Executive Summary

The One Big Beautiful Buildings Act (OBBBA) has enacted a comprehensive overhaul of the federal Qualified Opportunity Zone (QOZ) incentive program – “QOZ 2.0”, while not extended the QOZ 1.0 Program.

Anchored by the Senate version of the OBBBA, the legislation renews the government’s commitment to channeling long-term capital into economically distressed communities. The legislation includes significant structural reforms designed to ensure geographic equity, promote renewed rural development, strengthen compliance, and refine investor incentives, while transitioning the program from a sunset-driven mechanism into a permanent component of the Internal Revenue Code (“IRC”).

Background: The Evolution of Opportunity Zones

Enacted under the 2017 Tax Cuts and Jobs Act, the original Opportunity Zone program (“QOZ 1.0”) offered taxpayers the ability to defer, reduce, or eliminate capital gains tax liabilities by reinvesting those gains into designated Qualified Opportunity Funds (“QOFs”) located in low-income census tracts. While the incentive succeeded in catalyzing investment activity, it also faced criticism for a lack of transparency, overly generous tract designations in certain situations, and underperformance in the most distressed communities.

The QOZ 2.0 under the OBBBA aims to address these shortcomings and extend the benefits of the program indefinitely into the next generation of community and economic development policy.

Notably, it introduces a second round of Opportunity Zone designations for the 2027–2033 period, improves eligibility criteria, enhances tax incentives, and imposes robust reporting requirements.

Key Reforms to QOZ 2.0 Under the OBBBA

Permanent and Renewable Program Design

• The proposal makes the QOZ program a permanent fixture of the IRC, moving away from its previous time-limited framework.
• Redesignation of QOZs will occur on a decennial basis, beginning July 1, 2026, with new zones taking effect on January 1, 2027. This shift ensures that designated tracts reflect current economic realities, rather than outdated 2010 census data.

Stricter Census Tract Eligibility Requirements

• The OBBBA proposal tightens the eligibility thresholds for QOZ designation:
  • Census tracts must have median family income below 70% (down from 80%) of the state or metro area average.
  • A poverty rate of at least 20%, in combination with income below 125% of the area median, is also required.
  • The “contiguous tract rule” which previously allowed adjacent higher-income tracts to qualify, is being repealed.
• Puerto Rico’s special status allowing broader designations is removed.

Enhanced Incentives for Rural Development

• The QOZ 2.0 introduces Qualified Rural Opportunity Funds (QROFs) – vehicles designed to direct investment specifically into underserved rural areas.
  • QROFs will benefit from a 30% basis step-up for investments held for five years, compared to the 10% available to standard QOFs.
  • The substantial improvement test for property is reduced from 100% to 50% in rural zones.
  • Rural QOFs must invest 90% of assets in rural-designated tracts.

Updated Tax Incentives and Deferral Mechanics

Deferral of Capital Gains

• Capital gains invested in a QOF after January 1, 2027, are eligible for deferral until the earlier of disposition or the fifth anniversary of the investment date.
• This deferral for new investments will be on a rolling basis.
• Any investments in QOZs made before December 31, 2026 will be subject to the old QOZ 1.0 rules and not those under the OBBBA.

Step-Up in Basis

• Investors receive a gradual basis increase over six years, totaling 10%:
  • 1% per year for the first three years, 2% for the next two years, and 3% in the sixth year.
• For rural investments, the enhanced step-up can reach 30% under similar proportional phasing.
• Gains on QOF investments held for at least 10 years are excluded from taxation upon sale.
• Under a new approach, for investments held 30 years or longer, the basis is stepped up to fair market value, eliminating tax on appreciation up to that point.

Structural and Compliance Improvements

Strengthened Reporting and Oversight

• Under QOZ 2.0, new mandatory electronic reporting is imposed on QOFs and QOZ businesses (QOZBs), including disclosures on:
  • Asset locations
  • Economic sectors
  • Employment and housing impacts
• Penalties for non-compliance may reach up to $50,000, with higher fines for willful violations.
• The IRS is allocated $15 million to implement and enforce these provisions.

Clarifications and Limitations

• Interim gains (from property sold before the 10-year mark) are not automatically deferred unless reinvested into a new QOF.
• The bill does not include a “fund of funds” mechanism or special rules for reinvestment of gains during the holding period.
• QOZ 2.0 of the Senate version excludes certain proposals from the House version, including:
  • Allowing modest after-tax ordinary income investments (capped at $10,000)
  • Special provisions for affordable housing or workforce housing development
  • Expanded eligibility for operating businesses

Strategic Implications for Investors

Investors considering participation in the next phase of the QOZ program should take note of the following:

• Timing. Investments made after the current program’s expiration on December 31, 2026 will benefit from new designation rules and potentially better-structured incentives, but investors must ensure liquidity to meet 2026 tax obligations from investments under QOZ 1.0.
• Geographic Shifting. New designations will emphasize more distressed and rural communities, intentionally changing where capital will flow.
• Longer Horizons. The new incentive structure favors investors with longer-term commitments, particularly those targeting 10- to 30-year holds.
• Due Diligence & Compliance. Enhanced complexity, combined with new reporting rules, means investors must carefully vet and select QOF managers and tax advisors.

Conclusion

The proposed QOZ 2.0 reforms under the OBBBA represent a thoughtful recalibration of the QOZ 1.0 statutory framework.  By sharpening eligibility criteria, prioritizing economically distressed and rural communities, enhancing tax benefits for long-term investments, and imposing rigorous reporting/oversight, the legislation aims to strike a balance between investor incentive and community impact.

While many technical details remain to be finalized, the legislative trajectory points toward a more targeted, transparent, and sustainable Opportunity Zone framework in the years ahead.

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