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IRS Issues Transitional Guidance on Opportunity Zones

IRS Issues Transitional Guidance on Opportunity Zones

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The IRS released Notice 2026-40 on June 18, providing initial guidance on how the Opportunity Zone (“OZ”) program will operate following changes made by the One Big Beautiful Bill Act (OBBBA), enacted July 4, 2025. The notice outlines the transition from the current structure to a permanent framework and clarifies how existing rules apply through and beyond 2026.

Overview of Notice 2026-40

Notice 2026-40 is interim guidance, not a final regulation. In it, the IRS signals that it intends to issue proposed regulations incorporating these rules, which will later be finalized after a public comment period. Taxpayers can use the notice as interim guidance while Treasury and IRS develop proposed regulations.

Transition to a Rolling 10-Year Structure

The most immediate shift is structural. The OZ program is no longer tied to a fixed end date. Instead, Qualified Opportunity Zones (“Zones”) will be designated in rolling 10-year periods, with each designation beginning on January 1 following certification. Zones designated in 2026 will run from 2027 through 2036. Existing Zones are not extended. Puerto Rico zones expire at the end of 2027 and all other Zones expire at the end of 2028. This establishes a clear break between the current program and what follows.

Updated Zone Designation Rules

The guidance also changes how Zones are designated. The existing limit on how many census tracts a state can designate now applies within each 10-year period rather than as a one-time cap. Prior designations do not reduce how many Zones a state can nominate in future cycles, allowing states to reassess and designate new areas over time.

Changes to Investment Timing and Tax Treatment

For investors, the timing of gain recognition shifts beginning in 2027. Investments made through December 31, 2026 continue under the current rules, including the requirement to recognize deferred gain by that date unless it is triggered earlier by a sale or other taxable event.

Investments made beginning in 2027 follow a different structure. Taxes are generally deferred for up to 5 years from the date of investment, with gain recognized when the investment is sold, another taxable event occurs or the 5-year period ends. Holding the investment for that period can reduce the amount of taxable gain through a basis step (10%, or 30% for qualifying rural funds). 

Limitations on Existing Zones After 2026

The transition rules also narrow the use of existing Zones after 2026. As a general rule, property acquired after December 31, 2026 in Zones designated under the original program will not qualify unless specific conditions are met. Investments in newly designated Zones will qualify under the new framework. Projects that were already underway before the end of 2026 may continue to qualify if supported by a written plan and carried out in line with that plan. Businesses may also continue to qualify when replacing or upgrading assets used in ongoing operations, such as renovating between tenants or replacing building systems and equipment. Expansion into new property or new business activity in an existing Zones will generally not qualify after 2026.

What to Expect Next

The IRS has indicated that additional guidance is expected, including rules addressing how funds and businesses will be treated after a Zone’s designation period ends. Until then, Notice 2026-40 provides the beginning framework for evaluating OZ investments during the program’s transition from pre-to-post-OBBBA. 

The takeaway is timing. Investments made before 2027 remain under the current rules, while investments made beginning in 2027 follow a different framework. For activity in existing Zones, qualification will depend on whether it is tied to ongoing operations or supported by pre-2027 planning.

Contributors

Vadim Ronzhes, Partner. Frazier & Deeter Advisory, LLC

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