On September 30, 2025, the Treasury Department and IRS released guidance (Notice 2025-50 (Notice)) on changes made to Qualified Opportunity Zones (QOZs) by the "One Big Beautiful Bill Act" (OBBBA) concerning the definition of rural areas and the new substantial improvement requirements for rural areas under IRC Section 1400Z-2(d)(2)(D)(ii). The new provisions apply as of July 4, 2025.

The Notice applies to QOZs that were certified in 2018 (2018 QOZs) and does not apply to the forthcoming round of Opportunity Zone nominations, certifications and designations authorized by the OBBBA.

Background

Opportunity Zone investments must be made through Qualified Opportunity Funds (QOFs), which are specially created investment vehicles that invest at least 90% of their assets in Opportunity Zone Property, which may be Qualified Opportunity Zone Business Property (QOZBP) or a partnership or corporate interest in a Qualified Opportunity Zone Business (QOZB) that was created for the purpose of holding QOZBP.  QOZBP is tangible property that is:

• Used in a QOF's trade or business
• Purchased after December 31, 2017
• Originally used or substantially improved by the QOF
• Substantially used in an QOZ during substantially all of the QOF's holding period

Tangible property used in a QOF's trade or business is considered substantially improved if investments are made to the property during the 30 months following the property's acquisition, and those investments exceed the property's adjusted basis at the beginning of the 30-month period (i.e., the investments equal at least 100% of the property's basis after 30 months). For real estate investments, only the value of the building, and not the land, must be substantially improved.

OBBBA adds Qualified Rural Opportunity Fund

The OBBBA reinvented the Opportunity Zone regime to create rolling, 10-year QOZ designations for census tracts, with the first determination period beginning on July 1, 2026, and the new census tracts designations going into effect on January 1, 2027 (see Tax Alert 2025-1418).

The OBBBA codified the definition of “rural area” in IRC Section 1400Z2(b)(2)(C)(ii) applicable to amounts invested in QOFs after December 31, 2026. A “rural area” is defined as “any area other than—(I) a city or town that has a population of greater than 50,000 inhabitants, and (II) any urbanized area contiguous and adjacent to a city or town described in subclause (I).”

The OBBBA also introduced two new benefits for QOZs located in rural areas. First, it modified the substantial improvement requirements so that tangible property located entirely in a rural area would be considered substantially improved if its improvement costs equaled up to 50% of its adjusted basis (rather than 100% for tangible property located outside a rural area). Second, Qualified Rural Opportunity Funds (QROFs) receive a step-up in basis equal to 30% on capital gains deferred into a QROF after five years (as compared to 10% for non-QROFs).

Defining rural areas

The Notice defines rural areas for purposes of applying the substantial improvement test for 2018 QOZs. The Notice maintains the definition of a “rural area” in the OBBBA and further clarifies, for purposes of this definition, that (1) the 2020 Decennial Census  applies, (2) “urbanized area” is any area that is designated by the Census Bureau as an urban area, and (3) “contiguous and adjacent” means any areas that share a common boundary or at least one common point. Under this definition, the Treasury and the IRS have determined that 3,309 QOZ census tracts qualify as “rural areas,” which are listed in the Appendix to the Notice.

The Notice applies to all tangible property located in 2018 QOZs that consist entirely of a rural area that has been, or is in the process of being, substantially improved. The Notice applies for any determination made on or after July 4, 2025.

Implications

The Notice provides immediate, actionable guidance for investors currently holding tangible property that is located in a QOZ listed as a “rural area” in the Appendix to the Notice. The reduced threshold for properties in these locations to qualify as substantially improved may mean that some additional property may not need as much improvement as before.

More significantly, however, the Notice identifies the rural area QOZs that may be ripe for investment on January 1, 2027. While the Notice specifically states that it does not affect any new QOZ areas that will be selected on January 1, 2027, new investments made on or after January 1, 2027, may be made in the 2018 QOZ areas, because both maps overlap for the two years from January 1, 2027 through December 31, 2028.  In addition, this could indicate that Treasury will specifically indicate which new census tracts qualify as “rural areas.”