Key insights
- New guidance on Qualified Opportunity Zones gives investors and fund sponsors a clearer view of how OZ 1.0 investments transition into OZ 2.0. The guidance addresses designation timing, 2026 gain recognition, and long-term compliance rules affecting existing projects and future investment decisions.
- The 2026 recognition date remains a key planning point for existing OZ investors. Investors should model the tax impact of deferred gain recognition while also evaluating how the potential 10-year appreciation benefit may continue to apply.
- Existing projects should review written plans, funding timelines, and post-2026 capital expenditures before year-end 2026. The guidance provides transition paths for certain property acquisitions and compliance tests, but the treatment depends on facts, documentation, and timing.
Re-evaluate your Opportunity Zone strategy before year-end.
New guidance on Qualified Opportunity Zones (QOZ) makes year-end 2026 a critical planning point for existing investments, written working capital plans, and post-2026 property acquisitions.
Learn what investors, fund sponsors, developers, and operating businesses already working in OZ 1.0 communities or evaluating new OZ 2.0 opportunities should understand about the new guidance. Proposed regulations are expected to follow rules similar to the framework described in the guidance, formally known as IRS Notice 2026-40.
States receive a fresh opportunity to nominate OZ 2.0 tracts
One of the most important clarifications relates to how the statutory limitation on QOZ designations applies to the next designation cycle. States may nominate census tracts for the new QOZ designation period beginning January 1, 2027, without reducing that number for previously designated OZ 1.0 tracts.
This confirms OZ 2.0 creates a new designation cycle rather than extending the original map. States will have a new designation opportunity for the period beginning January 1, 2027, and ending December 31, 2036, for every low-income community certified and designated a QOZ during 2026.
Investors and fund sponsors should separately confirm whether existing OZ 1.0 locations remain eligible for all new post-2026 investment activity. States will have a renewed opportunity to identify communities for future OZ investment.
Existing Opportunity Zone investors still face 2026 gain recognition
For taxpayers who made qualifying Opportunity Zone investments under the original program, the notice confirms remaining deferred gain must generally be recognized in the taxable year including December 31, 2026, unless an earlier inclusion event occurs.
This mandatory income inclusion receives different treatment from a new eligible gain that could be rolled into another Qualified Opportunity Fund (QOF). Taxpayers must recognize the 2026 deemed inclusion even if they continue to hold their original qualifying investment.
The 2026 gain recognition rule applies to the original deferred gain while preserving the possibility of a separate 10-year benefit for post-investment appreciation if the taxpayer satisfies the applicable requirements. If the taxpayer continues to hold the qualifying investment and otherwise satisfies the applicable requirements, the taxpayer may still be eligible to make the basis-to-fair-market-value election on a later sale or exchange.
Investors should begin modeling the tax cost of the 2026 inclusion now. However, the long-term value proposition of many OZ 1.0 investments may remain intact because the potential exclusion of post-investment appreciation can continue beyond the 2026 inclusion date.
Late-2026 gains may still create OZ 2.0 planning opportunities
The notice provides helpful guidance for gains realized around the transition date. A taxpayer with eligible gain realized on, before, or after December 31, 2026, may be able to elect deferral under the new regime if the taxpayer timely invests the corresponding amount in a QOF on or after January 1, 2027.
For post-2026 qualifying investments, the gain inclusion date follows the new timing rule rather than the universal December 31, 2026, deadline. The deferred gain is generally included in income in the year that includes the earliest of a sale or exchange, another inclusion event, or the date that is five years after the qualifying investment was made.
The new rules also provide a basis increase for certain investments held at least five years. They include the general 10% basis increase and the enhanced 30% basis increase available for investments in a qualified rural opportunity fund.
These basis-increase rules are effective only for amounts invested in QOFs after December 31, 2026. Accordingly, the new 10% and 30% basis increases apply to post-2026 QOF investments rather than pre-2027 qualifying investments held by existing OZ 1.0 investors.
Taxpayers with gains arising in 2026 should pay close attention to the 180-day investment period. Depending on the facts, an investment made after January 1, 2027, may fall under the new OZ 2.0 framework.
Inclusion event gain requires separate analysis
The guidance draws an important distinction between the mandatory 2026 deemed inclusion and gain recognized from a separate inclusion event. Gain triggered by a separate inclusion event may be eligible for a new deferral election if the taxpayer satisfies the applicable requirements and makes a qualifying investment within the relevant 180-day period.
That treatment differs from the 2026 deemed inclusion of original deferred gain. The 2026 deemed inclusion generally must be recognized because the original deferral election remains in effect.
This distinction matters because OZ-related gain recognition events can receive different tax treatment. Investors and advisors should separately identify whether a gain item is the mandatory 2026 deemed inclusion or gain from a separate inclusion event before deciding whether a new deferral election may be available.
Post-2026 property acquisitions in existing OZ tracts remain available in limited circumstances
There’s also new guidance for QOFs and Qualified Opportunity Zone Businesses (QOZB) that own or operate property in existing OZ 1.0 tracts. In general, tangible property acquired after December 31, 2026, qualifies as QOZ business property in a previously designated QOZ only if it’s used in a newly designated OZ 2.0 tract, acquired for use in a QOZ designated after July 4, 2025, or covered by another exception.
