The Qualified Opportunity Zone (QOZ) program remains one of the most powerful tax-advantaged investment strategies available for taxpayers with capital gains. Recent legislative changes have permanently extended the Opportunity Zone program while introducing significant modifications that affect investors, Qualified Opportunity Funds (QOFs), and Qualified Opportunity Zone Businesses (QOZBs).

To help taxpayers navigate the transition from the original Opportunity Zone framework to the new permanent program, the IRS recently issued transitional guidance through Notice 2026-40. Understanding these changes is critical for investors seeking to maximize tax benefits and avoid costly surprises.

What Is a Qualified Opportunity Zone?

Created under the Tax Cuts and Jobs Act (TCJA), the Qualified Opportunity Zone program was designed to encourage investment in economically distressed communities across the United States.

The program allows taxpayers to defer taxable capital gains by reinvesting those gains into a Qualified Opportunity Fund within 180 days of the sale. QOFs then invest in qualifying Opportunity Zone assets, including Qualified Opportunity Zone Businesses and eligible commercial real estate projects located in designated zones.

For many investors, Opportunity Zones have offered three primary tax advantages:

• Deferral of eligible capital gains
• Potential reduction of deferred gain through basis step-ups
• Tax-free appreciation on qualifying investments held long term

How the Original Opportunity Zone Program Works

For investments made under the original Opportunity Zone rules:

• Capital gains can generally be deferred until the earlier of an inclusion event (such as a sale) or December 31, 2026.
• Investors receive a 10% basis step-up after five years.
• A 15% basis step-up applies after seven years.
• Appreciation on the Opportunity Zone investment may be excluded from federal capital gains tax if the investment is held for at least 10 years.

As the December 31, 2026, deferred gain recognition date approaches, many investors are evaluating their existing QOF positions and long-term tax planning strategies.

The Permanent Opportunity Zone Program Begins in 2027

The One Big Beautiful Bill Act (OBBBA) established a permanent Opportunity Zone framework with rolling 10-year designations, ensuring the program’s future while modifying several key tax incentives.

New Opportunity Zones will become eligible for investment beginning January 1, 2027, with approximately 6,500 zones expected to be designated nationwide. The original Opportunity Zone designations generally expire on December 31, 2028.

Key Changes Under the New Program

The permanent framework retains several attractive benefits while adjusting others:

Capital Gain Deferral Continues Eligible gains can still be deferred through investment in a Qualified Opportunity Fund.

Five-Year Basis Step-Up Remains Investors can still receive a 10% basis increase after a five-year holding period.

Seven-Year Step-Up Eliminated The additional 5% basis increase previously available after seven years has been removed.

Deferred Gain Recognition Accelerated Unlike the original program, deferred gains generally become taxable once the five-year holding period is reached.

Long-Term Gain Exclusion Preserved The ability to exclude appreciation on the Opportunity Zone investment itself remains available after a 10-year holding period and can continue for up to 30 years.

Additional Benefits for Rural Opportunity Zones The legislation creates enhanced incentives for qualifying rural Opportunity Zone investments, including a 30% basis step-up after five years.

IRS Notice 2026-40: Transitional Guidance Investors Should Understand

The IRS recently addressed several critical transition issues for existing and future Opportunity Zone investors.

Existing QOF Investments Cannot Be Re-Deferred

Investors holding qualifying QOF investments on December 31, 2026, must recognize any remaining deferred gain in the tax year that includes that date.

Importantly, those gains generally cannot be rolled into a new Qualified Opportunity Fund to create another period of deferral.

Existing Investors Can Still Benefit from Long-Term Appreciation Exclusion

Although deferred gains become taxable in 2026, investors may continue to hold their QOF interests.

Once the required 10-year holding period has been satisfied and other requirements are met, investors may elect to increase their basis to fair market value when the investment is sold. This can eliminate tax on appreciation occurring after the original investment date.

Inclusion Events Receive Different Treatment

The guidance distinguishes between:

• Deferred gains recognized on December 31, 2026, and
• Gains triggered by an earlier inclusion event.

If an inclusion event occurs before December 31, 2026, taxpayers may be able to defer recognized gain again by making another qualifying QOF investment within 180 days.

However, the 10-year holding period for future gain exclusion begins anew with the replacement investment.

Important Rules for Property Acquired After 2026

Notice 2026-40 also addresses how QOFs and QOZBs can continue operating in existing Opportunity Zones after the transition to the new program.

Generally, tangible property acquired after December 31, 2026, will not qualify as Opportunity Zone business property unless it is located in a newly designated Opportunity Zone under the permanent framework.

However, the IRS created two important exceptions:

1. Working Capital Safe Harbor

Property may continue to qualify if:

• A written working capital plan was adopted before December 31, 2026
• At least 10% of planned working capital assets were received before year-end 2026
• At least 5% was spent before December 31, 2026

2. Ordinary Course of Business Replacement Exception

Property acquired after 2026 may qualify when used to replace or modernize existing business property in an original Opportunity Zone.

Examples may include:

• Equipment replacements
• Facility modernization projects
• Necessary operational upgrades

This exception generally does not apply to business expansion projects or entirely new business activities.

Planning Opportunities Before the 2026 Deadline

With major Opportunity Zone deadlines approaching, investors, fund managers, and business owners should begin evaluating their positions now.

Key considerations include:

• Reviewing existing QOF investments before deferred gains become taxable
• Assessing eligibility for continued Opportunity Zone benefits
• Evaluating pending development projects in existing zones
• Determining whether working capital safe harbor requirements will be satisfied
• Exploring opportunities within newly designated Opportunity Zones beginning in 2027
• Considering enhanced incentives available for rural Opportunity Zone investments

Final Thoughts

The Opportunity Zone program remains a valuable tax planning and investment tool, but recent legislation and IRS guidance have changed several important rules. Investors who understand the transition from the original program to the permanent framework may be better positioned to preserve tax benefits and identify new opportunities.

Because these rules are complex and continue to evolve, taxpayers should work closely with a qualified tax advisor before making investment, reinvestment, or disposition decisions involving Opportunity Zone assets.

This blog post is for informational purposes only and does not constitute tax, accounting, or legal advice. Laws and regulations are subject to change, and the information provided may not apply to all situations. Consult a qualified professional for guidance specific to your circumstances.

Contact TRP Sumner PLLC

Questions about Qualified Opportunity Zones, Qualified Opportunity Funds, or IRS Notice 2026-40? Contact TRP Sumner to discuss how these changes may affect your tax strategy and investment plans.