Transitional Guidance on Qualified Opportunity Zones

Notice 2026-40 (Notice), released by the Department of the Treasury and the IRS on June 18, 2026, provides much-anticipated transitional guidance relating to Qualified Opportunity Zones (QOZ).

The QOZ program was created in 2017 under the Tax Cuts and Jobs Act (TCJA) and permanently extended under the One Big Beautiful Bill Act (OBBBA) in 2025. QOZ designations under the original TCJA program (“QOZ 1.0”) expire on December 31, 2028, whereas designations under the new OBBBA program (“QOZ 2.0”) begin on January 1, 2027. This creates a two-year overlap between the two programs. This, along with the remaining updates made by the OBBBA last year, created uncertainty in the tax community with respect to how the original QOZ 1.0 program continues to apply, during the overlap period, and after its expiration, as well as how the new QOZ 2.0 program should be implemented.

The Notice provides guidance and clarification by answering six specific questions, as detailed and grouped below.

Question #1 - QOZ Designations

The original statute provided that the number of designated QOZs may not exceed 25% of the total number of low-income community (LIC) population census tracts in the State. The OBBBA amended this to apply the 25% limitation to the number of QOZ designations made “during any period” (i.e., during the QOZ 2.0 10-year designation period – January 1, 2027, to December 31, 2036).

• QUESTION - Prior to this Notice, a question existed surrounding the overlap period from January 1, 2027, to December 31, 2028, where QOZ 1.0 and QOZ 2.0 zones will both be in effect. Do the existing zones get factored into the 25% limit of QOZ 2.0 designations?
• Notice Analysis - For purposes of applying the 25% limitation on the number of population census tracts in a State that may be designated as QOZs by the Secretary, the phrase “during any period” refers to the QOZ designation period beginning on the applicable start date and ending on the day before the date that is 10 years after the applicable start date during which an LIC is designated as a QOZ. For QOZ 2.0 programs, the applicable start date is January 1, 2027.
• ANSWER - The number of previously designated QOZs in a State will not affect the number of population census tracts that a State CEO may nominate to be designated as QOZs for the QOZ designation period beginning January 1, 2027.

Questions #2 and 3 - Potential to Continue to Defer QOZ 1.0 Gains

The QOZ statute provides that gain realized on or before December 31, 2026, and appropriately invested in a QOF on or before December 31, 2026, and which is deferred, must be included in the taxpayer’s gross income in the taxable year that includes the earlier of (i) the date on which an inclusion event occurs with respect to such qualifying investment (or portion thereof), or (ii) December 31, 2026.

• QUESTION - Prior to the Notice, a question existed about the potential to continue to defer previously deferred gain, which is recognized on December 31, 2026. Does the inclusion of such gain in income on December 31, 2026, allow a taxpayer to invest, within a 180-day period, such gain into a new QOF and continue to defer the gain and qualify for QOZ 2.0 benefits?
• Notice Analysis - Taxpayers that recognize deferred gain on December 31, 2026, continue to hold a qualifying investment for which an election under Internal Revenue Code §1400Z-2(a) remains in effect. As a result, the gain that is included in income on December 31, 2026, may not be deferred pursuant to either the prior statute or the changes under OBBBA because, as noted above, an election continues to be in effect with respect to the eligible gain that originally gave rise to the includible gain on December 31, 2026. Thus, no amount of such gain can be an eligible gain with respect to which a new deferral election may be made.
• ANSWER - Deferred gain recognized as taxable income as a result of the taxpayer holding that investment on December 31, 2026, is not eligible for further deferral under QOZ 1.0 or QOZ 2.0.

The Notice does state that a new deferral election may be made with respect to gain that is required to be included in taxable income due to an inclusion event (i.e., other than gain included as of December 31, 2026).

• QUESTION - Does the inclusion of deferred gain in income due to an inclusion event (i.e., gain recognized other than gain included as of December 31, 2026) allow a taxpayer to invest, within a 180-day period, such gain into a new QOF and continue to defer the gain and qualify for QOZ 2.0 benefits?
• Notice Analysis - Such inclusion event gain is treated as if it were realized upon the occurrence of the inclusion event rather than on the sale or exchange that gave rise to the original eligible gain to which the inclusion event relates. To the extent a taxpayer has an inclusion event with respect to any portion of a qualifying investment, that portion is no longer a qualifying investment, and the taxpayer is not eligible to make the 10-year FMV step-up election with respect to that portion of the qualifying investment.
• ANSWER - Inclusion event gain (i.e., gain recognized other than gain included as of December 31, 2026) may be deferred by making a qualifying investment within 180 days of the inclusion event date. A new deferral election may be made with respect to such gain, but the 10-year clock restarts. Likewise, to the extent the taxpayer continues to hold the portion of the old investment that had an inclusion event, such portion is no longer eligible for the 10-year FMV step-up benefit.

Question #4 - Ability to Invest in QOZ 2.0 with Pre-January 1, 2027, Gains

As a result of the OBBBA changes to the code, effective for amounts invested in QOFs after December 31, 2026, the taxable year of inclusion of deferred gain is that which includes the date that is 5 years after the date the qualifying investment was made. Likewise, if a qualifying investment is held for at least five years, a taxpayer’s basis in the qualifying investment increases by 10 percent (or 30 percent, in the case of any investment in a qualified rural opportunity fund).