Two transition paths are particularly relevant for existing projects.
Written working capital safe harbor
First, property acquired after 2026 may qualify if it’s acquired under a written working capital safe harbor plan adopted on or before December 31, 2026, provided several requirements are met.
Among other items:
- The acquisitions must be substantially consistent with the plan.
- The QOZB must have received at least 10% of the total estimated working capital assets by year-end 2026.
- The QOZB must expend at least 5% of those assets by year-end 2026. For purposes of the 5% expenditure threshold, amounts a QOZB is required to expend pursuant to a binding agreement entered into before January 1, 2027, are treated as expended by December 31, 2026.
The guidance also extends this safe harbor beyond tangible property: Stock or partnership interests acquired after December 31, 2026, pursuant to a qualifying pre-2027 written plan are treated as acquired after the "applicable date," which is significant for two-tier QOF/QOZB structures.
Replacement or modernization property
The guidance allows certain post-2026 acquisitions of replacement or modernization property in the ordinary course of an existing trade or business. This is particularly relevant for operating real estate assets, such as apartment buildings, where ordinary-course replacements and renovations may be necessary to continue operations. However, the notice distinguishes those replacement or modernization expenditures from acquisitions made to expand a business or enter a new trade or business.
Existing OZ projects should revisit their written plans, budgets, construction schedules, funding timelines, and expected post-2026 capital expenditures. In practice, the distinction between continuation, replacement, modernization, and expansion will be important.
Long-term compliance relief extends certainty for OZ 1.0 projects
Another key aspect of the new guidance is its treatment of compliance after the expiration of original OZ designations. Under the original program, Puerto Rico QOZ designations generally expire on December 31, 2027, while other original QOZ designations generally expire on December 31, 2028.
Treasury and the IRS expect forthcoming proposed regulations to include safe harbors allowing certain QOFs and QOZBs to continue treating expired previously designated QOZs as QOZs for specified purposes through December 31, 2047. These safe harbors are expected to apply to certain tests involving tangible property use, active conduct of a trade or business, gross income, and intangible property. This relief is tract- and project-specific.
For the substantial-use test, the tangible property must have been acquired on or before the tract's designation expiration date (December 31, 2027, for Puerto Rico; December 31, 2028, for all other tracts), or acquired pursuant to the working capital safe harbor or the ordinary-course replacement rule. For the QOZB gross-income and intangible-property tests, the QOZB must have begun active conduct of a trade or business in the tract on or before the tract's designation expiration date, or reasonably anticipate doing so under a qualifying pre-2027 written working-capital plan.
This relief provides important certainty for long-term projects. It gives investors and businesses a clearer basis for assessing whether existing assets can continue satisfying QOF and QOZB requirements after a tract's designation period expires.
Notice 2026-40 functions as transition guidance pending proposed regulations, and Treasury and the IRS indicate the forthcoming proposed regulations are expected to apply to taxable years ending after the date the notice was issued, signaling the interim positions should generally govern transition-period planning.
Opportunity Zone planning items to address now
For QOF sponsors, QOZBs, developers, and investors, the period before December 31, 2026, should be used to address several practical items:
- Model the tax impact of 2026 deferred gain recognition for existing OZ 1.0 investors.
- Consider whether a fair market value discount study should be performed to analyze the lesser-of rule for the 2026 gain inclusion, particularly where QOF interests may have declined in value. A supportable valuation analysis may help quantify whether the amount included in income is limited by the lesser of the remaining deferred gain or the fair market value of the qualifying investment, reduced by the taxpayer's basis.
- Confirm investor communications clearly explain how 2026 gain inclusion interacts with the potential 10-year appreciation benefit.
- Review late-2026 gain events to determine whether the 180-day investment period may extend into 2027.
- Evaluate written working capital safe harbor plans and determine whether they should be updated before year-end.
- Document capital received and expenditures made by December 31, 2026, where projects intend to rely on the transition rule for post-2026 property acquisitions.
- Classify future capital expenditures as replacement, modernization, expansion, or new business activity.
- Maintain support for QOF and QOZB testing after the expiration of current OZ designations.
How CLA can help evaluate Qualified Opportunity Zone strategies
The guidance gives investors and project sponsors a clearer path from OZ 1.0 to OZ 2.0. It confirms new designation capacity for the next OZ cycle, preserves important long-term benefits for existing investors, and provides transition rules for ongoing projects and businesses located in previously designated zones.
Existing OZ projects remain part of the transition framework, and they will need careful documentation and planning as the program transitions. Investors should prepare for 2026 gain inclusion, while QOFs and QOZBs should review development plans, capital expenditure schedules, and compliance processes before year-end 2026.
The next several months are an important window to evaluate existing structures, communicate with investors, and prepare for the next phase of Opportunity Zone investment. CLA can help you evaluate the important decisions before year end and plan for Opportunity Zone strategies in the future.
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