IRS Notice 2026-40

Transitional guidance on Qualified Opportunity Zones under OZ 2.0: what fund managers and investors need to know now.

On June 18, 2026, the IRS issued Notice 2026-40. This Notice is transitional guidance ahead of forthcoming proposed regulations. It resolves several timing and compliance questions created by the OBBBA. The positions below are reliable for planning today. They are not yet final regulations, so you should confirm current guidance before acting.

• The December 31, 2026 recognition date stands. Legacy investors who hold a qualifying investment through that date must include their remaining deferred gain in income for the 2026 tax year. The OBBBA did not delay or eliminate this date. The recognized gain also cannot be deferred again, because the original election remains in effect.

• The 10-year exclusion survives the inclusion. Recognizing the 2026 gain does not cost an investor the back-end benefit. An investor who meets the 10-year holding period remains eligible for the fair market value step-up under Section 1400Z-2(c) on a later sale.

• Inclusion-event portions lose the step-up. Any portion of an investment that has triggered an inclusion event is no longer a qualifying investment. That portion cannot use the 10-year election. Funds should track these portions separately at the investor level.

• New 2027 investments follow more favorable rules. Eligible gains invested on or after January 1, 2027 use the rolling five-year deferral. The five-year basis step-up is 10 percent for a standard fund and 30 percent for a Qualified Rural Opportunity Fund.

• Property in older zones after 2026 needs a safe harbor. Property a fund acquires in a previously designated zone after December 31, 2026 generally cannot qualify as zone business property. Two exceptions apply: a written working capital plan adopted on or before December 31, 2026, and the ordinary course replacement or modernization of existing property. Expansion into new capacity does not qualify.

• A compliance bridge runs through 2047. A fund may continue to treat an expired older zone as a zone for the substantial use test and the QOZB income tests through December 31, 2047. This protects existing investments and preserves clean 10-year exits after a zone designation lapses.

  
  

The Bottom Line for QOFs and Investors

Legacy OZ 1.0 positions face a real cash-tax event for the 2026 tax year, with no required distribution from the fund to cover it. The long-term exclusion stays intact for investors who hold for ten years. Funds with in-progress projects in older zones should confirm that each post-2026 acquisition fits a working capital plan or the ordinary course replacement rule. OZXpro is tracking Notice 2026-40 and will reflect these positions in the platform as the proposed regulations issue.