The Opportunity Zone regime, originally established in 2017, has been permanently extended by Public Law 119-21, "An Act to provide for reconciliation pursuant to Title II of H. Con Res. 14" (the "2025 Tax Law"). The extension addresses many of the criticisms of the original bill. The new rules create stable incentives for development in economically disadvantaged areas, with special incentives for rural projects. After reviewing the current Opportunity Zone rules, with a focus on the provisions that will remain in effect in the future, this Alert discusses the new incentives and new reporting requirements, and identifies some opportunities for new projects and challenges for existing projects.
Summary of Changes in OZ Program
- OZ benefits are now permanent.
- New zones are designated once every decade, with tougher standards for qualification. At least 25 percent of census tracts designated for OZ benefits in each state or territory must be rural.
- Gain invested into a Qualified Opportunity Fund ("QOF") is deferred for up to five years.
- Deferred gain is reduced by 10 percent (30 percent in the case of a rural QOF) if the QOF investment is held for at least five years.
- Existing rural QOF properties require a lower level of improvement to be qualified opportunity zone property.
- QOFs have new reporting obligations relating to project economic impact.
Summary of Current Rules
Tax Benefits
The Opportunity Zone regime was intended to encourage private-sector development of economically depressed areas. To do so, it has three main tax incentives:
- Deferral of gain invested in a Qualified Opportunity Fund ("QOF");
- Reduction in amount of deferred gain recognized if a QOF is held for a sufficient period; and
- Exclusion of gain on disposition of a Qualified Opportunity Fund or the QOF’s assets after a 10-year holding period in the QOF.
Under the original statute, the first two incentives were time-limited: Gain was deferred until the earlier of disposition of the QOF or December 31, 2026, and the reduction in gain deferred only applied if the holding period was a minimum of 5 years. This meant that the later a person invested in a QOF, the lower the benefits. These rules remain in effect for investments made through the end of 2026.
Qualified Opportunity Funds
For an entity to be a Qualified Opportunity Fund, it must make a timely election on its tax return and at least 90 percent of its assets must be "qualified opportunity zone business property." This includes (1) property used in a trade or business within a qualified opportunity zone and (2) interests in corporations and partnerships that are engaged in the active conduct of a trade or business in an opportunity zone, substantially all of the tangible assets of which are in an opportunity zone, and that satisfy other requirements.
Designation of Original Opportunity Zones
Under the original statute, qualified opportunity zones ("QOZs") were designated in 2017, effective for investment after December 31, 2017. In order to be nominated as a QOZ, a census tract needed to either (1) qualify as a "low-income community" or (2) be adjacent to a census tract that qualified as a "low-income community" and have a median family income no greater than 125 percent of that adjacent census tract. A census tract was a "low-income community" if either (1) it had a median family income no greater than 80 percent of median family income of the applicable metropolitan area (if it was within a metropolitan area) or of the state (if outside a metropolitan area) or (2) it had a poverty rate of at least 20 percent. Census tracts were nominated as QOZs by the governor or chief executive of the state or territory and then approved by the Treasury Department, except that all census tracts in Puerto Rico that were low-income communities automatically qualified as QOZs.
New Rules
New Opportunity Zone Designations
Designation Process
New Opportunity Zones will be designated on July 1, 2026, and each 10-year anniversary thereafter. Each designation will take effect on January 1 of the year following the designation, and will remain in effect until the day before the next set of designations takes effect. The first set of designations under the new law will take effect January 1, 2027, and remain in effect through December 31, 2036. Assuming a census tract satisfies the low-income community requirements set forth below at the time of redesignation, it could be redesignated after its initial designation. As before, census tracts will be nominated by the governor or other chief executive of the applicable state or territory and approved by the Treasury Department.
The total number of census tracts that may be designated by any state or territory cannot exceed the greater of 25 percent of the total low-income communities in the state or 25 low-income communities. The special rule designating every low-income community in Puerto Rico as an opportunity zone was repealed, so Puerto Rico will be subject to the same limitation as the rest of the United States.
Qualification Criteria
Different rules apply to census tracts in metropolitan areas and those outside metropolitan areas.
A census tract in a metropolitan area qualifies as a "low-income community" if either:
- Median family income in the census tract does not exceed 70 percent of the metropolitan area median family income, or
- The poverty rate in the census tract is at least 20 percent and median family income in the census tract does not exceed 125 percent of the metropolitan area median family income.
A census tract that is not in a metropolitan area qualifies as a "low-income community" if either:
- Median family income in the census tract does not exceed 70 percent of the statewide median family income, or
- The poverty rate in the census tract is at least 20 percent and median family income in the census tract does not exceed 125 percent of the statewide median family income.
Census tracts adjacent to low-income communities no longer are eligible for designation as opportunity zones.
These requirements collectively address one of the significant criticisms of the original Opportunity Zone legislation, namely that the designation process did not adequately target low-income areas but instead resulted in incentives for areas that would have been redeveloped even in the absence of incentives.
