Pennsylvania CPA Journal
It is an important year for opportunity zone investors and qualified opportunity fund managers. Both have a mandatory deferred gain reporting date coming up as well as new rules under the One Big Beautiful Bill Act.
Calendar year 2026 will be an important year for opportunity zone investors and qualified opportunity fund managers. Both have a mandatory deferred gain reporting date of Dec. 31, 2026, and will have new rules starting
Jan. 1, 2027, under the One Big Beautiful Bill Act (OBBBA). Investors and managers, along with their advisers, should carefully review the rules under the Tax Cuts and Jobs Act (TCJA) of 2017 and the OBBBA to optimize tax outcomes, maintain qualified opportunity fund compliance, and strategically plan for the future of qualified opportunity zones (QOZs).
TCJA and QOZ 1.0
QOZ 1.0 was enacted under the TCJA to encourage investment in economically distressed communities by allowing for a deferral, and potential reduction, of capital gains taxes by investing those gains in qualified opportunity funds that are in designated opportunity zones. A qualified opportunity fund is established as either a domestic partnership or domestic corporation (but not a single-member LLC). It must self-certify that it meets certain requirements – in particular, that at least 90% of its assets are QOZ property – by completing IRS Form 8996 and including it with its timely filed federal income tax return.
Under QOZ 1.0, qualified opportunity funds and their investors enjoyed three significant tax benefits.
First, they could defer gain on the disposition of property until the earlier of the date on which the subsequent investment is sold or exchanged or Dec. 31, 2026. The gain must be reinvested in a qualified opportunity fund within 180 days of the property’s disposition and, if the gain flowed from a partnership to its partners, the partners’ 180-day period begins on the last day of the partnership’s taxable year. Investors may elect to start their period on the due date (without extensions) of the pass-through entity’s tax return for the taxable year in which the sale or exchange took place (generally March 15 or April 15 of the following year).
Second, investors could eliminate up to 10% of the gain that has been reinvested in a qualified opportunity fund that is held at least five years, and another 5% of the gain if it is held at least seven years.
Third, they could eliminate all of the taxable gains associated with the appreciation in the value of the qualified opportunity fund that is held for at least 10 years.
QOZ 1.0 is scheduled to come to an end Dec. 31, 2026, when the tax on the deferred capital gains will need to be paid with the 2026 tax return. Investors may consider offsetting this gain with tax-loss harvesting, as well as carefully reviewing the qualified opportunity funds’ and their own liquidity. These gains cannot be rolled over into the new QOZ 2.0 (as discussed below), so proper planning is prudent and timely.
OBBBA and QOZ 2.0
The OBBBA made substantial changes to opportunity zones, creating a new program (QOZ 2.0) effective Jan. 1, 2027, with new zone designations, new basis adjustments, enhanced compliance and reporting requirements, and a 30-year limit for gain exclusion.
By July 1, 2026, and continuing for a 10-year period, state governors will designate census tracts meeting the new more restrictive criteria for QOZ 2.0 zones. Under QOZ 2.0, tracts only qualify if the median family income does not exceed 70% of state or metropolitan area median family income, or if the poverty rate is at least 20%. Census tracts that are adjacent to such areas, but themselves do not qualify, may not be designated as QOZ 2.0 zones.
A qualified opportunity fund that invests at least 90% of its assets in rural-area QOZs may enjoy enhanced tax benefits as a qualified rural opportunity fund (QROF). A rural area is any city or town with a population of less than 50,000 people. Taxpayers who invest in QROFs receive a 30% step-up in basis just prior to the five-year anniversary, compared with a 10% step-up in basis for other qualified opportunity funds. QROFs also enjoy relaxed requirements regarding the substantial improvement percentage of rural-area QOZs compared with nonrural QOZs.
Taxpayers who reinvest capital gains in a QOZ 2.0 zone within 180 days may defer the tax on such gains until five years after the date of this investment. This may provide a rolling gain deferral, compared to the fixed date under QOZ 1.0. In addition, taxpayers receive a 10% step-up in basis in this investment at the five-year anniversary date. Under QOZ 1.0, there was no additional step-up in basis after the seven-year anniversary date.
Timing may be crucial when considering gain elimination under OBBBA and QOZ rules. Under QOZ 2.0 for investments sold or exchanged within 30 years, the step-up in basis will reflect the fair market value as of the date of sale or exchange. If the investment is held for 30 years or more, the basis step-up will be frozen at the fair market value on the 30th anniversary of such investment, differing from the Dec. 31, 2047, sunset provisions under QOZ 1.0. Further timing, reporting requirements, and tax treatments will likely be clarified in forthcoming Treasury Regulations that are expected prior to Jan. 1, 2027.
Starting in 2027, qualified opportunity funds will have to report certain information annually to the IRS, including but not limited to, the following:
- The total assets held in the qualified opportunity fund.
- The value of QOZ property (or properties).
- The specific QOZ census tracts where investments are made.
- The QOZ business’s applicable trade or business code.
- The amounts invested in each QOZ business.
- The value of any tangible and intangible assets, and whether they are leased or owned by the qualified opportunity fund.
- The number of residential units owned.
- The number of full-time employees.
- The investors who dispose of any qualified opportunity fund investments.
Certain written statements must also be provided by the qualified opportunity fund to its investors and by the QOZ businesses to the qualified opportunity funds that invest in them. Failure to comply may subject the qualified opportunity funds to penalties of up to $10,000 per tax return, or $50,000 for qualified opportunity funds with over $10 million in assets. Willful noncompliance may be subject to even greater penalties.
Investors and their advisers may also want to confirm how quickly and to what effect local state law conforms to the Internal Revenue Code. For example, Pennsylvania and New Jersey automatically conform to federal changes, whereas other states may require specific legislative action.
Next Steps
Some advisers note that we may be in a QOZ investment “dead zone,” with many investors waiting until at least Jan. 1, 2027, to begin investing in qualified opportunity funds to take advantage of the QOZ 2.0 rules. However, any gains realized after July 5, 2026, can be reinvested in 2027 and satisfy the 180-day rule. In addition, for partnerships, there might be additional flexibility for timing because of the investors’ election, as discussed above.
Advisers may wish to discuss timely planning and preparation with their clients regarding the expiring and new QOZ rules throughout the rest of 2026 to minimize taxes, plan for liquidity, and structure future deals accordingly.
Brian M. Balduzzi, JD, LLM (Taxation), CFP, is an attorney with Faegre Drinker Biddle & Reath LLP in Philadelphia and is a member of the Pennsylvania CPA Journal Editorial Board. He can be reached at brian.balduzzi@faegredrinker.com.