Opportunity Zones: Time for Acting and Planning

The opportunity zone rules came into the tax code basically in 2018. The initial tax benefit is the ability to defer capital gain generally from any source through investment of the cash into a qualified opportunity fund (“QOF”). The 2025 Tax Act made the QOF program permanent.

Basically, the Governor of each state will nominate zones, and the Treasury Department will approve these selections if qualified. The original zones are commonly referred to as Round One Zones while those certified to start on January 1, 2027 are commonly referred to Round Two Zones. Any remaining deferral on investments in Round One Zones must generally be recognized on December 31, 2026 (limited by the relevant hypothetical fair market value gain). The recognition of this gain cannot be further deferred in a like-kind exchange or, apparently, through investment in a Round Two Zone.

Because of some esoteric rules applicable to QOFs, the typical structure for a QOF is as a limited liability company taxable as a partnership. The QOF then invests in a lower-tier limited liability company taxable as a partnership (“Property Owner LLC”). Again, typically, the Property Owner LLC acquires land and builds commercial or residential real property used in a trade or business.

The QOF rules are complex and often inconsistent. To make this discussion manageable, this TET Thought addresses general results, and an Investor should consult with his tax advisor regarding his unique situation. We are happy to assist.

An Investor in Round One should plan now regarding his 12/31/26 inclusion. The typical planning would be to recognize capital losses in 2026. That remains valid, and early planning is certainly better. However, that may be insufficient to eliminate the tax. We typically stress not having tax concerns cause bad economic decisions. The recognized gain, however, is limited to the relevant hypothetical gain. Logically, because the qualified investment began with a $0 tax basis, any material 12/31/26 gain indicates that significant equity appreciation has occurred. The QOF might persuade the Property Owner LLC to borrow and make distributions through the QOF to the QOF Members.

Although a tax partner has gain if a distribution exceeds his tax basis in his Interest, that should not be a problem. First, the 12/31/26 recognition increases such basis. Second, depending on the debt, the distributee tax partner’s basis is initially increased for the debt.

Real Estate Developers should also act now. In Virginia, Governor Spanberger has between July 1, 2026 and September 28, 2026 to designate Round Two Zones. At this writing, she has not done so; however, several websites are available to indicate what tracts are eligible. Again, economics should dictate tax and not vice versa. Round One transactions proved, however, that the QOF tax benefits can lower a Developer’s cost of equity capital.

That savings could be even more pronounce for a Developer that can locate, bind, and acquire economically logical Round Two property. No, Round One Investors cannot use a Round Two investment to defer their 12/31/26 gain. However, such an investment could defer other capital gain being recognized in 2026 and allow the Investor’s 2026 capital losses to be available to offset the 12/31/26 recognition. Although an Investor generally has 180 days from the date of the capital gain to invest in the QOF, if such gain is being allocated from a tax partnership, the Investor may have significantly longer.