IRS Issues Transitional Guidance on Qualified Opportunity Zones Under the One Big Beautiful Bill Act

The IRS recently released Notice 2026-40 (the “Notice”), which provides important interim guidance for investors, fund sponsors, qualified opportunity funds (QOFs), and qualified opportunity zone businesses (QOZBs) navigating the changes made to the Opportunity Zone incentive by the One Big Beautiful Bill Act (OBBBA), enacted in July 2025. The Notice previews the rules that Treasury and the IRS intend to include in forthcoming Treasury regulations, and taxpayers may rely on it in the meantime. The guidance focuses on three main areas: new Opportunity Zone designations going forward, transition rules for investors with existing deferred gains, and transition rules for QOFs and QOZBs operating in Opportunity Zones designated under the prior law.

The Notice clarifies how investors can defer gain that is triggered by an inclusion event, such as a sale, partial disposition, distribution in excess of basis, or decertification of a QOF. Under the Notice, gain triggered by an inclusion event may itself be eligible for a new deferral election, provided the taxpayer reinvests in a QOF within 180 days of the inclusion event date and meets the other, existing requirements. The gain triggered by an inclusion event, though, will no longer be a “qualifying investment” for QOFs, and the 10-year holding period for the fair market value basis step-up election will restart with the new QOF investment. Taxpayers contemplating a sale or other disposition in 2026 should carefully evaluate the trade-off between re-deferring the inclusion event gain and preserving their original 10-year basis step-up (and investment exit) timeline. If there is no other inclusion event, recognized gain that occurs on the deemed inclusion event of December 31, 2026 cannot be the qualifying gain for a new QOF investment because that original gain would still have a valid QOF investment election in place.

The Notice also provides a critical transition rule for the working capital safe harbor that allows QOZBs to acquire tangible property after December 31, 2026 in a previously designated Opportunity Zone and still have that property qualify as qualified opportunity zone business property. To take advantage of this rule, the QOZB must satisfy four conditions:  (1) the written working capital plan must be adopted on or before December 31, 2026; (2) property acquisitions must be made substantially consistent with that plan; (3) the QOZB must have received at least 10% of the total estimated working capital assets (i.e., cash) designated under the plan by December 31, 2026; and (4) the QOZB must have expended at least 5% of those working capital assets (i.e., cash) by December 31, 2026. Amounts required to be expended under a binding agreement entered into before January 1, 2027 are treated as already spent for prong (4) of that test. Separately, the Notice provides that tangible property acquired after December 31, 2026 in the ordinary course of business to replace or modernize existing property in a previously designated Opportunity Zone may still qualify, but property acquired to expand or transition a trade or business will not.

The Notice contains a number of additional helpful provisions, including safe harbors permitting QOFs and QOZBs to continue treating expired previously designated zones as Opportunity Zones for certain compliance purposes through December 31, 2047, and confirmation that the new 30-year cap on the fair market value basis step-up applies to amounts invested after December 31, 2026. However, the Notice does not address the additional reporting requirements that the OBBBA imposed on QOFs and QOZBs. Those reporting obligations are expected to be addressed in separate guidance, and clients should begin building the data infrastructure needed to track investor-level, asset-level, geographic, and employment information so they are well positioned to comply once that guidance is issued.

Recommended action items for clients include:

• Conduct a portfolio review of all current and contemplated Opportunity Zone projects, with a focus on those located in previously designated Opportunity Zones that will continue operating past 2026.
• Adopt or refresh a written working capital plan on or before December 31, 2026, ensuring it includes a designated purpose, expenditure schedule, and identification of property to be acquired or improved.
• Confirm that any QOZB intending to rely on the new transition rule has received at least 10% and expended at least 5% of its estimated working capital by December 31, 2026, and execute binding agreements before January 1, 2027 where appropriate to lock in expenditure treatment.
• Identify any inclusion events occurring in the 180 days before a contemplated new QOF investment, and calendar the reinvestment window from the inclusion event date.
• Evaluate whether new QOF investments should be made before or after January 1, 2027, given that different deferral, basis step-up, and 30-year cap rules will apply.
• Maintain contemporaneous documentation of plan adoption dates, schedules, receipts, expenditures, and the ordinary-course nature of any replacement property.
• Begin building tracking systems in anticipation of the OBBBA's enhanced reporting requirements.

Our team is available to consult with you on any aspect of Notice 2026-40, including how the transition rules apply to your specific investments, projects, and structures, and to assist with adopting compliant working capital plans, evaluating inclusion event strategies, and preparing for the upcoming reporting requirements.

We will continue to monitor developments in this area and will provide additional updates as the IRS and Treasury release further guidance, including the forthcoming Treasury regulations and any guidance addressing the OBBBA’s new reporting obligations.