The tax reconciliation bill passed by the House Ways and Means Committee on May 14, 2025 (the Bill), includes changes to the current incentives and requirements for Opportunity Zones and their investors. This Alert details the Bill's proposed changes. Additional changes may arise as the legislation moves through the House and Senate.

Current law

Opportunity Zones, which were created under the Tax Cuts and Jobs Act (TCJA), are designed to spur investment in distressed communities throughout the country by granting investors preferential tax treatment. These investments must be made through Opportunity Funds, which are specially created investment vehicles that must have at least 90% of fund assets invested in Opportunity Zones.

The preferential tax treatment offered under the Opportunity Zone program is threefold. First, investors can defer tax on capital gains invested into Opportunity Zones until no later than December 31, 2026. Second, investors that hold the Opportunity Fund investment for five or seven years as of December 31, 2026, receive a 10% or 15% reduction, respectively, on their deferred capital gains tax bill by increasing the basis of the original deferred gain. Finally, investors that hold the Opportunity Fund investment for at least 10 years can receive the added benefit of paying no tax on any realized appreciation in the Opportunity Fund investment.

Investments in Opportunity Funds may consist of partially of deferred gains and partially of basis or ordinary income, but the tax benefits under the Opportunity Zone Program accrue only on the eligible capital gains.

To date, the IRS has designated Opportunity Zones in all 50 states, the District of Columbia, American Samoa, Guam, Northern Marianas Islands, Puerto Rico and the Virgin Islands. (See Tax Alerts 2018-0806, 2018-0865, 2018-1050, 2018-1070, and 2018-1261). Those designations will expire after December 31, 2028.

Proposal

Opportunity Zone designations

The Bill would shorten the expiration date of current Opportunity Zone designations from December 31, 2028 to December 31, 2026, but allow additional Opportunity Zones to be designated from January 1, 2027 through December 31, 2033. The criteria for qualifying as a low-income community (and therefore an eligible census tract that may be designated as a qualified Opportunity Zone) would be narrowed so that areas with a median income of 70% or less of statewide median income (rather than 80% or less) would be eligible for designation. Similarly, low-income communities whose median income equaled or exceeded 125% of metropolitan area median family income would no longer be considered low-income communities.

The Bill would still authorize the Secretary to designate 25% of low-income communities (under the modified definition) in each state as qualified Opportunity Zones but would require an "applicable percentage" of those designations, in consultation with the Secretary of Agriculture, to consist entirely of rural areas, For any calendar year during which a designation is made, the applicable percentage would be the greater of 33% or the percentage of the US population living within a rural area for the preceding calendar year. Tracts contiguous to rural areas would be ineligible for purposes of this designation.

Modification of Opportunity Zone benefits

The Bill would extend the deadline for investors to elect to invest in Opportunity Funds from December 31, 2026 to December 31, 2033. The December 31, 2033 deadline would also apply to elections to defer recognition of gains invested in Opportunity Funds.

The Bill would eliminate the 15% basis increase for deferred-gain investments held at least seven years. The 10% basis increase for deferred-gain investments held at least five years would still apply. Recognized gain for deferred-gain investments would equal the difference between (1) the investment's deferred or fair market value (whichever is less); and (2) the investor's basis in the investment. Investors would be required to recognize some or all of the deferred gain by the earlier of (1) the date of the investment's disposition; or (2) December 31, 2033.

The Bill would increase the basis for deferred-gain investments in qualified rural opportunity funds to 30%. Qualified rural opportunity funds are defined as qualified opportunity funds holding at least 90% of their assets in either:

• "[Q]ualified opportunity zone business property substantially all of the use of which, during substantially all of the fund's holding period for such property, is in a qualified opportunity zone comprised entirely of a rural area"
• or
• "[Q]ualified opportunity zone stock, or a qualified opportunity zone partnership interest, in a qualified opportunity zone business in which substantially all of the tangible property owned or leased is qualified opportunity zone business property and substantially all the use of which is in a qualified opportunity zone comprised entirely of a rural area"

In an expansion of Opportunity Zone benefits, the Bill would permit investors to invest no more than $10,000 of ordinary income in a qualified opportunity fund. This investment would be limited to $10,000 in the aggregate per taxpayer for the entire opportunity zone program. The basis increase provisions that typically apply to capital gain investments would not apply to investments of ordinary income. For investments held for at least 10 years, however, no tax would apply to gains on ordinary-income investments.

Reporting requirements

The Bill would introduce statutory reporting requirements for qualified opportunity funds, qualified rural opportunity funds, and qualified opportunity zone businesses. As proposed, the funds would have to file information returns containing information listed in the Bill, including:

• The North American Industry Classification System (NAICS) code that applies to the trade or business
• The approximate number of residential units for any real property
• The approximate average monthly number of full-time equivalent employees

Failure to satisfy these requirements could result in penalties of $500 per day, up to a maximum of $10,000 per return for small funds and businesses (i.e., funds and businesses with $10 million or less in gross assets) and $50,000 for large funds and businesses (i.e., funds and businesses with more than $10 million in gross assets). For funds or businesses that intentionally disregarded the reporting requirement, the penalty would increase to $2,500 per day, up to a maximum of $50,000 for small funds and businesses, and $250,000 for large funds and businesses.

Under the Bill, qualified opportunity zone businesses and qualified rural opportunity zone businesses would be required to provide qualified opportunity funds with a written statement that would enable the qualified opportunity fund to meet these information reporting requirements. Qualified opportunity zone businesses and qualified rural opportunity zone businesses would also similarly be subject to penalties for failing to provide these written statements.

In conjunction with the new information reporting requirements, the Secretary, in consultation with the Director of the Bureau of the Census, would be required under the Bill to compile annual reports on qualified opportunity funds and qualified rural opportunity funds, which would track the investments made in each census tract and the impact on employment in the census tracts designated as Opportunity Zones.

Effective date

The changes affecting Opportunity Zone requirements and benefits would apply to investments made after the date that the legislation is enacted. The proposed reporting requirements would apply to tax years beginning after the date the legislation is enacted.

Implications

While the proposed Bill makes some changes to the current Opportunity Zone program, its key benefits — the capital gain tax deferral, basis exclusion, and no tax on the appreciation of a qualified investment held for at least 10 years — remain largely unchanged. This would mean that the Opportunity Zone program, as proposed in the Bill, has the potential to "unlock" additional capital gains and incentivize additional long-term investment in newly-designated low-income communities, including rural communities, throughout the country.

Many industry participants may be disappointed with the outcome, as many hoped for a further deferral of already deferred gain past the December 31, 2026 deadline. Additionally, while many people wanted non-capital gains to be eligible for Opportunity Zone benefits, the $10,000 lifetime cap likely provides little benefit as it would be difficult for a Qualified Opportunity Zone fund to cobble together $10,000 investments and turn that into a substantial project.

For existing QOF investors, the proposed Bill would mean that any eligible gains invested before January 1, 2027, would be subject to the existing law and, as such, would be subject to gain inclusion on December 31, 2026.

For taxpayers that have been considering investing, or reinvesting, in Opportunity Zones, the possible extension of the Opportunity Zone program is a positive sign. However, it is crucial to keep in mind that the Bill is subject to change and the proposals discussed in this Alert could differ substantially upon enactment.