Transitional guidance for Qualified Opportunity Zones (QOZs) has been released by the IRS ahead of proposed regulations implementing the QOZ changes made by OBBBA. (IRS Notice 2026-40)
For QOZ investors, the notice provides that taxpayers who invested in a QOZ fund prior to 2027 must still recognize deferred capital gains in their taxable income no later than December 31, 2026, and cannot defer those gains again.
Despite the mandatory gain recognition on December 31, 2026, the taxpayer continues to hold a “qualifying investment,” which means the taxpayer remains potentially eligible for the 10-year fair market value basis step-up, provided all other requirements are met.
If the taxpayer sells the QOZ fund interest after 2026, any capital gain realized from that sale would then be eligible for a QOZ deferral under the new OBBBA QOZ rules, which allow the taxpayer to defer gain recognition for up to five years from the QOZ fund investment date. However, taxpayers should weigh the benefit of this subsequent sale and the five-year deferral against the benefit of holding the investment for 10 years and getting the FMV step-up.
Additionally, any capital gains that are generated in the latter half of 2026 could qualify for the five-year deferral under OBBBA’s QOZ rules if they are invested in a newly designated QOZ on or after January 1, 2027 (within 180 days of the gain recognition).
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