Opportunity Zone Final Regulations: Tax Benefits and 2027 Changes

The Opportunity Zone final regulations, issued by the Treasury and IRS as Treasury Decision 9889 on January 13, 2020, set the operating rules for the program created by the 2017 Tax Cuts and Jobs Act: how investors defer capital gains through a Qualified Opportunity Fund, how funds and their underlying businesses must be structured and tested, and which property counts. Those rules govern investments made under the original program, whose deferred gains come due on December 31, 2026. A separate overhaul enacted in July 2025 (the One Big Beautiful Bill Act) and transitional IRS guidance in Notice 2026-40 change the framework for investments made on or after January 1, 2027.¹²

What TD 9889 Covers

TD 9889 was published on January 13, 2020, with an effective date of March 13, 2020. It consolidated and refined two earlier rounds of proposed regulations from 2018 and 2019 and addresses gain deferral elections, fund structure and testing, property and business qualification, leased property, inclusion events, and the mechanics of the ten-year exclusion. For taxable years beginning after December 21, 2017, but before the March 2020 effective date, taxpayers could either apply the final regulations or continue relying on the proposed regulations, so long as they did so consistently.³

The Three Tax Benefits Under the Final Rules

The final regulations preserve the three-tier structure Congress created: deferral, a partial basis step-up tied to holding period, and a separate ten-year exclusion for post-investment appreciation.

Gain Deferral

An investor who realizes an eligible capital gain may elect to defer it by investing a matching amount in a QOF within 180 days. The gain stays deferred until the earlier of a sale or exchange of the QOF interest or December 31, 2026.⁴ Only capital gains qualify. Ordinary income items, including Section 1245 depreciation recapture, are not eligible.³

Basis Step-Up After Five and Seven Years

A five-year hold produced a 10% increase in the basis of the deferred gain, effectively excluding 10% of that gain. A seven-year hold added another 5%, for a total 15% exclusion.⁵ Because the deferral window closes on December 31, 2026, only investments made on or before December 31, 2021, could reach five years in time, and only those made on or before December 31, 2019, could reach seven. Investments made after December 31, 2021, generally receive no basis step-up.⁶

Ten-Year Exclusion of Appreciation

An investor who holds a QOF interest for at least ten years may elect to step the basis of that interest up to fair market value on the date of sale, eliminating federal tax on appreciation that accrued during the holding period. The exclusion covers the growth in the QOF investment itself, not the original deferred gain, and does not reach gains from the sale of inventory in the ordinary course of business.⁴

The 180-Day Investment Window

The 180-day clock generally starts on the date the gain would be recognized for federal income tax purposes. For Section 1231 property, the final regulations adopted a “gross approach”: eligible gains are not reduced by Section 1231 losses, and the 180 days run from the date of sale rather than the last day of the taxable year.³

Partners, S corporation shareholders, and trust beneficiaries have three choices for when their 180 days begin: the date the entity realized the gain, the last day of the entity’s taxable year, or the entity’s original return due date (excluding extensions). For installment sales occurring after 2017, an investor may use a single 180-day period beginning on the last day of the sale year, or start a fresh 180-day period each time a payment arrives.⁴

Qualified Opportunity Fund Requirements

A QOF must be organized as a corporation, partnership, or LLC treated as one of those entities for federal tax purposes, and it must be organized for the purpose of investing in Qualified Opportunity Zone property. An entity self-certifies by filing Form 8996 annually with its federal income tax return.⁷

The 90% Asset Test

At least 90% of a QOF’s assets must be qualified opportunity zone property. Compliance is measured by averaging the fund’s percentages on the last day of the first six-month period of the taxable year and the last day of the taxable year itself.⁷ The final regulations let QOFs exclude recently contributed property from the calculation under specified conditions and add safe harbors for funds in a wind-down period or during a substantial improvement period.¹

Voluntary Decertification

A QOF may voluntarily decertify, effective the first day of the month after the decision. Decertification, voluntary or otherwise, is itself an inclusion event, triggering recognition of deferred gains for the fund’s investors.⁸

Qualified Opportunity Zone Businesses

A QOF can invest directly in qualified opportunity zone business property or hold an interest in a Qualified Opportunity Zone Business. A QOZB must clear several tests.

