News & Insights

By Phil Jelsma, partner and chair of the tax practice group

According to the Economic Innovation Group, Qualified Opportunity Zones (QOZs) — an economic development tool designed to spur economic investment in distressed communities by providing tax breaks to investors — were the first federal development program to use capital gains tax incentives to drive investment in designated low-income areas.

Designed to bolster and refine the Opportunity Zone program — originally created as part of the 2017 Tax Cuts and Jobs Act — the recently enacted One Big Beautiful Bill Act (OBBBA) makes six significant changes to QOZ rules. Generally, the Opportunity Zone program is now permanent and provides additional incentives to QOZ investors.

The specific changes are summarized below:

1. The QOZ program is now permanent

Rather than expiring Dec. 31, 2026, the Opportunity Zone program has been made permanent, with a rolling 10-year designation cycle. Every 10 years, the governors will propose new opportunity zones, and the Treasury Department will certify those zones with new effective dates for the designation on July 1, 2026, and every 10 years thereafter. It is not clear what will happen to the prior census tracts that used to be opportunity zones, but it would appear those seemed safe or unchanged for purposes of the new law.

2. Gain deferral and basis step-up

Now, on the fifth anniversary of each investment date, there will be a 10% basis step-up in the QOZ assets. OBBBA eliminated the additional 5% step-up that had previously applied at the seven-year anniversary date.

3. Eligibility criteria changed

Tightening the definition of “low-income,” the OBBBA changes the census tract eligibility from the existing rules, which required the tract have a poverty rate of at least 20% of medium family income, not to exceed 80% of the state or metropolitan area of family income. After Dec. 31, 2026, census tracts qualify if medium family income does not exceed 70% — instead of 80% — of the applicable state or metropolitan area family income, or if they have a poverty rate of at least 20% and a median family income not exceeding $125 of the area median. Additionally, the continuous tract rule has been repealed. A census tract will no longer automatically qualify as a low-income community for OZ designation solely because it is contiguous to a qualifying low-income community. Instead, each tract will need to independently meet the criteria for low-income community status under the revised definition.

Finally, the designation for all of Puerto Rico is also repealed. As a result of these changes, the number of eligible zones is expected to decrease.

4. Qualified Rural Opportunity Zones

The OBBBA creates a new category of QOZs — the Qualified Rural Opportunity Fund” (QROF). A QROF is essentially a Qualified Opportunity Fund (QOF) that must invest at least 90% of its assets in QOZ property situated entirely in a rural area. In the context of QROFs, rural areas are defined as any area other than (1) a city or town with a population greater than 50,000, and (2) an urbanized area adjacent to a city or town with a population in excess of 50,000. The benefits of a QROF include a 30% basis step-up after five years — rather than 10% — and the substantial improvement requirement, which typically requires the QOF to double the tax basis of previously depreciated property as reduced to 50% of the adjusted basis. This reduced substantial improvement threshold is effective immediately, although most of the other provisions come into effect on Dec. 31, 2026.

5. Waiting 30 years

To clarify certain provisions under existing law, for investments sold or exchanged after 30 years, there will be a basis step-up to fair market value on the date the property is sold. For investments held more than 30 years, the basis step-up will be frozen at fair market value on the 30th anniversary of the investment. It is not clear whether the QOF could then start depreciating this new higher basis.

6. OBBBA introduces new reporting changes

The OBBBA mandates detailed annual reporting from QOFs, including information on asset values, investment locations (census tracts), NAICS codes, employment figures, residential units and the value of tangible and intangible property.

Failure to comply with these new requirements can result in higher penalties — up to $10,000 per return, or up to $50,000 if the QOF assets exceed $10 million.

Conclusion

While these changes were designed to make the OZ program more effective and drive more investment in underserved communities, the increased reporting requirements may pose challenges.

It will be interesting to see what fallout results from these new changes — particularly, the impact of the special incentives for rural opportunity zones funds. It is certainly possible that many areas throughout California, including Imperial, San Bernardino and Riverside Counties, may qualify for these new benefits.

The article was published in The Los Angeles Daily Journal and The Daily Transcript (subscription required).

Phil Jelsma is a partner and chair of the tax practice group at Crosbie Gliner Schiffman Southard & Swanson (CGS3) – a San Diego-based commercial real estate law firm with offices in Los Angeles. He is recognized as a leading joint venture and tax attorney with a 30-year background in real estate exchange transactions, syndications, nonprofit corporations and international tax planning.

About Crosbie Gliner Schiffman Southard & Swanson LLP (CGS3)

CGS3 is a recognized leader among a new generation of commercial real estate law firms with practice areas covering the entire commercial real estate life cycle, including finance, acquisition/disposition, entity formation, tax, development, land use, leasing, distressed asset workouts and dispute resolution. Earning a reputation as one of California’s leading commercial real estate law firms, CGS3 continues to recruit some of the state’s top real estate attorneys from both large corporate firms and senior in-house positions. For more information, visit http://www.cgs3.com.