Here Are the Opportunity Zone Tax Changes Investors Must Know

Approximately 25,000 distinct investors (21,000 individuals and 4,000 corporate entities) have invested over $100 billion in capital gains in Qualified Opportunity Funds (QOFs) since 2017. Opportunity Zone 1.0 deferrals expire at the end of 2026, and OZ 2.0 begins for investments made on or after Jan. 1.

Since “rollovers” generally aren’t permitted, the transition creates three immediate planning assignments for QOFs and Qualified Opportunity Zone Businesses (QOZBs):

Preparing for Dec. 31 gain recognition. Investors in OZ 1.0 must recognize deferred gain on Dec. 31. Because the reportable amount is the lower of the deferred gain or the investment’s fair market value on Dec. 31, valuations must be secured, and strategies such as cost segregation studies and tax loss may be available to mitigate the 2026 tax hit.

Blake Christian (left) and Abi Yanke. PHOTOS: Courtesy Holthouse, Carlin & Van Trigt

OZ investors can also deduct any basis increase earned for a five- or seven-year hold (15 percent for funding on or before Dec. 31, 2019, or 10 percent for funding from Jan. 1, 2020, through Dec. 31, 2021).

For example, a taxpayer who invested $1 million of deferred gain on Dec. 1, 2019, in a QOF interest now worth $700,000 would generally report $700,000 less the 15 percent basis increase ($150,000) — for a net 2026 gain of $550,000. Special valuation rules apply to QOZBs that used debt to finance losses or distributions.

Identifying eligible gains and locations for OZ 2.0. While the new tract map takes shape, investors should identify eligible 2026 gains, the funding date each gain allows, and potential OZ 2.0 locations.

Notice 2026-40 and the cutoff for OZ 1.0 property. Notice 2026-40 provides that property acquired after Dec. 31, 2026, generally will not qualify as Qualified Opportunity Zone Business Property (QOZBP) in a previously designated OZ 1.0, with exceptions for property acquired under a written working-capital, safe-harbor plan and for ordinary-course replacement or modernization property.

Unfinished OZ 1.0 projects must update their business plans and ensure at least 10 percent of total funding has been contributed to the QOZB and at least 5 percent of the budget spent or placed under binding contract. See our 10 Things to Know About the IRS’s Recent OZ 1.0 to 2.0 Transition Guidance for more.

Deferred gain is reportable in 2026, even if the investor still holds the interest, but that inclusion does not end the potential benefit of a qualifying sale after a 10-year hold. Notice 2026-40 bars reinvesting this “Deemed Included Gain” in another QOF. However, a de-certification, an asset sale or a liquidation of the OZ structure before year-end may generate gain eligible for a new OZ Fund.

Valuation discounts require documentation — they should not be assumed from a project’s general financial difficulties.

A coordinated 2026 projection should also weigh same-year capital losses and carry forwards, passive losses (where activity rules permit), net operating losses, charitable deductions and depreciation, at both the federal and state level. See our 2026 Opportunity Zone planning alert for more.

For QOF investments made beginning Jan. 1, OZ 2.0 provides a new, rolling deferral period: Gain becomes taxable upon an earlier inclusion event or five years after the investment, with a 10 percent basis increase or 30 percent for qualified rural opportunity funds. The exclusion qualifying of appreciation after a long-term hold remains a central incentive.

Rural projects also benefit from having qualifying property in a fully rural zone. The substantial improvement threshold has been reduced from 100 percent to 50 percent of the building’s adjusted basis.

Investors generally have 180 days from the gain event to invest in a QOF. Pass-through owners may instead use the entity’s year-end or the unextended due date of its return.

Installment-sale gain may be tied to each payment date or year-end and K-1 recipients reporting capital, or those with 1231 gains may elect to start the 180-day window on either Dec. 31 of the year of sale, or March 15 of the following year.

These rules can carry 2026 gains into 2027 and the more valuable OZ 2.0 treatment. IRS transition guidance expressly permits this if the investment meets the applicable 180-day deadline and the new program’s requirements are met. The correct start date must be documented. Neither a late investment nor an artificial change in payment terms creates eligibility. For more, see our Extending the OZ Investment Window

Sponsors with unfinished OZ 1.0 developments should compare remaining cash, equity and financing against construction schedules and asset tests. A project in a re-designated tract may tap new OZ 2.0 dollars, but that capital needs its own eligible gain, timely QOF investment and compliant deployment.

Before the new OZ map is certified, investors can calculate their 2026 inclusion, and sponsors can document how they will complete existing projects, positioning both to act quickly in 2027.

Blake Christian is a tax partner in the Salt Lake City and Long Beach, Calif., offices of full-service CPA firm Holthouse, Carlin & Van Trigt (HCVT). Abi Yanke is a tax manager in HCVT’s Salt Lake City office.

Source: commercialobserver.com — article syndicated from the publisher’s feed; all rights remain with the original publisher.