Opportunity Zones are an economic development tool that the Internal Revenue Service (IRS) says are intended to encourage economic development and create jobs in distressed communities. The IRS explains that these areas are “economically distressed” places where new investments may be eligible for preferential tax treatment. The IRS also states that Opportunity Zones were added to the tax code by the Tax Cuts and Jobs Act on Dec. 22, 2017.

The IRS says localities qualify as Qualified Opportunity Zones (QOZs) when a state, the District of Columbia, or a U.S. territory nominates them and the U.S. Treasury Secretary, through delegated IRS authority, certifies the nominations. QOZ designations have been made in parts of all 50 states, the District of Columbia, and five U.S. territories, according to the IRS. The IRS provides the official lists in IRS Notices 2018-48 and 2019-42 and links to a map showing the designated census tracts.

How the tax incentive works

According to the IRS, the Opportunity Zone incentives are provided to taxpayers who invest eligible gains in a Qualified Opportunity Fund (QOF). Eligible gains include capital gains and qualified section 1231 gains if they would be recognized for federal income tax purposes before Jan. 1, 2027 and do not arise from a transaction with a related person. The IRS notes that qualified section 1231 gains are generally those reported on Form 4797, Sales of Business Property.

The IRS explains that to obtain deferral, an investor must invest eligible gain in a QOF in exchange for an equity interest (not a debt interest) within 180 days of when the gain would otherwise be recognized. The IRS describes this as a qualifying investment. The IRS states that the deferral lasts until the earlier of an inclusion event or Dec. 31, 2026.

What the time periods can provide

The IRS describes tiered benefits that depend on how long the QOF investment is held. If the investment is held at least five years, the basis in the QOF investment increases by 10% of the deferred gain, according to the IRS. If held at least seven years, the basis increases by an additional 5% of the deferred gain, the IRS says.

The IRS also states that if the investor holds the QOF investment for at least 10 years, the investor may elect to adjust the basis of the QOF investment to its fair market value at the time of sale or exchange. According to the IRS, this can allow the exclusion of gain on appreciation. The IRS adds that a similar rule can exclude an investor’s share of gains and losses from sales of assets by the QOF or certain lower-tier partnerships, if detailed conditions are met.

What counts as eligible gain and how timing works

According to the IRS, eligible gains that can be deferred include both capital gains and qualified 1231 gains recognized before Jan. 1, 2027, and not from transactions with related persons. The IRS says nonresident alien individuals and foreign corporations can generally choose to defer eligible gains that would otherwise be subject to federal income tax to them, with conditions for treaty benefits.

The IRS states that the 180-day investment period generally begins on the date the gain would be recognized if it were not deferred. The IRS provides specific timing options for partners, S corporation shareholders, and certain beneficiaries, and separate rules for regulated investment company or real estate investment trust capital gain dividends.

The IRS says property other than cash can be contributed to a QOF, but cautions that when non-cash property is transferred, only part of the investment may be a qualifying investment. The IRS explains that in such cases the deferrable gain is limited to the basis of the contributed property, even if the property’s value is higher.

What a Qualified Opportunity Fund is

The IRS defines a Qualified Opportunity Fund as an investment vehicle organized as a partnership or corporation for the purpose of investing in QOZ property. The IRS adds that a QOF elects to self-certify by filing Form 8996 with its timely filed federal income tax return and may be structured as a limited liability company treated as a partnership or corporation for federal tax purposes.

The IRS explains that QOZ property includes a QOF’s qualifying ownership interest in a corporation or partnership that is a QOZ business, or certain tangible property used in a business in the QOZ. The IRS sets conditions for qualifying interests, including acquisition after Dec. 31, 2017 solely in exchange for cash, and that during 90% of the holding period the entity was a QOZ business. The IRS also notes that working capital is not QOZ property for a QOF.

What counts as Qualified Opportunity Zone business property

According to the IRS, tangible property counts as QOZ business property when it is put to use in a trade or business of the QOF or a QOZ business, was bought after Dec. 31, 2017, and either its original use in the QOZ began with the QOF or QOZ business or it was substantially improved by the QOF or QOZ business. The IRS states that during substantially all of the period the property is held, substantially all of its use must be in a QOZ. The IRS interprets “substantially all” for these requirements as at least 90% for the holding period test and at least 70% for the use test, which together mean at least 63% of the use over the entire time must be in a QOZ.

The IRS describes when original use begins and when vacant property can qualify as original use property. The IRS also explains substantial improvement, stating that within a 30‑month period, additions to basis must exceed the adjusted basis at the start of that period, and notes how in‑process improvements may be treated during that window. The IRS provides examples on what counts as significant physical work, and outlines when leased property can qualify, including market‑rate terms and additional conditions for related parties.

The IRS also says that certain mobile property and inventory can qualify, and describes a safe harbor for equipment used across multiple tracts and an annual choice to include or exclude inventory from specific calculations.

How QOZ businesses are evaluated

The IRS states that a QOZ business must earn at least 50% of its gross income from business activities within a QOZ each taxable year. The IRS provides three safe harbors to meet this test, based on hours of services, amounts paid for services, or the location of necessary tangible property and business functions. The IRS clarifies that satisfying any one safe harbor is sufficient for the 50% gross income test.

When deferred gain becomes taxable

The IRS explains that deferred gain must be included in income at the earlier of an inclusion event or Dec. 31, 2026. The IRS describes an inclusion event as an event that reduces or terminates a qualifying investment in a QOF, and notes examples such as sales, gifts, certain distributions, or liquidation of the QOF. According to the IRS, the amount of deferred gain included depends on the fair market value of the qualifying investment at the time of the event and basis adjustments.

Where to find designated zones and identifiers

The IRS points to IRS Notices 2018-48 and 2019-42 for the list of designated QOZ census tracts. The IRS also notes that the numbers shown on the list and map are U.S. Census Bureau census tract identifiers, and that 11‑digit GEOIDs can be found using the Census Bureau’s Geocoder with specified settings.