The original opportunity zone rules had a hard stop: gain deferred into a qualified opportunity fund (QOF) came back into income no later than the tax year that includes December 31, 2026. Section 70421 of Public Law 119-21, approved July 4, 2025, kept that date for existing investments but turned the program into a permanent one, with new zone maps every 10 years and a rolling 5-year deferral for new money. This article covers what changed, which rules apply to which investment, and what a tax practice should do before year-end 2026.
What makes the program permanent?
Three amendments do the work:
- The election no longer expires. Section 1400Z-2(a)(2) now says only that no deferral election may be made for a sale or exchange if an earlier election for that same sale or exchange is in effect. The old cutoff date for elections is gone.
- Zones are redrawn every decade. New section 1400Z-1(c)(2)(C) defines the "decennial determination date" as July 1, 2026, and each July 1 that falls 10 years after the prior one.
- Each designation lasts 10 years. Under amended section 1400Z-1(e), a designation runs from the "applicable start date," the January 1 after the Secretary certifies the zone, to the day before the 10-year anniversary of that date. Notice 2026-40 confirms that tracts certified and designated during 2026 have a designation period from January 1, 2027, through December 31, 2036.
The act also tightened the definition of a low-income community for new designations. A tract qualifies if its median family income does not exceed 70 percent of the statewide (or metropolitan area) median, or if it has a poverty rate of at least 20 percent and a median family income no higher than 125 percent of the relevant median. The rule allowing certain contiguous tracts was repealed, and the special Puerto Rico rule is repealed effective December 31, 2026. The limit on the number of tracts a state may designate now applies "during any period," and Notice 2026-40 states that previously designated zones do not reduce the number a governor may nominate for the period beginning January 1, 2027.
What happens to existing investments on December 31, 2026?
This is the urgent part for 2026 returns. Notice 2026-40 states that gain deferred for a qualifying investment made on or before December 31, 2026, must be included in income in the tax year that includes the earlier of an inclusion event or December 31, 2026. Investors who still hold their QOF interests through that date recognize the remaining deferred gain, which the notice calls "deemed included gain," computed under the prior version of section 1400Z-2(b)(2).
Two consequences follow from the notice:
- The deemed included gain cannot be deferred again. The original deferral election stays in effect, so the gain recognized on December 31, 2026, is not eligible gain for a new election under either the old or the new statute.
- The 10-year benefit survives. Because the election remains in effect, an investor who later meets the 10-year holding period and the other requirements can still make the section 1400Z-2(c) election to step up basis on a sale.
Practically, these clients have taxable gain on their 2026 return with no cash from a sale. Build it into fourth quarter estimates and the safe harbor analysis. See estimated tax payments and safe harbors.
How does deferral work for new investments?
For amounts invested in QOFs after December 31, 2026, amended section 1400Z-2(b) provides:
- Rolling 5-year inclusion. Deferred gain is included in the tax year that includes the earlier of the date the investment is sold or exchanged, or the date 5 years after the investment was made. Notice 2026-40 adds inclusion events other than a sale or exchange to that list.
- Basis step-up after 5 years. An investment held at least 5 years gets a basis increase equal to 10 percent of the deferred gain, or 30 percent for an investment in a qualified rural opportunity fund. The increase is treated as occurring before the 5-year inclusion date, so it reduces the amount included.
- Amount included. The included amount is the lesser of the deferred gain or the investment's fair market value on the inclusion date, minus the taxpayer's basis in the investment (which starts at zero).
Notice 2026-40 also confirms that a taxpayer with gain realized on, before or after December 31, 2026, who timely invests on or after January 1, 2027, may elect deferral under the new rules. A client with a large gain late in 2026 may therefore choose to invest in 2027, within the 180-day window, to reach the new regime. Model both paths before giving advice.
What changed for the 10-year exclusion?
