The “One Big Beautiful Bill” (OBBB) includes a permanent extension of the Opportunity Zone provision that was a novel feature of the 2017 Tax Cuts and Jobs Act (TCJA) and new reporting requirements that will materially alter the compliance landscape for both new and existing funds. This update provides a review of the OBBB’s critical changes to the Opportunity Zone framework.
As background, the TCJA created the Opportunity Zone incentive which allows taxpayers to defer paying taxes on capital gains if those gains are used to “substantially” improve property in target census tracts selected by the governor of each state. The program was a key driver of housing development, catalyzing an investment of some $40 billion.
The OBBB does not extend or change the mechanics of the original program, but instead layers on a permanent framework that will see a rolling (decennial) zone selection process and a fixed five-year deferral period beginning with investments made in 2027. Further, both the investment vehicle, known as qualified opportunity funds (QOFs), and the underlying business, known as qualified opportunity zone businesses (QOZBs), will be subject to robust reporting requirements once rules are issued. The OBBB also prioritizes investment into “rural” areas through additional incentives.
Changes to the Deferral Benefit
1. TCJA Framework: Under the original framework, qualifying investments deferred taxes on realized eligible gains until the earlier of an exit from the QOF or Dec. 31, 2026—regardless of when the investment was made. Additionally, investors received a step-up of basis of 10% after holding their QOF investment for five years and an additional step-up of 5% after holding it for seven years.
2. OBBB Framework: To the chagrin of existing investors, the Dec. 31, 2026, deferral deadline was not extended.[1] However, the OBBB creates a rolling deferral framework for new investments made after Dec. 31, 2026. As a result, investments made on and after Jan. 1, 2027, will receive five years of deferral and a step-up of basis of 10% in year five. The seven-year basis step-up has been removed. Additionally, for certain “rural” funds (more details below), investors will receive a 30% basis step-up in year five.
Changes to the Exclusion Benefit
The exclusion framework for both TCJA and OBBB investments is now capped at 30 years. On the 30-year anniversary of any eligible QOF investment, the basis in the investment is automatically stepped up to its fair market value, thereby allowing for a “tax-free” exit from the investment. Any incremental gain after 30 years will not be taxed, however.
Increased Reporting Requirements
The OBBB creates a three-tier reporting waterfall whereby the underlying business investment (i.e., the QOZB) must report to the investment fund (i.e., the QOF), which then must report to the investors in the fund and to the IRS. The Department of Treasury is also required to report aggregated data collected from the QOFs. The exact reporting and compliance framework will be created, which will also determine which years QOFs will be required to report, potentially including 2025. Here is a non-exhaustive list of the specific information that is required to be reported:
· The value of a QOF’s total assets
· The QOZ census tracts into which a QOFs has invested or the QOZB operates
· The number of residential units owned by a QOF or the underlying QOZBs
· The number of full-time employees employed by a QOF or QOZB
· The value of tangible property owned or leased by a QOZB and a QOF
There are material penalties for reporting failures, including losing the Act’s tax benefits and fines of up to $250,000 per any one tax return, depending on the size of the fund and whether such failures were intentional. The exact reporting and compliance framework has not yet been created but it will be before the end of 2025, and it will also include which years QOFs will be required to report, potentially including 2025.
Zone Designation
The OBBB creates a decennial zone selection process, with the first round of new zones to be identified by July 1, 2026—though we expect states to act much quicker—and such zones to become effective on Jan. 1, 2027. A new round of zones will be selected every 10 years. The eligible zone selection criteria has been tweaked (70% of the statewide median family income for census tracts in non-metropolitan areas and 70% for metropolitan median family income for census tracts in metropolitan areas), but the criteria still key off of income and poverty rates, and each state will be able to select a similar number of zones to the original framework. Further, the entirety of Puerto Rico will no longer be a zone, and tracts that are contiguous to tracts that qualify based on low-income status are no longer eligible.
Special Incentives for Rural Funds
The OBBB further incentivizes QOF investment in “rural” areas that receive opportunity zone designation. A “rural” area is a census tract that does not contain, nor is contiguous or adjacent to, a city or town with a population greater than 50,000 or areas adjacent to such cities or towns.
Investors who hold at least 90% of the assets in such rural areas will receive a 30% basis step-up at five years. Additionally, the underlying “substantial improvement” standard is reduced by 50%.
Managers of existing funds and businesses should start preparing now to comply with the Opportunity Zone incentive’s updated framework and ensure that they are able to secure the data they need to meet the incentive’s new reporting requirements. In particular, the requirement to report “employees” may necessitate restructuring the business relationships of a QOZB to ensure it is actively conducting a trade or business as required by the incentive.
Those wishing to participate in the new framework should consider how they can realize capital gains to correspond with the Jan. 1, 2027, investment start date. If structured properly, any capital gain realized in 2026 should be eligible for deferral under the new framework, if the existing rules are not modified. Further, investors should consider front loading property acquisitions in eligible zones. Large multi-family was the most prominent investment under the first framework and will likely continue as the investment of choice. State policy makers should also carefully consider zone selection to focus on areas that will benefit from the sustained investment, such as underserved rural areas.
If you are interested in learning more about how the OBBB modified the opportunity incentive, or if you are looking for counsel, Ross Keogh can be reached at rkeogh@parsonsbehle.com.
[1] Consider that the budgetary cost of a one-year extension on $40 billion in invested funds would be about $10 billion.