Tangible Property and Income Tests

At least 70% of the tangible property owned or leased by a QOZB must be qualified opportunity zone business property, and that property must be used in a zone at least 90% of the time it is held. Combining the two produces an effective requirement that at least 63% of the property’s total use occurs within a zone.⁴ A QOZB must also earn at least 50% of its gross income from activities conducted within a qualified opportunity zone, with safe harbors based on hours of services performed in the zone, amounts paid for services in the zone, or whether the business’s necessary tangible property and functions are located in the zone.⁷

Prohibited Businesses

Golf courses, country clubs, massage parlors, hot tub and suntan facilities, racetracks, gambling facilities, and liquor stores cannot qualify. The final regulations added a de minimis carve-out: a QOZB may lease less than 5% of its property to a prohibited business without disqualification.⁹

Active Trade or Business

Merely signing a triple-net lease on real property does not, by itself, constitute the active conduct of a trade or business. But a triple-net lease that sits inside a broader leasing operation can qualify. The regulations illustrate the point: an owner of a mixed-use building who leases one floor triple-net while actively managing the rest is treated as conducting an active trade or business with respect to the entire property.¹⁰

Original Use and Substantial Improvement

Tangible property held by a QOF or QOZB must be acquired by purchase after December 31, 2017, and must either meet the original use requirement or be substantially improved.⁷

Original Use

Property meets original use when it is first placed in service for depreciation or amortization purposes within the zone. Used property qualifies if no one has previously placed it in service in that particular zone. A vacant building can qualify as original-use property if it was vacant for at least three years after the zone’s designation date, or if it became vacant at least one year before designation and stayed vacant through the purchase date. The final rules cut this vacancy period from the five years originally proposed.⁴¹¹

Substantial Improvement

Property is substantially improved when additions to its basis over any 30-month period after acquisition exceed the adjusted basis at the start of that period, a rule sometimes called the doubling basis test. The improvement work does not have to be complete by the end of the 30 months.⁴ Land is generally excluded from the substantial improvement requirement, provided a building on the land is used in an active trade or business.¹² The final regulations also allow multiple buildings on the same parcel to be treated as a single property for the test, so the aggregate investment need only equal combined initial basis rather than doubling each building.¹¹

The Working Capital Safe Harbor

The final regulations provide a 31-month working capital safe harbor that lets a QOZB hold cash and liquid assets while deploying capital, without failing the business qualification tests. Three conditions apply: the business must designate the assets in writing for use in developing a trade or business in the zone, keep a written spending schedule consistent with an ordinary business startup, and actually use the assets in a manner substantially consistent with that plan.¹³ A QOZB in a federally declared disaster area may add up to 24 months to the standard 31, and startup businesses may qualify for a 62-month safe harbor.¹

Leased Property

Leased tangible property can count as qualified opportunity zone business property. Leases between unrelated parties must be entered into after December 31, 2017, on market-rate terms. Related-party leases carry additional constraints: no prepayments exceeding 12 months, and where the property was previously used in the zone, the business must make a “fresh purchase” of other qualified property equal in value to the leased property within the earlier of the lease’s end or 30 months after receiving the leased property.⁴

Inclusion Events

Certain transactions end the deferral early and force the investor to recognize the remaining deferred gain. Inclusion events include selling or exchanging the QOF interest, liquidation of the QOF before December 31, 2026, gifting the interest, transferring it to a spouse in a divorce, transferring it to a non-grantor trust, and distributions that exceed the investor’s basis. A transfer to a revocable grantor trust is not an inclusion event, and a merger of two QOF partnerships does not trigger recognition if the investor receives only a qualifying interest in the surviving fund.⁴

If no earlier inclusion event occurs, the deferral automatically ends on December 31, 2026. Gain from an inclusion event may itself be re-deferred through a new QOF investment, and the investor’s remaining QOF interest continues to qualify to the extent deferred gain remains.⁸

The December 31, 2026 Recognition Date

All previously deferred gains from the original program must be recognized no later than December 31, 2026. The amount recognized is the lesser of the original deferred gain or the fair market value of the QOF investment on that date, reduced by any applicable basis step-up.⁶ If fair market value has fallen below the original deferred gain, the lower figure may be used, though the IRS can challenge aggressive valuations. The Code does not prescribe a valuation methodology for QOF interests; the general fair market value standard from Revenue Ruling 59-60 applies, and discounts for lack of marketability and lack of control may be appropriate depending on the facts.¹⁴