For investments held at least 10 years, amended section 1400Z-2(c) sets basis at fair market value on the date of sale if the investment is sold before the 30th anniversary of the investment. For investments held longer, basis is fixed at fair market value on the date 30 years after the investment. Appreciation after year 30 is taxable. Like the other section 1400Z-2(b) and (c) changes, this rule applies to amounts invested in QOFs after December 31, 2026.
What are the rural fund benefits?
A qualified rural opportunity fund is a QOF that holds at least 90 percent of its assets in qualified opportunity zone property in zones made up entirely of rural areas. A rural area is any area other than a city or town with more than 50,000 inhabitants and any urbanized area contiguous and adjacent to such a city or town. The benefits are:
- The 30 percent basis step-up after 5 years, for amounts invested after December 31, 2026.
- A lower substantial improvement threshold. For existing buildings in a zone made up entirely of a rural area, the additions to basis needed to substantially improve the property are 50 percent of adjusted basis rather than 100 percent. The IRS states this rule applies as of July 4, 2025. Notice 2025-50 provides the guidance and, according to the IRS release, identifies 3,309 existing zones as comprised entirely of a rural area.
What new reporting applies?
The act added three Code sections, effective for taxable years beginning after the date of enactment:
- Section 6039K. Every QOF files an annual return with fund-level data (total assets, QOZ property values on each testing date) and investment-level data for each business it holds: the business's identifying information, NAICS codes, census tracts, owned and leased tangible property, approximate residential units and approximate full-time equivalent employees. It also reports each investor who disposed of an interest during the year, with acquisition and disposition dates and amounts, and must furnish a statement to those investors. Rural funds file under the same rules. The return must be filed electronically.
- Section 6039L. A qualified opportunity zone business owned by a QOF must furnish the fund the information the fund needs for its return, as regulations prescribe.
- Section 6726 penalties. Failure to file a complete and correct section 6039K return carries a penalty of $500 per day, capped at $10,000 per return, or $50,000 for a fund with gross assets above $10,000,000 at year-end. For intentional disregard, the amounts become $2,500 per day and caps of $50,000 and $250,000. The amounts are indexed for returns required to be filed in calendar years after 2025.
The IRS has issued proposed regulations on QOZ information reporting and updated QOF certification procedures (REG-116506-25). Check the current forms and instructions before preparing a fund's 2026 return.
Client checklist
- List every QOF investment by client, date, amount of deferred gain and remaining basis.
- Compute the 2026 deemed included gain and add it to 2026 projections and estimates.
- Confirm 10-year dates for each investment to plan the section 1400Z-2(c) election.
- For new gains, compare investing before and after January 1, 2027, within the 180-day window.
- For fund clients, map each asset to its census tract and rural status, and set up a data request to portfolio businesses that supports section 6039K reporting.
- For rural rehab projects, document the 50 percent substantial improvement computation.
For the other business changes in the same law, see the 2026 client meeting checklist. Founders weighing a QOF against holding startup stock should also read the section 1202 changes.
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Sources
- U.S. Government Publishing Office, Public Law 119-21, section 70421: https://www.govinfo.gov/content/pkg/PLAW-119publ21/html/PLAW-119publ21.htm
- Internal Revenue Service, Notice 2026-40, Transitional Guidance on Qualified Opportunity Zones: https://www.irs.gov/pub/irs-drop/n-26-40.pdf
- Internal Revenue Service, Treasury, IRS provide guidance for opportunity zone investments in rural areas (IR-2025-96, Notice 2025-50): https://www.irs.gov/newsroom/treasury-irs-provide-guidance-for-opportunity-zone-investments-in-rural-areas-under-the-one-big-beautiful-bill
- Internal Revenue Service, Opportunity zones: https://www.irs.gov/credits-deductions/businesses/opportunity-zones
- Federal Register, REG-116506-25, Information Reporting Regarding Qualified Opportunity Zones and Updated Qualified Opportunity Fund Certification and Decertification Procedures: https://public-inspection.federalregister.gov/2026-18574.pdf
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