The Qualified Opportunity Zone (QOZ) program provides tax incentives—including capital gains deferral and potential elimination—to investors who reinvest gains into designated low-income communities across the United States. Recent tax law changes have made the program permanent and significantly altered its structure, creating important implications for both existing and prospective investors in Qualified Opportunity Funds (QOFs).
With proposed regulations on the way, the IRS has released transitional guidance via IRS Notice 2026-40 for investors, QOFs, and Qualified Opportunity Zone businesses (QOZBs). Here's what you need to know.
The Qualified Opportunity Zone program is a federal tax incentive program that allows investors to defer, reduce, or eliminate capital gains taxes by reinvesting eligible gains into a Qualified Opportunity Fund within 180 days. The program was created by the Tax Cuts and Jobs Act (TCJA) to stimulate economic development in designated low-income communities.
QOFs must maintain at least 90% of their assets in QOZ property. Qualifying investments include those in QOZBs and in new or substantially improved commercial buildings located within QOZs.
The One Big Beautiful Bill Act (OBBBA) established a permanent QOZ program, replacing the original time-limited structure with rolling 10-year designations. The first round of newly designated zones eligible for investment begins January 1, 2027, with approximately 6,500 new zones expected. Original QOZ designations generally expire on December 31, 2028.
The permanent program retains some benefits but eliminates others:
The permanent program is better suited for investors with long time horizons who can commit to a 10-year hold, while the original program was more advantageous for those seeking the seven-year step-up that has since been removed.
IRS Notice 2026-40 is the IRS's transitional guidance addressing key issues for investors, QOFs, and QOZBs navigating the transition from the original program to the permanent one. The guidance covers three primary areas.
Investors who hold a qualifying QOF investment through December 31, 2026, must include the remaining rollover gain in their income for the tax year that includes that date. Importantly, they cannot defer that gain by rolling it into a new QOF.
However, existing QOF investors may choose to continue holding their investments. If an investor reaches the 10-year holding period and meets certain requirements, they can elect to adjust their basis at sale or disposition to the investment's fair market value at that time—effectively eliminating taxable gains accrued after the date of the original investment.
The treatment of inclusion event gains differs depending on timing:
Under the OBBBA, property acquired by a QOF or QOZB after December 31, 2026, generally cannot be treated as QOZB property unless it is acquired for use in a QOZ designated after July 4, 2025. This means tangible property acquired after 2026 generally does not qualify as QOZB property if it is located in one of the originally designated QOZs.
IRS Notice 2026-40 outlines two exceptions:
Working Capital Safe Harbor
This exception applies if:
Ordinary Course of Business Exception
This exception applies when a QOF or QOZB acquires tangible property in an existing QOZ, in the ordinary course of business, to replace existing tangible business property—provided other requirements are met. Covered replacements include the replacement or modernization of property necessary for the business. Property acquired to expand a business or transition to a new business does not qualify.
QOZBs and QOFs active in existing QOZs should confirm they can satisfy one of these two exceptions before the end of 2026.
The IRS guidance also provides transitional rules—including safe harbors—for how QOFs and QOZBs can continue to treat a location as if it were in a QOZ after an existing designation expires.
Q: Can I still defer capital gains by investing in a Qualified Opportunity Fund in 2026?
Yes. Taxpayers can still defer eligible short- or long-term capital gains by reinvesting them into a QOF within 180 days of the sale. However, under current rules, deferred gains from original QOF investments must be recognized by December 31, 2026, and cannot be rolled into a new QOF to restart the deferral clock.
Q: What happens to my existing QOF investment after December 31, 2026?
Existing QOF investors are not required to sell or exit their investments. If you continue holding and reach the 10-year threshold, you may be eligible to adjust your basis to fair market value at the time of disposition, eliminating taxable gains accrued after your original investment date.
Q: What is a rural Qualified Opportunity Zone, and how is it different?
The OBBBA created a new category of QOZ specifically for rural areas. Rural QOZs offer a 30% step-up in basis on the rollover gain after five years—compared to the 10% step-up in standard QOZs under the permanent program. This makes rural QOZs potentially more attractive for investors focused on rollover gain reduction.
Q: When will the new permanent QOZ designations take effect?
The first round of newly designated zones under the permanent program becomes eligible for investment on January 1, 2027. Approximately 6,500 new zones are expected to be designated, while original QOZ designations generally expire on December 31, 2028.
Q: Does the 10-year tax exemption on QOF investment gains still apply under the permanent program?
Yes. The permanent exclusion of gains on the QOF investment itself—after a 10-year holding period—remains intact under the OBBBA, and can apply for up to 30 years after the original investment.
The QOZ program remains a compelling vehicle for deferring and potentially eliminating capital gains—but the rules have changed significantly, and the window for action on several transitional provisions closes at the end of 2026.
At SD Mayer, we help investors and businesses cut through the complexity of programs like this and identify strategies that genuinely move the needle. If you have questions about how IRS Notice 2026-40 affects your existing QOF investments, or how the permanent program might factor into your broader tax planning, we can walk you through the details. Reach out to our team today.