Because QOF investments are often illiquid, investors may owe federal capital gains tax, net investment income tax, and possibly state tax without a matching cash distribution from the fund. Tax payments tied to the 2026 recognition may be due as early as January 15, 2027, depending on the investor’s estimated tax position.¹⁵

What Changes for Investments Made on or After January 1, 2027

President Trump signed the One Big Beautiful Bill Act on July 4, 2025, making the Opportunity Zone program permanent and rewriting several core terms for investments made on or after January 1, 2027.²

A New Round of Zone Designations

Governors will designate a new map of Qualified Opportunity Zones effective January 1, 2027, through December 31, 2036. The 90-day nomination window opens July 1, 2026, with nominations due by September 28, 2026 (governors may request a 30-day extension). Each state may nominate up to 25% of its eligible low-income census tracts, rounded up. Eligibility is tighter: the income ceiling for a low-income community drops from 80% to 70% of the relevant median family income, tracts with median incomes above 125% of the statewide or metropolitan median are barred, and the ability to designate contiguous tracts that are not themselves low-income has been eliminated. The nationwide total is expected to fall from roughly 7,826 tracts to about 6,544.¹⁶

Revised Deferral and Basis Rules

For investments made after December 31, 2026, deferral runs five years from the date of investment rather than to a fixed calendar endpoint. A 10% basis step-up is available at the five-year mark; the seven-year step-up is gone.¹⁷ The ten-year exclusion for post-investment appreciation stays, but for holds longer than 30 years the stepped-up basis freezes at the fair market value on the 30th anniversary.² Gains deferred under the original program and recognized on December 31, 2026, cannot be re-deferred under the new rules; certain other gains realized in 2026 or triggered by inclusion events may qualify for the post-2026 benefits if invested in a QOF on or after January 1, 2027.¹⁸

The OBBBA also introduces a limited one-time, lifetime election allowing individuals to invest up to $10,000 of ordinary income into a QOF. That amount is eligible for the ten-year exclusion but not for the five-year basis step-up.¹⁹

Qualified Rural Opportunity Funds

The OBBBA creates a new category, the Qualified Rural Opportunity Fund, to steer capital to rural areas. A rural area is any area other than a city or town with a population greater than 50,000, excluding urbanized areas contiguous and adjacent to such a city or town, based on the 2020 Decennial Census.²⁰²¹²

Mandatory Reporting

New IRC Sections 6039K and 6039L, effective January 1, 2027, impose annual reporting requirements on QOFs and QROFs. Funds must disclose total assets, qualified opportunity zone property values per testing date, NAICS codes, census tract locations, investment amounts, residential unit counts, and average monthly full-time equivalent employees, among other items. For each investor who disposes of an interest during the year, the fund must report the holder’s name, tax identification, and acquisition and disposal dates. Penalties run $500 per day, capped at $10,000 per return for standard funds and $50,000 for funds with gross assets exceeding $10 million. Intentional disregard raises the daily penalty to $2,500, with caps of $50,000 and $250,000. All figures are indexed for inflation.²²

Transitional Guidance: Notice 2026-40

The IRS released Notice 2026-40 on June 18, 2026, to bridge the original designations and the new round. Tangible property acquired after December 31, 2026, generally cannot qualify as qualified opportunity zone business property in a “previously designated” zone. Two exceptions apply. Property acquired under a written working capital plan adopted on or before December 31, 2026, still qualifies if the QOZB has received at least 10% of its estimated working capital and expended at least 5% by year-end 2026. Property acquired in the ordinary course of business to replace or modernize existing tangible property also remains eligible, though not for expansion into new trade or product lines.²³¹⁸

Entities in previously designated zones may continue to treat those locations as qualified opportunity zones for purposes of the substantial use and active business conduct tests through December 31, 2047.²⁴

State Conformity Is Not Automatic

The federal rules do not bind every state. California, Massachusetts, and North Carolina are among the states that do not conform, so investors there may owe state tax on deferred gains and get no state-level benefit from the basis step-up or ten-year exclusion.²⁵ New York decoupled from the federal deferral and basis step-up provisions effective January 1, 2021, while continuing to conform to the ten-year exclusion for appreciation on QOF investments.²⁶ States with no capital gains tax, including Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, and Wyoming, sidestep the conformity question.

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