Impact of the 2025 Reconciliation Act on Qualified Opportunity Zones

On July 4, 2025, President Donald Trump signed into law “[a]n Act to provide for reconciliation pursuant to title II of H. Con. Res. 14.” (formerly known as the One Big Beautiful Bill Act, referred to herein as the “Act”), an all-encompassing reconciliation bill including sweeping domestic policy changes championed by the president that are expected to impact virtually every industry, business, and household of America.

The Act contains substantial changes to the Internal Revenue Code of 1986, as amended (the “Code”), making many provisions of the 2017 Tax Cuts and Jobs Act (“TCJA”) that were scheduled to expire in 2025 permanent. As discussed in more detail below, the Act notably included significant changes to the qualified opportunity zone (“QOZ”) program that make the QOZ program permanent, establish new rules regarding designation of QOZs, provide additional benefits for projects based in rural areas and create a new compliance and penalty regime for the QOZ program.

Background

As described in more detail in our prior alerts¹, the QOZ program was introduced as part of the TCJA to promote investment in qualifying low-income communities designated by states as QOZs. The QOZ program provides tax incentives to invest in qualified opportunity funds (“QOFs”), including a temporary deferral of invested capital gains, as well as a permanent exclusion of a portion of those invested capital gains and a complete exemption from capital gains tax for future appreciation, provided certain holding periods are satisfied.

Very generally, as discussed in more detail in our prior alerts, to qualify as a QOF, an entity must hold at least 90% of its assets in (i) certain tangible property located and used in a business in a QOZ (“QOZ Business Property”) or (ii) equity investments in one or more businesses located in a QOZ (a “QOZ Business”) (i.e., “qualified opportunity zone stock” or “qualified opportunity zone partnership interests”). A QOZ Business must have at least 70% of its tangible assets consist of QOZ Business Property and meet certain requirements regarding the use of its intangible property within a QOZ as well as generating income in the QOZ. Any QOZ Business Property must be acquired for initial use within a QOZ or be “substantially improved” by the QOF or QOZ Business. In addition, limitations are imposed on a QOF or QOZ Business holding excess financial property or engaging in certain “sin businesses.”

The Act includes a number of changes to the QOZ program, including making the QOZ program permanent, permitting states to re-designate their QOZs every 10 years, enhancing the benefit of certain QOZ investments in rural areas and including more onerous compliance requirements and associated penalties.

Extension of QOZ Program

Any capital gains invested in QOFs prior to the Act are required to be recognized on December 31, 2026. However, the Act eliminates this sunset date for future investments in QOFs and permits investors to defer capital gains invested in a QOF on a rolling basis with these capital gains deferred for up to the earlier five years from investment or when the investment is sold, whichever comes first.

The Act also substantially extends investors’ ability to eliminate capital gain on future appreciation from QOF investments. Any new investments are eligible from an exemption from capital gains on post-investment appreciation. This exemption is applied by providing a step-up basis to fair market value on sale after a 10-year holding period is satisfied with respect to any appreciation until the 30th anniversary of the investment. Under current Treasury Regulations, elimination of gain on future appreciation is limited to appreciation determined as of 2047 (i.e., 30 years after the initial introduction of the QOZ program but without extension for investments made after January 1, 2018).

QOZ Designations

The original QOZ rules permitted states to designate QOZs on a one-time basis determined exclusively based on 2010 census data. Accordingly, states were unable to update or revise QOZ designations based on current economic conditions. In light of the permanent extension of the QOZ rules under the Act, the Act introduces a requirement for states to re-evaluate QOZ designations every 10 years beginning on July 1, 2026 based on current economic data[confirm]. Notably, July 1, 2026 provides investors with 6 months advance notice of QOZ designations before the January 1, 2027 effective date of the new rules, eliminating the potential “dead zone” where QOF managers may be fundraising or seeking investment opportunities without knowing whether a property will be designated as a QOZ tract.

The treatment under the Act of QOZs that lose their status as a result of this redesignation process is not entirely clear and future regulatory and agency guidance regarding treatment of pre-change QOZs, compliance for QOFs holding these properties, will be critically important to QOF managers and investors.

Tightened QOZ Designation Standards

The original QOZ rules permitted states to designate areas not otherwise qualifying, but which were contiguous with low-income communities, as QOZs, The Act eliminates states’ ability to designate contiguous tracts as QOZs, forcing states to designate only areas with a median family income below 70% of the state or metro median (as opposed to 80% under current law), or a poverty rate of at least 20% combined with income below 125% of the median.

New Rural Opportunity Zones

The Act creates a new category of QOFs referred to as a qualified rural opportunity fund (“QROF”). A QROF is a fund holding at least 90% of its assets in qualified opportunity zone property located entirely within rural-designated QOZs, areas outside and not adjacent to, areas with populations over 50,000.

Projects involving rehabilitation of existing projects in these rural areas are faced with a lower standard for the “substantial improvement” test, requiring that the investment in improvement to existing property represents only 50% of the adjusted basis (rather than the 100% standard under current law), making it easier to invest in projects involving rehabilitation of existing structures in rural areas.

Investors in QROFs will benefit from this lower investment cost as well as a 30% basis step-up for investments held at least five years rather than the current 10%, further reducing tax on deferred capital gains invested in a QROF.

New Reporting Requirements

Under the TCJA, compliance requirements for a QOF were minimal, with compliance limited to filing an annual Form 8996.

Under the Act, QOFs are required to file detailed reports on an annual basis including the name and address of their QOZ Businesses, the NAICS classification of the businesses conducted and information about residential units held and information regarding employees of the relevant QOF and its QOZ Businesses; QOZ Businesses are required to provide sufficient information to the QOF to comply with these requirements.  
Significant penalties will apply for failure to comply with these requirements, ranging from $10,000 for small QOFs and up to $50,000 for large QOFs (i.e., QOFs with gross assets in excess of $10 million). Additional penalties will apply for willful noncompliance.

The Treasury Department will also be required to publish annual, detailed reports on QOFs and QROFs in an effort to provide the public with information regarding the impact and efficacy of the program.

¹ See client alerts generally describing the QOZ rules, proposed regulations, final regulations and specific opportunities for early stage companies and stadium development and sports industry operating businesses using the applicable links.

This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Alexander Anderson, an O’Melveny partner licensed to practice law in New York; Will Becker, an O’Melveny partner licensed to practice law in Texas; Billy Abbott an O’Melveny partner licensed to practice law in California; Eleanor Gilbert Dunn, an O’Melveny associate licensed to practice law in Texas; and Lauren Lekey, an O’Melveny associate licensed to practice law in California, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.

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