The One, Big, Beautiful Bill (OBBB) made a variety of changes to the opportunity zone (OZ) incentive, which was originally created in 2017 as part of the Tax Cuts and Jobs Act (TCJA). Most importantly, it made the opportunity zone incentive a permanent part of the Internal Revenue Code (IRC). Participants in the opportunity zone incentive need to be aware of the significant differences between the OBBB version of opportunity zones (OZ 2.0) and the TCJA version (OZ 1.0), so that they can plan and implement their strategy to optimize their opportunity zone tax benefits.
A refresher on opportunity zones and OZ 1.0
The goal of the opportunity zone incentive remains the stimulation of economic development and job creation in designated low-income or economically distressed communities by offering tax benefits to those who reinvest capital gains into qualified opportunity funds (QOFs).
The original opportunity zone rules provide the following benefits to taxpayers who invest capital gains into a QOF within 180 days and file Form 8997 with the IRS to defer such gains:
- Capital gain deferral. Temporary deferral of capital gains invested into a QOF through Dec. 31, 2026.
- Basis increase. 10% reduction of such deferred capital gains in the form of a basis step-up if the taxpayer’s investment in the QOF is held for five years and 15% reduction if held for years before the deferred capital gain is required to be recognized.
- Capital gain exclusion. 100% exclusion of capital gain on exit if the QOF investment is held for 10 years or more, in the form of a basis step up to fair market value upon exit.
QOFs are corporations or partnerships formed to invest in qualified opportunity zones (QOZs). OZ 1.0 QOZs were selected by each state in 2018 using criteria based on median family income or poverty rates with some flexibility that allowed contiguous census tracts to qualify under certain circumstances. A QOF can invest directly in QOZ business property (QOZBP) or into QOZ businesses (QOZBs), which invest in QOZBP. If a QOF fails to keep 90% of its assets invested in QOZBP or QOZBs, it can be subject to penalties for failing to meet the “investment standard” test.
To be eligible for QOF investment, a QOZB must:
- Ensure that at least 70% of its owned and leased tangible property is QOZBP.
- Earn at least 50% of its revenue from an active business within the QOZ.
- Use a substantial portion (40%) of its intangible property in an active business within the QOZ.
- Limit nonqualified financial property (NQFP) to 5% of its average assets.
- Refrain from operating any type of “sin” business disallowed under the opportunity zone rules (e.g., gambling, massage parlor, liquor store, etc.)
How OBBB changed (and didn’t change) opportunity zone tax benefits
In addition to opportunity zones becoming a permanent part of the IRC, key changes that generally improve the opportunity zone incentive in OZ 2.0 include:
- Rolling five-year temporary capital gain deferral period (vs. OZ 1.0’s deferral until Dec. 31, 2026).
- Step-up in basis of 10% at five years (30% for investments in new “qualified rural QOFs”).
- Rolling 30-year cap on the 100% exclusion of capital gain upon exit after a 10-plus-year holding period (vs. OZ 1.0’s sunset in 2047).
- Automatic step-up in basis to fair market value after 30 years (vs. OZ 1.0’s sale requirement to benefit from the step up to fair market value).
Investments in QOFs made on or after Jan. 1, 2027, receive the OZ 2.0 benefits listed above. Investments in QOFs made on or before Dec. 31, 2026, receive OZ 1.0 tax benefits.
The table below summarizes the differences between OZ 1.0 and OZ 2.0 tax benefits:
Perhaps the most important item to note about what hasn’t changed is the Dec. 31, 2026, deadline for recognition of deferred capital gains under OZ 1.0.
How the OBBB changed qualified opportunity zone designations
When they made opportunity zones permanent, legislators created a 10-year “rolling” QOZ selection process to ensure that opportunity zone incentives continue to benefit areas most in need of investment as determined by each state. The next decennial QOZ designations will become effective Jan. 1, 2027. In comparison with the OZ 1.0 QOZ designation process, OZ 2.0 has:
- Removed the contiguous tract option.
- Reduced the median family income qualification threshold from 80% to 70%.
- Added a provision that tracts qualifying with a more than 20% poverty rate are disqualified if median family income is above 125%.
- Removed a blanket designation for all of Puerto Rico.
Such changes are expected to lead to a 25% reduction in the number of QOZs from 8,764 to approximately 6,500.
Planning is crucial: Optimize the tax benefits of opportunity zones 2.0
Like many of the changes that the OBBB made to the IRC, the permanent extension of the opportunity zone incentive has created opportunities and potential pitfalls that taxpayers need to be aware of to optimize their tax benefits. Here are our top 10 planning strategies to help taxpayers navigate these recent changes.