Incentives for New Investment
The Opportunity Zone regime has three main tax incentives:
- Deferral of gain invested in a Qualified Opportunity Fund ("QOF");
- Reduction in amount of deferred gain recognized if a QOF is held for a sufficient period; and
- Exclusion of gain on disposition of a Qualified Opportunity Fund or the QOF’s assets after a 10-year holding period in the QOF.
Under the original statute, the first two incentives were time-limited: Gain was deferred until the earlier of disposition of the QOF or December 31, 2026, and the reduction in gain deferred only applied if the holding period was a minimum of five years. This meant that the later a person invested in a QOF, the shorter the deferral, and any QOF investments after December 31, 2021, were not eligible for the reduction in gain – making later investments less financially attractive than earlier investments.
The new statute addresses this limitation two ways, for investments in QOFs made on or after January 1, 2027:
- Gain on any amounts invested in a QOF are deferred until the earlier of the fifth anniversary of the date of the investment or the date of disposition of interests in the QOF.
- Gain is equal to the difference between (a) the lesser of the amount of deferred gain invested in the QOF and the fair market value of the interest in the QOF and (b) the basis in the QOF. Initial basis in the QOF is zero, but that basis is increased by 10 percent of the deferred gain if the investment is held for at least five years prior to the gain recognition date (30 percent in the case of a "Qualified Rural Opportunity Fund").
Qualified Rural Opportunity Funds
"Qualified Rural Opportunity Fund" (QROF) is a new concept. A QOF is a QROF if at least 90 percent of its assets are either:
- QOZ business property substantially all of the use of which is in a QOZ comprised entirely of a rural area or
- Interests in an entity that qualifies as a QOZB and substantially all of the tangible assets owned or leased by which are used in the active conduct of a trade or business in a qualified opportunity zone comprised entirely of a rural area.
A rural area means any area other than a city or town with a population greater than 50,000, or any area contiguous and adjacent to such a city or town. The statute does not define "contiguous" but presumably suburbs and exurbs of a city would be deemed "contiguous and adjacent" to the city.
QROFs that acquire existing properties have a lower standard to qualify those properties as QOZ business property. Under the general rules, a building that was in service prior to acquisition by a QOF or QOZB qualifies as QOZ business property if the QOF or QOZB invests an amount in improvements at least equal to the adjusted basis of the building. QROFs only need to invest 50 percent of the adjusted basis of the building to qualify. In other words, if a building were purchased for $10 million, a QROF would need to invest only a further $5 million to make it QOZ business property, while a non-rural entity would need to invest a further $10 million.
Information Reporting
The new rules require QOFs to provide a significant amount of information with their annual returns, beyond merely reporting on value of qualified opportunity zone property relative to value of all property held by the QOF. Among other things, this includes:
- Identification of the QOZ in which the QOF (or subsidiary) operates
- The nature of the business of the QOF (or subsidiary)
- The value of all property owned or leased by the QOF or subsidiary entity, identification of items that are owned vs. items that are leased, and identification of which assets are within vs. outside QOZs
- If the QOF holds any real property (or is invested in an entity that holds any real property), the approximate number of residential units held
- The approximate number of full-time equivalent employees of the QOF and entities in which the QOF invests, or other indications of employment impact as may be determined by the Treasury Department
The list is non-exclusive; the statute grants clear authority for Treasury to request other information. Failure to comply with disclosure requirements carries serious penalties. Importantly, these reporting requirements will apply to all QOFs beginning in 2026, not just QOFs established under the new rules.
The information gathered under these rules will be compiled and published on an aggregate basis by the Treasury Department. Some of the data will be published on a census tract by census tract basis, allowing for more detailed analysis and media reporting on the Opportunity Zone program.
Observation
Investment timing is less critical. The rolling five-year gain deferral period takes pressure off investment at the start of the decennial cycle. For example, if a project isn’t ready to take investment until 2030, the investor benefits would be the same as a project ready for investment in 2027, in each case as long as the investor held the QOF and the QOF retained its investment in the project for at least five years from the date of the investment.
Rural projects receive additional incentives. The potential 30 percent reduction in capital gains for a rural project and the reduced standard for "substantial improvement" can significantly increase the economic return on a rural project. This may make rural OZ projects more attractive, especially when combined with other rural incentives, such as the EB-5 program preference for rural programs. As a practical matter, particularly in light of the other incentives discussed below, the most attractive rural opportunity zone projects at first are likely to be manufacturing and agricultural production facilities.
Program benefits can be combined with other incentives. The 2025 Tax Law includes other incentives for new project development that can be combined with the general OZ incentives. For example, a project can fully expense certain assets and then, if the project is sold after a decade, the gain would not be subject to recapture income. This benefit is most pronounced with certain manufacturing and production property on which construction is commenced before 2029 and that is placed in service before 2031, where even the building may be fully expensed. Given that commercial buildings are normally expensed over 39 years, this represents a significant tax benefit. As such, potential opportunity zone based manufacturing businesses have a significant incentive to begin fundraising and, if necessary, obtaining required zoning and permitting, soon so that construction commences before 2029 and they are placed in service before the 2031 deadline.