Opportunity Zone Funds

By Jerry Baker · Founder & Managing Principal, Baker 1031 Investments · Reviewed September 8, 2026

Funds investing in designated Opportunity Zones, with potential tax incentives for eligible gains and a longer horizon.

Read this first, because the law changed and most published material has not caught up. There are two Opportunity Zone regimes running at once, and the dividing line is the date your money goes into the fund — not the date you realised the gain. Money invested on or before December 31, 2026 falls under the old rules, which means the deferred gain is recognised on your 2026 return and no basis step-up is available. The deferral benefit for new investors resumes January 1, 2027, in zones designated to take effect that same day. Anyone telling you today that a QOF will defer your gain for years is describing a regime that, for a 2026 investment, no longer applies.

Basic overview

Opportunity Zones are a capital-gains incentive, not a real estate structure. You take a capital gain from selling anything — a business, stock, a painting, real estate — and invest an amount equal to that gain into a Qualified Opportunity Fund within 180 days. The gain is deferred. Hold the fund investment ten years and the appreciation inside the fund can be excluded from tax entirely.

Note what that is not. It is not a 1031 exchange, it does not require real property on either end, and it does not defer your gain forever. The deferred gain comes back at a statutory inclusion date. Only the new appreciation is potentially excluded.

What changed in 2025, and what applies right now

The One Big Beautiful Bill Act (Pub. L. 119-21, enacted July 4, 2025) rewrote the programme in §70421. The effective-date clause is the sentence that matters: the amendments "shall apply to amounts invested in qualified opportunity funds after December 31, 2026."

	Invested on or before Dec 31, 2026	Invested on or after Jan 1, 2027
Deferral ends	December 31, 2026 — recognised on your 2026 return	Five years after the investment is made
Basis step-up on deferred gain	None available — the 5-year tier required investing by 2021, the 7-year tier by 2019	10% at five years; 30% for a qualified rural opportunity fund
7-year tier	Expired	Does not exist — repealed
10-year exclusion	Still available; regulation sets an outer limit of Dec 31, 2047	Available, but fair market value is frozen at the 30-year mark
Which zones	2018-vintage zones (expire Dec 31, 2028; Puerto Rico Dec 31, 2027)	Newly designated zones, effective Jan 1, 2027 through Dec 31, 2036

The IRS confirmed the transition in Notice 2026-40: taxpayers holding a qualifying investment "through December 31, 2026, are required to include in income in the taxable year that includes that date the amount of remaining deferred gain," and that deemed included gain "may not be deferred" again. The same notice confirms that a gain realised on, before or after December 31, 2026 can be deferred if the investment is made on or after January 1, 2027, with inclusion five years later.

There is a second dividing line, on the property rather than the money. Notice 2026-40 states that property acquired by a fund or business after December 31, 2026 "cannot be QOZBP unless the property is acquired for use in a QOZ that is designated after July 4, 2025," subject to narrow exceptions for pre-2027 working-capital plans already substantially funded and for ordinary-course replacement property.

A caution on sources. The IRS's own Opportunity Zones FAQ page, reviewed as recently as July 2026, still describes only the pre-2025 rules including the flat December 31, 2026 inclusion date. It is not wrong about the old regime; it simply has not been updated for the new one. Read it alongside Notice 2026-40, not instead of it.

What you are investing in

A Qualified Opportunity Fund — "any investment vehicle which is organized as a corporation or a partnership for the purpose of investing in qualified opportunity zone property" (§1400Z-2(d)(1)), which must hold at least 90% of its assets in qualifying property, tested twice a year. A single-member LLC cannot be a QOF, because it is disregarded rather than classified as a corporation or partnership.

In practice most funds use a two-tier structure: the QOF owns an interest in a qualified opportunity zone business, which need only meet a 70% tangible property standard and can use the 31-month working capital safe harbour to hold cash while it builds (Treas. Reg. §1.1400Z2(d)-1(d)(3)(v), extendable to 62 months for a start-up). Most real estate QOFs are ground-up development or substantial rehabilitation, because acquired property generally has to be substantially improved.

