The Rolling Five-Year Deferral for Opportunity Zone (OZ) Investments After 2026

The statute now ties the inclusion date to your own investment date

Amended section 1400Z-2(b)(1) includes the deferred gain in the taxable year that includes the earlier of the date the investment is sold or exchanged or the date five years after the investment was made. Notice 2026-40, section 4.02(2), reads the regulations' inclusion event list into that rule, so the real trigger is the earliest of a sale, any other inclusion event, or the fifth anniversary. The amendments apply to amounts invested after December 31, 2026.

Section 1400Z-2(b)(2)(A) sets the amount included: the lesser of the deferred gain or the fair market value of the investment on the inclusion date, minus your basis in the investment. Basis starts at zero for the deferred portion and, under section 1400Z-2(b)(2)(B), increases by 10% of the deferred gain once the investment has been held five years, or 30% for an investment in a qualified rural opportunity fund. The seven-year increase in the old statute is gone.

Because the five-year date runs from each investment, an investor who funds two gains in different years has two inclusion dates. Form 8997, the annual investor statement, tracks each fund interest and each deferred gain separately, including whether it was short-term or long-term.

Inclusion events can pull the date forward: sales, gifts and distributions, but not death

Reg. section 1.1400Z2(b)-1(c) lists the inclusion events. A transfer of the fund interest by gift is one, regardless of whether it is a completed gift for federal gift tax purposes. A distribution from a fund taxed as a partnership is one to the extent the property distributed exceeds the partner's basis. A contribution of the interest to a partnership under section 721 generally is not, provided the regulation's conditions are met.

A transfer by reason of the taxpayer's death is not an inclusion event, but the deferral does not die with you. Paragraph (c)(4)(iii) of the regulation makes the deferred gain includible by the person who takes the interest under section 691(a)(1), that is, as income in respect of a decedent, and section 1014(c) denies a basis step-up to such items. A later sale by the estate, a trust or an heir is an inclusion event under paragraph (c)(4)(ii). That is a sharp contrast with real estate held outright, where the step-up at death ends a 1031 deferral for good, as swap till you drop planning explains.

Section 4.03 of Notice 2026-40 adds one wrinkle: gain triggered by an inclusion event can itself be deferred into a fund within 180 days of the event, but the portion of the original investment affected by the event stops being a qualifying investment and loses the ten-year election.

The December 31, 2026 cliff still applies to earlier money, and 2026 investing does not escape it

Prior section 1400Z-2(b)(1)(B) and Reg. section 1.1400Z2(b)-1(b) require gain deferred through a qualifying investment made on or before December 31, 2026 to be included in the taxable year that includes that date. Notice 2026-40, section 4.01, calls the result deemed included gain and states that it may not be deferred again under either the prior or the current statute, because the original election remains in effect.

The practical difference is stark. Fund a gain in December 2026 and the deferred gain is on your 2026 return, with whatever step-up you earned under the old schedule, which for a 2026 investment is none. Fund the same gain in January 2027 and nothing is included until 2032 at the latest, with a 10% or 30% reduction. Section 4.02(2) of the notice confirms that gain realized before December 31, 2026 qualifies for the new rule when the investment is made on or after January 1, 2027 inside the 180-day window.

Investors already in a fund keep the ten-year election after the 2026 inclusion. Section 4.01(3) of the notice says the investment remains a qualifying investment, so the fair market value basis election on a sale after year ten is still available, subject to the holding period and the other requirements.

A hypothetical $600,000 gain: the year-five tax and what the step-up is worth

Hypothetical, round numbers. You sell stock in October 2026 with a $600,000 long-term gain and invest $600,000 in a fund in March 2027, inside your 180 days. Nothing is included in 2026 or 2027. In March 2032 the five-year date arrives; basis rises by $60,000 and $540,000 is included, assuming the interest is then worth at least $600,000. At the 2026 top rate of 20% that is $108,000, plus $20,520 of net investment income tax if your income is over the $250,000 joint threshold, both at whatever the rates are in 2032.

Paying in 2027 instead would have cost $120,000 plus $22,800 of net investment income tax at the same rates. The step-up saves $12,000 of federal income tax outright and the deferral keeps roughly $140,000 working in the fund for five years. In a qualified rural opportunity fund the step-up is $180,000, the included gain $420,000 and the tax $84,000. Qualified rural opportunity funds explains that structure.

If the fund interest is worth less than $600,000 in March 2032, the included amount is the lower fair market value minus basis, so a fund that has lost value reduces the deferred-gain bill. Rates in 2032 may be higher or lower than 2026 rates. Run your own numbers with your CPA.

Planning around year five: cash, the ten-year hold and the alternatives

The fund does not have to distribute anything in year five, and most real estate funds are still holding property then, so the tax is paid from other assets. Ask the sponsor how it handles the year-five date before investing; QOF due diligence lists the questions. After inclusion the investment continues, and section 1400Z-2(c) lets you elect fair market value basis on a sale after ten years, capped at the thirtieth anniversary for post-2026 money, which the ten-year and thirty-year rules cover.

For a gain from real estate the comparison is different. A 1031 exchange defers the whole gain with no fifth-anniversary bill and reinvests the full sale price rather than the gain alone; 1031 versus an opportunity fund versus paying the tax and is a 1031 tax-free or deferred set out the trade. A DST can be the replacement property in that exchange. For a gain from a business or securities there is no exchange route, and the five-year deferral is what remains. Our opportunity zone fund page describes how we place clients in these funds.