High-earning investors who placed realized capital gains into Qualified Opportunity Funds (QOFs) under the Opportunity Zones program will face a tax bill as the deferral period ends on December 31, 2026. The program, established by the Tax Cuts and Jobs Act of 2017, incentivizes investment in economically distressed areas designated by states and certified by the Treasury. Investors could defer taxes on prior gains until this deadline, and early participants also received step-ups in their basis, reducing taxable amounts.

As of the end of 2024, there were roughly 12,800 QOFs with about 41,000 investors, the majority of whom are individuals with an average adjusted gross income of $738,000. Early investors who moved their gains into these funds before year-end 2019 received a 15% basis step-up, while those who invested by the end of 2021 received a 10% step-up. Those who invested later get only the tax deferral benefit without additional step-up reductions, meaning they will owe taxes on 100% of their deferred gains once deferral ends.

While taxes on deferred gains will be due at the end of 2026, many investors are expected to keep their investments to benefit from the potential for tax-free gains if held for at least ten years. This long-term holding rule offers the largest tax incentive, making it unlikely for investors to cash out simply to cover tax liabilities. Some funds might even provide liquidity options or financing to help investors meet their tax obligations without selling.

Starting in 2027, the Opportunity Zones program will see changes as new zones are designated every ten years under permanent legislation enacted last year. Future investors will get a five-year deferral and a 10% basis step-up regardless of when they invest, offering more predictability. Additionally, investments in rural Opportunity Zones will gain an enhanced tax benefit, including a 30% step-up in basis after five years, further incentivizing capital flow to these areas.