• QUESTION - Prior to this Notice, a question existed as to whether pre-January 1, 2027, gains could be invested into QOZ 2.0 QOFs. Under existing law and the 180-day investment period, this seemed technically possible, but does the intent of the law allow for this?
• Notice Analysis – A taxpayer with eligible gain realized on, before, or after December 31, 2026, who timely invests a corresponding amount in a QOF on or after January 1, 2027, may elect to defer the recognition of that gain under the QOZ 2.0 program. As mentioned above, the deferred gain with respect to a qualifying investment made on or after January 1, 2027, must be included in gross income in the taxable year that includes the earliest of (i) the date on which such qualifying investment (or portion thereof) is sold or exchanged, (ii) the date on which an inclusion event other than a sale or exchange occurs with respect to such qualifying investment (or portion thereof), or (iii) five years from the date the qualifying investment was made.
• ANSWER – Pre-January 1, 2027, gains are eligible for investment under the QOZ 2.0 program as long as the investment is made after December 31, 2026, and all other requirements are met.

Question #5 - Acquisition of Property after December 31, 2026

The original statute provided that qualifying property purchased by a QOF or a QOZ Business needed to have been acquired by purchase after December 31, 2017. The OBBBA, which is effective for property acquired after December 31, 2026, requires that the property be purchased after the “applicable start date,” which is the January 1 following the date on which such QOZ was certified and designated as a QOZ. The Notice states that the concept of an applicable start date is only valid for QOZs designated after the date of the enactment of the OBBBA.

• QUESTION - As a result of the changes made by the OBBBA to the purchase requirement of qualifying tangible property, it is unclear whether property in zones designated under the QOZ 1.0 program is eligible to be purchased after December 31, 2026 (the effective date of this particular OBBBA provision). If the concept of an “applicable start date” only applies to QOZs designated after the enactment of the OBBBA, can property purchases after December 31, 2026, be made of property designated under QOZ 1.0 zones?
• Notice Analysis - A previously designated QOZ does not have an “applicable start date” because its designation took place before the date of enactment of OBBBA. Therefore, property acquired by a QOF or QOZ Business after December 31, 2026, cannot be QOZ Business Property unless (i) the property is acquired for use in a QOZ that is designated after July 4, 2025, or (ii) one of two exceptions applies:
  1. Working Capital Safe Harbor Plan Exception (Exception #1 – “Working Capital Exception”):
     • If an entity acquires property after December 31, 2026, for use in a QOZ 1.0 zone and pursuant to a written plan meeting the requirements of the working capital safe harbor rules, then that property may satisfy the purchase requirement if:
       • the working capital plan was adopted on or before December 31, 2026,
       • the relevant property acquisitions are made in a manner substantially consistent with that plan,
       • the QOZ Business has received at least 10% of the total estimated working capital assets designated in writing pursuant to the plan by December 31, 2026, and
       • the QOZ Business expends at least 5% of the total estimated working capital assets by December 31, 2026.
     • Amounts required to be expended by a QOZ Business pursuant to a binding agreement entered into prior to January 1, 2027, will be considered to be expended for purposes of the requirement to expend 5% of the total estimated working capital assets by December 31, 2026 (see above).
     • QOZ Stock and QOZ Partnership Interests also need to be acquired after an “applicable date,” which is with respect to any corporation or partnership that is a QOZ Business, the earliest applicable start date with respect to the QOZ Business Property held by such QOZ Business.
       • Stock or partnership interests acquired after December 31, 2026, pursuant to a written plan described above are treated as acquired after the “applicable date.”
  2. Tangible Property for Use in Ordinary Course of Business Exception (Exception #2 – “Ordinary Course Exception”):
     • Tangible property acquired after December 31, 2026, by a QOF or QOZ Business for use in the ordinary course of its trade or business in a QOZ 1.0 zone to replace existing tangible business property may be treated as QOZ Business Property if the general tangible property requirements are otherwise met (original use or substantial improvement, etc.).
     • Replacements in the ordinary course of a trade or business include the replacement or modernization of property necessary to continue the operations of the trade or business.
     • Replacements in the ordinary course of a trade or business do not include tangible property acquired pursuant to the expansion of a trade or business or the transition of a trade or business into a new trade or business.
• ANSWER - Property acquired after December 31, 2026 either needs to be in a zone that is designated as a QOZ 2.0 zone, or if relating to a QOZ 1.0 zone, needs to meet one of two exceptions: (1) Working Capital Exception, which requires (a) a working capital plan to be in place by December 31, 2026 relating to the acquisition of such property, (b) acquisitions are made consistent with the plan, (c) 10% of total working capital assets have been received by December 31, 2026, and (d) 5% of total working capital assets have been expended by December 31, 2026, or (2) Ordinary Course Exception, which requires that such tangible property acquired by a QOF or QOZ Business be for the replacement of existing tangible business property and for use in the ordinary course of its trade or business.

