The New Rules for Qualified Opportunity Zones

The Qualified Opportunity Zone (QOZ) program is undergoing significant changes, primarily driven by proposed legislation like the “One Big Beautiful Bill Act” (OBBBA) in the US Congress. While some details may vary between the House and Senate versions, here’s a summary of the key new rules and proposed changes:

1. Permanence and Re-designation of Zones:

• Permanent Program: The QOZ program is expected to become a permanent fixture, eliminating the previous sunset date for new investments (originally December 31, 2026).
• Decennial Re-designation: New QOZs will be designated every 10 years, starting July 1, 2026, with effective dates for investments beginning January 1, 2027. This means states will propose new zones, and the Treasury Secretary will certify them, ensuring the program continues to target areas of need.
• Stricter Eligibility: The criteria for designating “low-income communities” are becoming stricter. The median family income threshold for a tract to qualify is expected to drop from 80% to 70% of the area or statewide median. The provision allowing contiguous non-low-income tracts to be designated is also likely to be eliminated.

1. Investment Deferral and Basis Step-Up:

• Extended Deferral: For investments made after December 31, 2026, the deferral of capital gains tax will be extended, with a rolling five-year deferral period. This means the deferral will no longer be tied to a fixed date like December 31, 2026, but will be five years from the date of investment.
• New Basis Step-Up Schedule: The current 10% basis step-up after five years and 15% after seven years will be revised. For investments made after December 31, 2026, a 10% basis step-up will be available after five years.
• Ordinary Income Investments: A significant new allowance is the deferral of up to $10,000 of ordinary income invested in a Qualified Opportunity Fund (QOF) after December 31, 2026.

1. Emphasis on Rural Zones:

• Rural QOZ Set-Aside: A notable change is the push to designate more rural QOZs. At least 33% of new QOZs are expected to be in rural areas.
• Enhanced Rural Benefits: Investments in “Qualified Rural Opportunity Funds” (QROFs) will receive additional incentives:
• Increased Basis Step-Up: A 30% basis step-up will be available for qualified rural investments held for at least five years, significantly higher than the 10% for other QOZ investments.
• Reduced Substantial Improvement Requirement: For rural projects, the “substantial improvement” requirement (which generally means investing at least 100% of the building’s adjusted basis into improvements) will be reduced to 50%, making it easier to rehabilitate existing properties.
• Definition of Rural: Rural QOZs are generally defined as areas outside cities or towns with populations over 50,000 and not adjacent to urbanized areas.

1. Increased Reporting and Penalties:

• Expansive Reporting Requirements: Both Qualified Opportunity Funds (QOFs) and Qualified Opportunity Zone Businesses (QOZBs) will face significantly increased reporting requirements. This includes details like the average number of full-time equivalent employees, NAICS codes, and information on residential units.
• Non-Compliance Penalties: Stiff penalties for non-compliance are being introduced, potentially up to $50,000 for larger QOFs, with higher fines for intentional disregard of reporting requirements. All reports must be filed electronically.

1. Other Important Changes:

• Elimination of 2047 Cliff Date (for new investments): For qualifying investments in QOFs made on or after January 1, 2027, the previous December 31, 2047, deadline for selling the investment to achieve the tax-free gain benefit is eliminated. Investors will have the option to step up their basis to fair market value after 30 years.
• No Forced Exit from OZ Investment: This means investors who hold their QOZ investment for over ten years will not be forced to sell by a certain date to realize the tax-free gain on appreciation for investments made after December 31, 2026.
  It’s important to note that while these changes are largely expected to be enacted, specific details and effective dates can still be subject to legislative finalization. Investors and fund managers should stay informed about the precise language of the enacted legislation to ensure compliance and maximize benefits.