What you actually own

An equity interest in the fund — partnership units or corporate stock. Not real property, and not a security you can sell into a market. The QOF interest is what the ten-year clock runs on, so any transfer, redemption or restructuring that counts as an "inclusion event" can forfeit the exclusion for that portion of your investment.

What your responsibilities are

Invest within 180 days of the date the gain would be recognised (§1400Z-2(a)(1)(A)). Partners and S corporation shareholders get alternative starting dates.
Invest only the gain. Anything beyond the gain amount is a separate, non-qualifying investment under the mixed-funds rule (§1400Z-2(e)(1)), and it does not get the benefits.
File Form 8997 every year you hold a QOF investment, with a timely filed return including extensions (Form 8997). This is not optional and it is separate from the fund's own filing.
Have cash for the inclusion date. The deferred gain becomes taxable while your money is still locked in the fund. The fund does not distribute cash to pay it.
Avoid inclusion events. Many ordinary partnership transactions qualify. Ask before doing anything with the interest.

Who manages it, and what they are on the hook for

The fund sponsor: sourcing, building, operating and eventually selling. They also carry compliance obligations that got materially heavier in 2025. Funds self-certify on Form 8996 and now face a new annual information return under §6039K covering assets, census tracts, owned and leased property values, residential unit counts, employee counts, and every investor disposition — with penalties under §6726 of "$500 for each day during which such failure continues," capped at $10,000 per return, $50,000 for funds over $10 million in gross assets, and up to $250,000 for intentional disregard.

That regime took effect for tax years beginning after July 4, 2025. It is worth asking a sponsor how they are handling it; the answer tells you something about the operation.

Does this qualify for a 1031 exchange?

No, and the framing is the wrong way round. These are alternative treatments of a gain, not complementary ones. You cannot 1031 into a QOF, and a QOF investment is not replacement property.

	§1031 exchange	Opportunity Zone fund
What qualifies	Real property only, held for business or investment	Any capital gain, or qualified §1231 gain, from a sale to an unrelated person
How much to reinvest	Entire proceeds, including debt relief, to fully defer	Only the gain
Clocks	45 days to identify, 180 days to close	180 days to invest; no identification requirement
Depreciation recapture	Deferred through carryover basis	Not deferred — §1245 and §1250 recapture is ordinary income, taxable in the year of sale
Related-party limit	50% relatedness	20% relatedness — stricter
What you end up owning	Real property, or a DST interest treated as real property	An equity interest in a fund entity

That recapture row deserves emphasis, because it is the most expensive misunderstanding in this area. Under Treas. Reg. §1.1400Z2(a)-1(b)(11)(iii)(A) a §1231 gain is qualified only "to the extent that it exceeds any amount … treated as ordinary income under section 1245 or section 1250." A depreciated rental property sold into a QOF strategy generates a recapture bill in the year of sale that no deferral touches.

Who invests in this

Someone with a large gain from something that is not real property — a business sale, concentrated stock, crypto — where §1031 was never available.
Someone who missed a 1031 deadline and has a gain looking for a home within 180 days.
Someone who wants only to reinvest the gain and keep their basis liquid, which a 1031 exchange does not permit.
Someone with a genuine ten-year horizon, for whom the exclusion of appreciation — not the deferral — is the point.
From January 1, 2027: someone who wants the deferral, now with a five-year clock and a 10% step-up, or 30% in a rural fund.

Who does not

Anyone whose gain is from real property and who can complete a 1031 exchange. An exchange defers recapture; a QOF does not.
Anyone investing in the remainder of 2026 for deferral. There is none left; the gain is recognised on the 2026 return. Investing now buys the ten-year exclusion only.
Anyone who will not have cash to pay the inclusion-date tax out of other resources.
Anyone who needs the money inside ten years. The benefit that survives is a ten-year hold, and most funds have no redemption mechanism at all.
Anyone attracted primarily by the tax break. A tax incentive does not fix a bad development deal, and the incentive is worth nothing on a project that loses money.

