What Is a QOZ Fund? Structure, Tax Benefits, and 2025 Changes

A QOZ fund, formally a Qualified Opportunity Zone Fund or QOF, is an investment vehicle organized as a corporation or partnership that pools capital gains and puts them to work in economically distressed census tracts in exchange for federal tax breaks. It was created by the Tax Cuts and Jobs Act of 2017 and made permanent by the One Big Beautiful Bill Act signed on July 4, 2025.¹ Investors who roll a capital gain into a QOF can defer tax on that gain, shave a slice off it after five years, and, if they hold the fund investment for at least ten years, pay no federal tax on its appreciation at all.

How a QOZ Fund Is Structured

Federal law defines a QOF as a corporation or partnership organized for the purpose of investing in Qualified Opportunity Zone property, and it must hold at least 90 percent of its assets in that property.² Sole proprietorships, trusts, and disregarded single-member LLCs do not qualify on their own. A multi-member LLC that elects partnership treatment does qualify, and that is the most common setup.

The fund’s organizing documents have to state the QOZ investment purpose. From there, the fund can put its money into one of three things: stock in a domestic corporation operating in a zone, a capital or profits interest in a domestic partnership operating in a zone, or tangible business property used directly in a zone. A fund that buys and operates real estate itself is called a direct investment fund. One that instead holds equity in a lower-tier operating partnership or corporation is a feeder fund. Larger funds often layer both, with operating subsidiaries beneath the QOF.

There is no application to become a QOF and no IRS approval. The entity self-certifies by filing Form 8996 with its federal income tax return and continues filing it every year to report the 90 percent asset test.³

The Three Tax Benefits

The QOF incentive works in three stages, tied to how long you hold the investment.

Deferral of the Original Gain

When you sell an asset at a gain and reinvest that gain into a QOF within the allowed window, you can elect to defer federal tax on the gain until an inclusion event occurs. For investments made before 2027, the inclusion event for any remaining deferred gain is December 31, 2026, which is when the deferred tax comes due whether or not you have sold the QOF interest.⁴ For gains rolled in after December 31, 2026, the deferral runs five years from the date of investment instead of ending on a single fixed calendar date.

A 10 Percent Basis Step-Up at Five Years

Hold the QOF investment for at least five years before the deferral ends and the basis of your deferred gain increases by 10 percent. That 10 percent is permanently excluded from tax when the deferral closes. The additional 5 percent step-up for seven-year holds that existed under the original program is gone; the cap on the basis increase is now 10 percent for standard zones.²

Permanent Exclusion at Ten Years

This is the largest incentive. Hold the QOF investment for at least ten years and, when you sell, you can elect to step the basis in the QOF interest up to fair market value on the sale date. Any appreciation in the fund investment itself escapes federal tax entirely.⁴ The ten-year exclusion applies only to gain on the QOF investment, not to the original deferred gain, which was already recognized when the deferral period ended. For a real estate holding that doubles over a decade, the ten-year exclusion can be worth far more than the deferral.

Getting Money Into a Fund: What Qualifies and When

Only capital gains and qualified Section 1231 gains from business property are eligible, and the gain must come from a sale or exchange with an unrelated party. For QOZ purposes, “related” uses a 20 percent common-ownership threshold rather than the usual 50 percent, so transactions between parties with 20 percent or more shared ownership do not produce eligible gains.² Only the gain portion qualifies, not the full sale proceeds.

The window to invest is 180 days from the date the gain would otherwise be recognized.⁴ Miss it and the gain is taxed in the year it was realized. The investment has to be in exchange for an equity interest in the QOF, not a loan or debt instrument.

Partners and S corporation shareholders have more room. If the pass-through entity realized the gain, the individual can start their 180-day period on any of three dates: the date the entity recognized the gain, the last day of the entity’s tax year, or the unextended due date of the entity’s return for that year. That flexibility is why most individual investors reach a QOF through a K-1.

