The federal Qualified Opportunity Zone (QOZ) program incentivizes investment in designated low-income communities (or "zones") across the United States. The One Big Beautiful Bill Act (OBBBA) updates the program and makes it permanent. These revisions could boost future construction activity and even offer tax breaks to ambitious contractors. But there are risks to consider.
Congress created the QOZ program under the Tax Cuts and Jobs Act (TCJA). It generally allows taxpayers to defer eligible short- or long-term capital gains by reinvesting those gains in a Qualified Opportunity Fund (QOF) within 180 days. According to the IRS: "A QOF is an investment vehicle that files either a partnership or corporate federal income tax return and is organized for the purpose of investing in QOZ property."
More specifically, investments may be made in new or substantially improved commercial buildings in a QOZ, as well as in so-called QOZ businesses. A construction business can become a QOZ business that qualifies for QOF funding if it meets the following requirements:
In addition to gaining an equity interest in the fund, QOF investors receive generous tax benefits. Under the original TCJA program, taxes on their capital gains were deferred until the earlier of 1) the sale or exchange of the taxpayer's investment in the fund, or 2) December 31, 2026. After five years, taxpayers received a 10% step-up in tax basis for the investment, meaning only 90% of the original gain was taxable. After seven years, the step-up jumped to 15%. The gains on investments left in a QOF for at least 10 years were fully tax-exempt.
Important: Because the TCJA's recognition date is December 31, 2026, investors generally needed to invest years ago to qualify for the full five- or seven-year basis step-ups.
As mentioned, the OBBBA significantly impacts the program. For starters, it establishes rolling 10-year QOZs that are scheduled to become available for investment on January 1, 2027. Current zones sunset at the end of 2026 under transitional rules.
The law also shifts some of the tax perks. Under the new permanent rules, beginning in 2027, investors generally defer eligible gains for five years, at which point the deferred gain is recognized and investors receive a 10% basis step-up. The TCJA's additional seven-year step-up no longer applies. However, the exclusion of future gains from federal taxes on investments held in a QOF for at least 10 years remains available — keeping the strategy viable for decades rather than ending in 2026.
The OBBBA also creates a new kind of fund focused on rural areas. Qualified rural opportunity funds must invest at least 90% in rural QOZs, similar to regular QOFs. But they offer more valuable tax perks, allowing investors a 30% step-up on rollover gains. The IRS says that 3,300 of the more than 8,700 existing QOZs are already in rural areas.
The expanded QOZ program is likely to increase construction activity in eligible low-income communities after January 1, 2027. That's when QOFs will begin receiving new funds and looking for places to invest them. The increased activity could translate to more projects, including affordable housing and commercial development.
Moreover, construction companies that are QOZ businesses can receive QOF funds directly. So, you may want to consider forming your own QOF for suitable projects and soliciting taxpayer investments. Or, if you have realized eligible capital gains, you could reinvest those gains in a QOF to obtain the benefit of deferred or eliminated capital gains taxes.
Investment opportunities aside, be sure to recognize the risks of any QOZ project before signing on. For example, the tax breaks apply to the "substantial improvement" of buildings (not land), subject to a 30-month deadline following the property's acquisition. For standard QOZs, property is substantially improved if, during any 30-month period after the property is acquired, investments in the property exceed 100% of the property's adjusted basis at the start of the period. For rural areas, these investments must exceed 50% of the initial adjusted basis.
These rules could put serious scheduling and completion pressures on your team and other parties involved. Thoroughly inspect the property and carefully evaluate project timelines to determine whether the owner's plans are realistic. Also, negotiate protective contract terms in the event of unexpected delays.
The QOZ program could prove a boon for the construction industry — even if the positive results may not materialize until 2027 or later. If you're interested, now's the time to get a head start on reviewing the relevant details and preparing your company to participate in QOZ projects or QOF investments. We'd be happy to help you evaluate the program from either angle or both.
Modified tax benefits. While taxpayers can still temporarily defer their rollover gains, the step-up perk has been amended. As before, taxpayers will receive the 10% step-up in basis on the fifth year of their investments — but the rollover gains will be recognized on the fifth anniversary of the investment. Moreover, the OBBBA repeals the TCJA's additional 5% step-up after seven years. However, taxpayers can continue to benefit from a permanent exclusion of gains attributable to appreciation of the QOF investment itself if the investment is held for at least 10 years, up to 30 years after investment.
Enhanced savings in rural communities. The OBBBA creates new qualified rural opportunity funds (QROF). These funds, which must invest at least 90% in rural QOZs, come with more generous tax benefits than the standard QOFs. Where investors in the latter receive a 10% step-up in basis on their rollover gain after five years, investors in the rural funds will receive a 30% step-up on their rollover gain after five years.
Heightened reporting requirements. Under the OBBBA, QOFs and QROFs must report detailed information about their holdings, such as:
In addition, if a QOF investor disposes of an interest, the fund must provide a statement to both the investor and the IRS. Failure to comply with the reporting requirements could result in penalties of up to $10,000 per required informational return, or up to $50,000 for funds with more than $10 million in gross assets. The new reporting rules apply to tax years beginning after July 4, 2025.
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