New IRS opportunity zone guidance: Key transition rules for real estate industry - by Sandy Klein

As the Qualified Opportunity Zone (QOZ) program moves from the Original Opportunity Zone regime (QOZ 1.0) to the new framework beginning in 2027 (QOZ 2.0), a recently released notice from the IRS provides important transition guidance. While additional regulations are expected, the notice offers meaningful direction for developers, fund sponsors, and investors with existing projects.

The guidance in IRS Notice 2026-40 generally allows properly structured QOZ 1.0 projects to continue qualifying after 2026, including preserving the potential 10-year appreciation exclusion. However, relief is limited. Developers planning post-2026 acquisitions, expansions, or new phases in previously designated opportunity zones should carefully review the transition rules before proceeding.

Existing Projects Can Continue, but Future Acquisitions Face Limits
The notice confirms that investors can still contribute eligible gain to a QOF on or after Jan. 1, 2027, and receive Opportunity Zone benefits even if the project is located in a former QOZ 1.0 census tract. However, the underlying project must continue to satisfy the transition rules.

For tangible property acquired after Dec. 31, 2026, the rules become more restrictive. Because original QOZ 1.0 census tracts do not have an “applicable start date” under the new law, newly acquired property generally will not qualify as QOZ business property unless one of two transition exceptions applies.

Working Capital Safe Harbor Exception
Real estate projects already underway may continue acquiring qualifying property after 2026 if they adopted a written working capital safe harbor plan on or before Dec. 31, 2026. To qualify, the acquisitions must remain substantially consistent with the written plan, the QOZ business must have received at least 10% of the total planned working capital by year-end 2026, and at least 5% of the planned working capital must have been spent (or committed under a binding contract) by that date. These requirements reinforce that working capital plans must be contemporaneous, detailed, and supported by actual project activity, not prepared after the fact. 

Ordinary-Course Replacement Exception
The notice also permits post-2026 acquisitions of replacement property in the ordinary course of business. This relief covers items such as HVAC systems, windows, flooring, appliances, and similar replacements necessary to continue operating an existing property.

Importantly, this exception does not apply to business expansions or new development phases.

Investors Should Also Prepare for 2026 Gain Recognition
Notice 2026-40 confirms that deferred gains from pre-2027 QOF investments generally become taxable in the year including Dec. 31, 2026, and that this deemed inclusion cannot be rolled into a new opportunity zone deferral.

However, determining the amount of gain recognized is more complicated than many investors realize. Some taxpayers have focused solely on obtaining a lower fair market value appraisal of their QOF interest before year-end. In practice, the calculation requires applying the statutory “lesser of” test, and for partnerships and S corporations (which comprise many real estate QOF structures), the analysis generally is not a simple fair market value determination. Instead, the regulations require comparing the remaining deferred gain against the gain that would be recognized in a hypothetical fully taxable disposition of the QOF interest at fair market value. 

For many mature real estate funds, prior depreciation allocations and cash distributions may result in negative outside tax basis, causing the “lesser of” test to produce the full remaining deferred gain regardless of appraisal discounts. Conversely, newer funds that have not yet generated significant losses or distributions may see different results. As a result, investors should not assume that obtaining a valuation discount will reduce their 2026 tax liability; each fund requires its own facts-and-circumstances analysis. 

Planning Opportunities
Notice 2026-40 provides meaningful relief for existing projects but also creates new planning considerations.

Developers should:
• Review working capital safe harbor plans before year-end 2026. 
• Confirm future acquisitions qualify under one of the transition exceptions. 
• Evaluate phased developments and expansion projects before acquiring additional property. 
• Begin investor communications regarding the 2026 gain recognition event and potential cash flow implications. 

Early planning will be critical to preserving opportunity zone benefits as projects transition into the post-2026 framework.

Sandy Klein, CPA, is the managing partner of Katz, Sapper & Miller’s New York office, Manhattan, N.Y.