What to expect as an investor

A K-1 rather than a 1099. Little or no distribution in early years — most of these are development projects, and construction does not pay distributions. A ten-year-plus hold, with an inclusion-date tax bill along the way. Little liquidity: these are Regulation D private placements with no market, and the SEC and NASAA have said plainly that interests in a QOF "will typically constitute securities."

The risks

Regime risk, right now. Two sets of rules, an unamended body of regulations still written against the old one, and proposed regulations that Treasury has said are coming but had not been published as of early September 2026. Some questions do not currently have clean answers.
Zone risk. The 2018-vintage designations expire December 31, 2028, and property acquired for them after 2026 generally cannot qualify. The 2027 zone list did not exist yet as of this writing — nominations were still open.
Development risk. Ground-up construction, entitlement, cost overruns, lease-up. This is the highest-execution-risk category on this site.
Location risk. These are, by definition, low-income census tracts. Some are genuinely on the way up. Some are not.
Compliance risk. A fund that fails the 90% test owes a monthly penalty, and a business that fails its tests can taint the fund's status.
Illiquidity. Ten years, no market, and any exit may itself be an inclusion event.
Fraud risk. Documented, not theoretical — see below.

The worst case

Two ways this goes badly, and they can happen together.

The ordinary one: the project fails, your fund interest is worth little or nothing, and the ten-year exclusion is worthless because there is no appreciation to exclude. Meanwhile you still owed tax on the deferred gain at the inclusion date, paid from other money. You lose the investment and you paid the tax you were trying to defer.

The other one: the SEC has brought fraud cases in this space. In SEC v. Burrell and Activated Capital, LLC (Litigation Release 25263, November 2021), the Commission alleged the defendant raised approximately $6.3 million for Opportunity Zone investments and "misappropriated investor money by using it to purchase properties in the name of entities that were not owned by the investors or the funds," along with misrepresenting an outside custodian and the principals' own investment. A tax incentive that requires a ten-year hold with no interim liquidity is an attractive setting for that kind of conduct, which is why sponsor diligence matters more here than almost anywhere else.

The best case

You invest a gain that had no other shelter, the development is completed and stabilised, and after ten years you elect under §1400Z-2(c) to treat your basis as fair market value on sale — so the appreciation is excluded from federal tax entirely. You paid tax on the original deferred gain at the inclusion date and nothing on the growth. For a large gain in a project that works, that is a materially better outcome than any other treatment available.

For a post-2026 investment, add a 10% step-up at five years, or 30% in a qualified rural opportunity fund — and note that the rural substantial-improvement threshold dropped from 100% of basis to 50%, effective July 4, 2025, which changes the arithmetic on rural rehabilitation.

The investment process

Establish the gain — amount, character, and the date the 180-day clock starts. Recapture is not eligible; segregate it early.
Decide the regime. Investing before year-end 2026 versus on or after January 1, 2027 produces materially different outcomes from the same gain. If the 180-day window straddles the year end, this is a live planning choice, not a formality.
Diligence the fund — sponsor, project, capital stack, and compliance operation.
Subscribe under Regulation D, with accreditation verification.
Invest the gain amount within 180 days. Keep basis dollars out unless you intend a non-qualifying investment.
File Form 8997 with that year's return, and every year after.
Pay the inclusion-date tax from other resources.
Hold to ten years, avoiding inclusion events.
Elect under §1400Z-2(c) on disposition.

How to review one of these

Which regime does this fund expect its investors to be in? A sponsor still marketing "deferral to 2026" for money going in this month is either behind on the law or hoping you are.
Which zone, and what vintage? 2018-designated, expiring 2028? Or contingent on a 2027 designation that has not been made yet?
The project on its own merits. Would you invest without the tax benefit? If not, the tax benefit is not the reason to.
The 90% and 70% testing plan, and whether the working capital safe harbour is properly documented — the regulation requires a written designation and a written schedule.
Who holds the money, and who verifies it. Custody is the fraud vector.
The sponsor's §6039K readiness.
Exit mechanics at year ten, and whether the fund's own plan preserves your election.
Whether anyone has modelled your inclusion-date cash need. If the sponsor has not raised it, raise it yourself.

