Program Made Permanent with Decennial Redesignation

The QOZ program is being made permanent while introducing a decennial redesignation process beginning July 1, 2026. Unlike the original program where states made one-time designations based on 2010 census data, QOZs must now be re-evaluated every 10 years using current economic conditions.

Practitioner Impact: July 1, 2026 provides investors with 6 months advance notice before the January 1, 2027 effective date, eliminating the potential “dead zone” where QOF managers may be fundraising without knowing zone designations.

Qualified Rural Opportunity Funds (QROFs) with Enhanced Benefits

The OBBBA creates a new category called Qualified Rural Opportunity Funds (QROFs) for funds holding at least 90% of assets in qualified opportunity zone property located entirely within rural-designated QOZs. Rural areas are defined as locations with populations under 50,000 that are not adjacent to urbanized areas with populations in excess of 50,000.

Enhanced Tax Benefits for QROFs:

• 30% basis step-up for investments held at least five years (triple the standard 10% increase)
• Lower “substantial improvement” test requiring only 50% of adjusted basis (rather than 100%)
• Easier qualification for rehabilitation projects in rural areas

Tightened Eligibility Criteria

The legislation lowers the QOZ designation criteria for the “low-income community” designation from 80% of area or statewide median income to 70%. Additionally, the provision allowing governors to designate contiguous census tracts as QOZs has been eliminated. Designated tracts must meet stricter standards with either median family income below 70% of state or metro median, or a poverty rate of at least 20% combined with income below 125% of the median.

Comprehensive QOF Reporting Requirements and Penalties

The OBBBA introduces the most substantial compliance changes since the program’s inception. The new §6039K and §6039L establish detailed fund reporting regimes, while §6726 creates new penalty provisions.

QOF Reporting Requirements Include:

• Name, address, and tax identification of QOZ businesses
• NAICS classification of business activities
• Information about residential units and employee counts
• Value of total assets, QOZ property values, and census tract investments

Penalty Structure:

• $10,000 for small QOFs, up to $50,000 for QOFs with gross assets exceeding $10 million
• $2,500 per day for intentional disregard, with caps of $50,000 for small funds and $250,000 for large funds

Simplified Rolling Five-Year Deferral System

The legislation restructures the deferral system for Opportunity Zone investments made on or after January 1, 2027. Unlike the original program’s fixed sunset dates, the new system provides a rolling five-year deferral for each investment.

Key Features:

• Each qualifying gain invested after December 31, 2026 receives its own five-year deferral period
• Standard QOF investors receive a flat 10% basis step-up after holding the investment for five years
• QROF investors receive a 30% basis step-up after five years
• Recognition occurs at the earlier of (a) disposition of the QOF investment or (b) five years after the investment date
• The 10-year holding period for fair market value step-up remains available for complete exclusion of appreciation

Example of Corrected Gain Deferral and Basis Step-Up:

Nick sells stock in March 2027 with a $1,000,000 gain. He invests the full $1,000,000 into a standard Qualified Opportunity Fund (QOF) in April 2027. He holds the QOF investment for 7 years, selling in April 2034. During this time, Nick’s investment appreciates to $1.8 million.

Step-Up on Deferred Gain Portion

Tax Consequences in 2032:

• Nick receives a 10% basis step-up after 5 years (April 2032)
• Total basis increase on deferred gain = $100,000 (10% of $1,000,000)
• Nick recognizes his deferred gain minus basis step-up: $1,000,000 − $100,000 = $900,000 taxable deferred gain in 2032, five years after the investment date.

Tax Consequences on Sale in 2034:

• The appreciation on his QOF investment is $800,000 ($1.8M − $1M).
• Because Nick held the QOF investment for only 7 years (less than 10 years), he does NOT qualify for the fair market value step-up election, so the $800,000 appreciation is taxable as capital gain.
• If Nick had held his QOF investment for 10 years (instead of 7 years) he would have saved approximately $190,000 of federal tax.