published FAQ says the same thing independently. The practical consequence is a tax bill in tax year 2026 for a great many existing investors, on a gain realized years earlier, from an investment that has produced no cash. The offsetting point is that Notice 2026-40 also states the ten-year fair market value election under section 1400Z-2(c) remains available on a later sale of that same investment, subject to the holding period and the other requirements. Recognition of the deferred gain does not forfeit the bigger benefit.

What changes for money invested from 2027. The deferral election is no longer sunset. The inclusion date becomes the year that includes the earlier of a sale or exchange of the investment and "the date which is 5 years after the date the investment in the qualified opportunity fund was made," which converts a fixed cliff into a rolling five-year deferral. The basis step-up is a single step: an investment held at least five years has its basis increased by 10 percent of the deferred gain, or 30 percent for an investment in a qualified rural opportunity fund. The former seven-year, five-percent step does not exist in the replacement text. The ten-year fair market value election is now capped in time: basis is the fair market value on the sale date where the investment is sold before the date 30 years after it was made, and otherwise the fair market value at 30 years. The Act also added section 6039K, requiring annual information returns from qualified opportunity funds and qualified rural opportunity funds.

The rural category is new and is the only place the enhanced numbers appear. A "rural area" is defined as any area other than a city or town with a population greater than 50,000 inhabitants and any urbanized area contiguous and adjacent to such a city or town. A qualified rural opportunity fund is one holding at least 90 percent of its assets in qualified opportunity zone property in a zone comprised entirely of a rural area. Two enhancements attach: the 30 percent five-year basis step-up, and a substantial improvement threshold halved to 50 percent of the property's adjusted basis. That second change took effect on enactment rather than in 2027, so it applies now.

Who becomes eligible in future rounds also changed. The low-income community test in section 1400Z-1(c)(1) now uses 70 percent of statewide or metropolitan median family income rather than borrowing the new markets tax credit test, the poverty-rate route is capped by reference to median family income, and the contiguous-tract route was repealed. The 25 percent cap on how many tracts a state may designate now applies per designation period, and the IRS has said in Notice 2026-40 that the number of previously designated zones in a state will not affect how many tracts its chief executive may nominate for the period beginning January 1, 2027.

What the page will not tell you, and why. Notice 2026-40's sections 3 through 5 are described in the notice itself as rules that anticipated proposed regulations are expected to contain. They are not law, and the working-capital safe harbours and the continuation rules for expired zones in section 5 are firmly in that category. Anyone relying on them is relying on an announcement of an intention to propose.

Facts about the product rather than about the tax rules. A qualified opportunity fund is a private fund with fund-level compliance obligations, including a 90 percent asset test and now annual reporting under section 6039K. Interests are generally illiquid and the tax design pushes toward holding for a decade or more, so the timetable is set by the incentive rather than by the investor. Sponsors charge fees at the fund level, which sit between the underlying project's economics and the investor's return. And the largest benefit, the ten-year exclusion, is worth something only if the investment appreciates: an exclusion of gain on an investment that lost money is worth nothing, and the deferred gain is still taxable.

For an investment made from 2027 onward, the sequence is this.

1. Realize a capital gain from a sale or exchange.
2. Invest a corresponding amount in a qualified opportunity fund within 180 days of that sale or exchange, and elect deferral under section 1400Z-2(a).
3. Hold. Your basis in the fund investment starts at zero.
4. At five years, the deferral ends. The deferred gain is included in the taxable year that includes the earlier of a sale of the investment and the fifth anniversary of it, reduced by the basis step-up earned at five years.
5. Hold to ten years for the real benefit, then elect under section 1400Z-2(c) to treat basis as fair market value, which removes tax on the investment's own appreciation. That election is capped at the value at 30 years.

A hypothetical, on the post-2026 rules. Delphine realizes a $200,000 long-term capital gain in March 2027 and invests $200,000 in a qualified opportunity fund within 180 days, electing deferral. Her basis in the fund interest starts at zero.

At five years, the basis increases by 10 percent of the deferred gain, which is $20,000. The amount included is the lesser of the deferred gain and the fund interest's value at that date, reduced by basis; assume here that the investment is worth at least the $200,000 she put in, so the amount included in income is $200,000 less that $20,000 step, or $180,000, in the taxable year containing the fifth anniversary. Had the fund been a qualified rural opportunity fund, the step would be 30 percent of $200,000, or $60,000, and the included amount $140,000. A fund that had fallen in value would produce a smaller inclusion, because the statute measures against the lower of the two figures.

Her basis after that inclusion is the $180,000 of gain recognized plus the $20,000 step, or $200,000, which is what she put in. Suppose she sells in year twelve for $350,000. Without the ten-year election her gain would be $350,000 less $200,000, or $150,000. With the election, basis becomes the fair market value on the sale date and there is no gain on that $150,000 of appreciation.

Now the transition, which is where the money is in the current tax year. Someone who invested in a fund in 2021 and deferred a gain does not get any of the above. The 2025 amendments reach only amounts invested after December 31, 2026, so the prior rules apply, and under those rules the remaining deferred gain is included in the taxable year that includes December 31, 2026. That inclusion cannot be deferred by reinvesting. The ten-year election on that same investment is still available later.

Pros

• The ten-year election removes tax on the fund investment's own appreciation entirely, which is a stronger benefit than deferral and is unaffected by the 2026 recognition.
• Designation is now permanent on a ten-year cycle rather than a single 2018 round, so the program is no longer winding down.
• For investments made from 2027, deferral rolls with the investment date instead of ending on one fixed calendar date for everyone.
• The rural category carries a materially larger five-year step-up and a halved substantial-improvement threshold.
• Only the gain has to be reinvested, not the sale proceeds, which is a real difference from a like-kind exchange of real property.

Cons

• Anyone already invested owes tax for tax year 2026 on the remaining deferred gain, on an investment that has generated no cash, and that inclusion cannot be deferred again.
• The benefit that justifies the structure requires a ten-year hold in an illiquid private fund, so the tax design sets the holding period.
• Fund-level fees sit between the project economics and the investor's return, and the compliance machinery, including the 90 percent asset test and the new annual reporting under section 6039K, is a real cost carried inside the fund.
• The exclusion is worth nothing if the investment does not appreciate, while the deferred gain remains taxable regardless.
• Existing zones expire, on December 31, 2028 and a year earlier in Puerto Rico, so a zone's designated status is not permanent even though the program is.
• Much of the published guidance on the new regime consists of rules the IRS says it anticipates proposing, which is not law.