What the Fund Has to Do to Stay Qualified

The 90 percent asset test is the central compliance rule. A QOF has to hold at least 90 percent of its total assets in Qualified Opportunity Zone property, measured twice a year: on the last day of the first six-month period and on the last day of the tax year. The IRS averages those two figures.³

Businesses the fund invests in have their own layer of rules. A Qualified Opportunity Zone business must use at least 70 percent of its tangible property in a zone during at least 90 percent of the time it holds that property, and it can hold less than 5 percent of its average assets in nonqualified financial property like stocks, bonds, and options.⁴

Property acquired by the fund also has to be either newly placed in service in the zone (original use) or substantially improved, meaning improvements exceeding the property’s adjusted basis within 30 months of acquisition.⁵

Some businesses are off-limits regardless of location. A QOZ business cannot be a private or commercial golf course, country club, massage parlor, hot tub facility, suntan facility, racetrack or other gambling facility, or a store whose principal business is selling alcoholic beverages for off-premises consumption.⁶ A QOF that invests in one of those businesses fails the qualified property test on that investment.

What Changed in 2025

The One Big Beautiful Bill Act, signed July 4, 2025, converted the program from a temporary incentive into a permanent one and rewrote several mechanics.

The December 31, 2026 sunset for new investments is gone. The QOZ incentive is permanent.
Gains rolled into a QOF after December 31, 2026 defer for exactly five years from the investment date rather than snapping to a single calendar deadline.
The basis step-up is capped at 10 percent after five years for standard zones. The former additional 5 percent step-up at seven years is eliminated.
Rural QOZ investments get a 30 percent basis step-up after five years, and the substantial improvement threshold for rural property drops to 50 percent of adjusted basis.²
Starting July 1, 2026, states can nominate new census tracts every ten years. New tracts must independently meet an income threshold of no more than 70 percent of area median family income, closing the earlier loophole that let wealthier tracts qualify by sitting next to distressed ones.

Investors with pre-2027 QOF interests still face the December 31, 2026 recognition date for their deferred gains. The rolling five-year deferral only covers gains invested after that date, so 2026 is a transition year: existing investors get a tax bill on their deferred gain while the program simultaneously reopens with new terms.

What Happens If Something Goes Wrong

Falling below the 90 percent asset threshold does not end the fund, but it starts a monthly penalty. The shortfall (the gap between 90 percent of total assets and the actual value of zone property) is multiplied by the IRS underpayment interest rate for the quarter and divided by 12 to produce the monthly penalty.⁷ It compounds fast and can eat the tax benefits investors came in for.

If a QOZ business owned by the fund has a defect that disqualifies it, the fund has six months to cure the problem. If the defect is not corrected in that window, the penalty applies retroactively to every month, including the cure period.⁸

The worst outcome is decertification. Whether the fund voluntarily decertifies or the IRS strips its status, losing QOF designation is an inclusion event for every investor still holding a qualifying interest, and all remaining deferred gain becomes immediately taxable.⁸ A full liquidation triggers the same event for every investor on the full amount of the qualifying investment. In a fund with many investors who came in at different times, that can produce a wave of unexpected tax bills, which is why fund-level compliance is worth serious diligence before you write the check.

1
Internal Revenue Service. Opportunity Zones
2
Office of the Law Revision Counsel. 26 USC 1400Z-2 – Special Rules for Capital Gains Invested in Opportunity Zones
3
Internal Revenue Service. Certify and Maintain a Qualified Opportunity Fund
4
Internal Revenue Service. Opportunity Zones Frequently Asked Questions
5
Office of the Law Revision Counsel. 26 USC 1400Z-2 – Special Rules for Capital Gains Invested in Opportunity Zones
6
Office of the Law Revision Counsel. 26 USC 144 – Qualified Small Issue Bond
7
Internal Revenue Service. Instructions for Form 8996
8
Internal Revenue Service. Final Regulations Governing Investing in Qualified Opportunity Funds