Frequently asked questions

If I invest in a QOF this month, when does my deferred gain become taxable?

On your 2026 return. Under the pre-2025 rules, which still govern amounts invested on or before December 31, 2026, the inclusion date is December 31, 2026 — and Notice 2026-40 confirms that gain cannot then be deferred again. For a 2026 investment the deferral benefit is effectively already spent.

So is there any reason to invest before year end?

The ten-year exclusion under §1400Z-2(c) still applies to a 2026 investment, and that is the larger benefit in most models anyway. But it should be the stated reason, not a deferral pitch. If deferral matters to you and your 180-day window allows it, investing on or after January 1, 2027 is a different and probably better answer.

Can I still get the 10% or 15% basis step-up?

Not on a 2026 investment. The 10% tier required five years before December 31, 2026 — so investing by 2021 — and the 15% tier required seven years. Under the new regime a 10% step-up returns at five years for post-2026 investments, and 30% for a qualified rural opportunity fund. The 7-year tier was repealed.

Is the Opportunity Zone programme expiring?

No. It was made permanent in 2025 — the sunset clause was repealed outright — with rolling decennial zone designations. What expires are the specific 2018-vintage zones, on December 31, 2028 (Puerto Rico, December 31, 2027).

Can I use an Opportunity Zone fund instead of a 1031 exchange?

You can, but understand what you give up. A 1031 exchange defers depreciation recapture; a QOF does not — §1245 and §1250 recapture is ordinary income taxable in the year of sale. On a long-held, heavily depreciated rental property, that difference alone can decide the question.

Do I have to reinvest all my sale proceeds?

No, and this is a genuine advantage over a 1031 exchange. Only an amount equal to the gain needs to go into the fund. Your basis stays yours. Investing more than the gain creates a non-qualifying portion under the mixed-funds rule that gets none of the benefits.

What happens if I need to sell before ten years?

You lose the exclusion for the portion disposed of, and most funds have no redemption mechanism in any case. Ten years is the plan, not the maximum.

Are the 2027 Opportunity Zones known yet?

Not as of this writing. Treasury published the eligible tract list in April 2026 — 25,332 low-income communities, of which 8,334 are entirely rural — and governors' nominations run to late September or October 2026, with Treasury certification by late November or December. The zones then take effect January 1, 2027. Any fund naming its 2027 zones today is anticipating, not reporting.

Is there SEC or FINRA guidance on Opportunity Zone funds?

There is a joint SEC staff and NASAA statement from July 2019 on the securities-law issues, which says interests in a QOF "will typically constitute securities" and walks through Regulation D, broker registration and Investment Company Act questions. There is no FINRA rule or notice specific to Opportunity Zones. And no regulator approves individual funds.

What reporting do I have to do?

Form 8997 every year you hold a QOF investment, filed with a timely return including extensions, showing beginning holdings, current-year deferrals, dispositions and ending holdings. The fund files Form 8996 and, for tax years beginning after July 4, 2025, a new annual information return under §6039K with day-count penalties for failure.

Sources

Every statement of law on this page traces to one of these. They are primary sources -- the Code, the regulations, the rulings, and the regulators’ own investor guidance -- rather than industry summaries of them.

Gerald F. “Jerry” Baker, III — Founder & Managing Principal, Baker 1031 Investments · FINRA Series 22 / 63 · SIE. Read full bio →

This page is educational and is not investment, tax, or legal advice, an offer to sell, or a solicitation of an offer to buy any security. Structures described here are general and vary by offering; the terms that govern any particular investment are in that offering’s private placement memorandum. Offerings are available only to accredited investors. Securities offered through Aurora Securities, Inc., member FINRA/SIPC. Baker 1031 Investments, LLC is independent of Aurora Securities, Inc. Real estate and other alternative investments involve risk, including possible loss of principal. Baker 1031 Investments is not a tax or legal advisor; consult your own CPA and attorney about your circumstances.

Opportunity Zone Funds for Investors With Capital Gains