Note that QOF acquisitions of QOZ Business stock or partnership interests after December 31, 2026, within which property relates to QOZ 1.0 zones, appear to only qualify as good QOZ Business Property for the QOF (i.e., 90% test) if the underlying QOZ Business had a written plan in place regarding the need for such cash.

The Notice provides the following five examples describing the application of the Working Capital and Ordinary Course Exceptions mentioned above:

• Example #1 – Property fails to meet Working Capital Exception and Ordinary Course Exception

A manufacturer in a QOZ 1.0 designated zone buys an adjacent warehouse in 2028 to expand capacity for a new product. The zone does not have a QOZ 2.0 designation, there is no written plan, and the purchase is an expansion, so it fails the general rule and both the Working Capital and Ordinary Course exceptions. Therefore, it is not QOZ Business Property.

• Examples #2 and #3 - Property meets Ordinary Course Exception

An apartment building in a QOZ 1.0 zone requires window replacements and the purchase of replacement appliances, fixtures, cabinetry, flooring, and similar tangible property as units turn over. Separately, a restaurant in a QOZ 1.0 zone renovates and modernizes its kitchen to maintain operations. Both are ordinary-course replacements that qualify as QOZ Business Property. Therefore, in both instances, the Ordinary Course Exception is satisfied.

Example #4 - Property meets Working Capital Exception

A QOF funds a C corporation to build a $50 million mixed-use real estate development under a 55-month master written plan adopted in 2024. The fund invests $30 million in 2024 for the commercial phase (completed in 2026) and invests additional cash in December 2026 for the residential phase that begins in 2027. The development is not located in a QOZ 2.0 tract. However, because the acquisitions of tangible property follow the pre-2026 plan, and therefore the Working Capital Exception, the property may qualify as QOZ Business Property if the ongoing acquisitions are made in a manner substantially consistent with the plan.

• Example #5 - Property meets Working Capital Exception - QOZ Business stock acquired after December 31, 2026

On the same facts as above, the residential phase runs over budget in late 2027 and needs more capital to finish, including a pool that was part of the original 2024 written plan. In December 2027, the QOF acquires additional stock of the C corporation in exchange for cash. The residential real property may qualify as QOZ Business Property, assuming all other requirements are met. Likewise, because the additional stock was acquired in exchange for cash needed to complete development of the project, including the acquisition of property qualifying under the Working Capital Exception, it may be treated as having been acquired after the applicable date (January 1, 2027) pursuant to the special rule for acquisitions of stock or partnership interests after December 31, 2026, relating to QOZ 1.0 property.

Question #6 - Compliance Matters

The QOZ statute includes various requirements, the satisfaction of which are dependent on whether property owned by a QOF or QOZ Business is located in a QOZ. Notwithstanding that zones inevitably expire, the code also provides that the ability to make an election for the 10-year FMV step-up for qualifying investments is not impaired solely because the designation of one or more QOZs ceases to be in effect.

• QUESTION - There is uncertainty about how the various compliance tests will be met when zones cease to be QOZs. If the QOZ 1.0 zones expire at the end of December 31, 2028, without being redesignated, will the various compliance tests fail as a result?
• Notice Analysis - The Treasury Department and the IRS expect that forthcoming proposed regulations will include the following safe harbors for QOFs and QOZBs to continue to satisfy the compliance requirements after the expiration of a QOZ’s 1.0 designation period.
  • Substantial Use in a QOZ for Substantially All of Holding Period

For tangible property to qualify as QOZ Business Property, substantially all of the use of that property must be in a QOZ for substantially all of the entity’s holding period for such property. If property otherwise qualifies as QOZ Business Property, a QOF or QOZB that acquires that property on or before the expiration of its QOZ designation period (December 31, 2027, or December 31, 2028, as applicable), or pursuant to Exception #1 or #2 of the Notice, may continue to treat a QOZ 1.0 zone, the designation of which has expired, as a QOZ solely for purposes of this substantial use in a QOZ for substantially all of holding period requirement through December 31, 2047.

• • 50% Gross Income and 40% Intangible Property Tests

For an entity to qualify as a QOZB, at least 50% of its gross income must be derived from the active conduct of a trade or business in a QOZ, and 40% of its intangible property must be used in the active conduct of a trade or business in a QOZ. A QOZB that has begun to engage in the active conduct of a trade or business within a QOZ 1.0 zone on or before the expiration of its QOZ designation period (December 31, 2027, or December 31, 2028, as applicable), or that reasonably anticipates to begin doing so in accordance with a written plan that meets the requirements of Exception #1 of the Notice, may continue to treat a QOZ 1.0 zone, the designation of which has expired, as a QOZ solely for the purposes of these 50% and 40% tests through December 31, 2047

• ANSWER – The Treasury Department and IRS anticipate issuing regulations that will provide safe harbors that will allow taxpayers to treat expired QOZ designations as valid for purposes of certain compliance tests.

The Notice states that the Treasury Department and the IRS anticipate that forthcoming proposed regulations, which will incorporate the guidance provided in the Notice, will propose that the final regulations, once published in the Federal Register, would apply to taxable years ending after the date the Notice is issued to the public.