The IRS issued Notice 2026-40 on June 18, 2026, providing critical transition rules for expiring opportunity zone census tracts certified under the Tax Cuts and Jobs Act of 2017.
The guidance, known as QOZ 1.0, addresses how existing opportunity zone projects may continue operating as the programme approaches key transition dates ahead of the new framework taking effect.
New opportunity zone census tracts, designated under the One Big Beautiful Bill Act of 2025 and referred to as QOZ 2.0, will become effective for investment in qualified opportunity funds on or after January 1, 2027.
Investors who made capital contributions to a qualified opportunity fund on or before December 31, 2026, remain eligible for QOZ 1.0 federal income tax benefits, including deferral of eligible capital gain recognition until December 31, 2026.
Those investors also retain full elimination of taxable gain upon exit after holding their interest for 10 years, including eliminating depreciation recapture, provided the sale occurs by December 31, 2047.
Investors contributing capital after December 31, 2026, fall under QOZ 2.0 rules, which offer a five-year deferral of eligible capital gain recognition and a 10% tax basis step-up after that period, rising to 30% for Qualified Rural Opportunity Funds.
The existing QOZ 1.0 census tracts are set to expire on December 31, 2028, with Puerto Rico census tracts expiring a year earlier on December 31, 2027.
The Notice provides three principal categories of transition relief for projects located in QOZ 1.0 census tracts, including a working capital safe harbour, a provision for ordinary-course replacement property, and ongoing compliance safe harbours following expiration.
Under the working capital safe harbour, tangible property acquired after December 31, 2026, in a QOZ 1.0 census tract may qualify as QOZ Business Property if acquired under a written plan adopted by December 31, 2026, with the business having received at least 10% and expended at least 5% of total planned working capital by that date.
The ordinary-course replacement provision allows certain tangible property acquired after December 31, 2026, in a QOZ 1.0 tract to qualify as QOZ Business Property when replacing or modernising existing business property, though this does not cover expansion into new lines of business.
Following the expiration of a QOZ 1.0 designation, compliance safe harbours will allow certain requirements to be tested as though the expired tract remains a certified opportunity zone, but only for limited purposes and generally only through December 31, 2047.
The Notice also confirms that QOZ 2.0 investments made to a fund after 2026 and deployed into a business with an underlying project in a QOZ 1.0 tract that met the required conditions by end of 2026 will be treated as qualifying investments, enabling access to enhanced QOZ 2.0 tax benefits.
Treasury and the IRS have stated they intend to issue proposed regulations generally consistent with the transitional rules described in Notice 2026-40, though future guidance may differ from or modify those transition rules.
The analysis of Notice 2026-40 was provided by James O. Lang, Lawrence H. Brenman, Sanford C. Presant, Brian Gaudet, and Laura Hendee Siman of Greenberg Traurig, LLP.