For money invested in a Qualified Opportunity Fund after December 31, 2026, the deferred gain is taxed in the tax year that includes the earlier of a sale of the investment or its 5th anniversary, and holding the full 5 years raises basis by 10 percent of the deferred gain, or 30 percent in a Qualified Rural Opportunity Fund (Public Law 119-21, sec. 70421(c)(2)). As of October 2026, that rolling 5-year clock replaces the single December 31, 2026 date that governs older investments.
OZ 1.0 means investments made on or before December 31, 2026, and OZ 2.0 means investments made after that date. This page covers the deferral and step-up for OZ 2.0, contrasts OZ 1.0, and works the formula through a hypothetical. The separate 10-year exclusion is on the 10-year exclusion and 30-year cap.
- Inclusion
- Year of 5th anniversary
- Standard step-up
- 10% of deferred gain
- Rural step-up
- 30% of deferred gain
- Applies to
- Amounts invested after Dec 31, 2026
The rule in the amended statute
Amended section 1400Z-2(b)(1) says gain deferred under subsection (a) "shall be included in gross income in the taxable year which includes the earlier of" two dates: the date the investment is sold or exchanged, or the date 5 years after the investment in the fund was made. Notice 2026-40 sec. 4.02(2) adds a third trigger for investments made on or after January 1, 2027: an inclusion event other than a sale or exchange, such as a gift. See inclusion events.
Each investment runs on its own clock. An investor who invests in March 2027 and again in October 2028 has two inclusion years, 2032 and 2033 for a calendar-year taxpayer. The timing rule taxes the gain in the tax year that includes the anniversary, not on the anniversary itself, so the tax is reported with that year's return.
How much is included: the lesser-of formula
Amended section 1400Z-2(b)(2)(A) sets the included amount as the excess of the lesser of the deferred gain or the fair market value of the investment on the inclusion date, over the taxpayer's basis in the investment. Written as a formula:
Included gain = lesser of (deferred gain, fair market value on inclusion date) minus basis
Basis starts at zero (section 1400Z-2(b)(2)(B)(i)). If the investment is held at least 5 years, basis rises by 10 percent of the deferred gain, or 30 percent for an investment in a Qualified Rural Opportunity Fund (section 1400Z-2(b)(2)(B)(iii)(I)). The statute treats that increase as occurring before the 5-year inclusion date (clause (iii)(II)), so the step-up reduces the gain taxed at year 5.
After inclusion, basis rises again by the amount of gain recognized (clause (ii)). That matters for the 10-year exclusion and for any later sale that does not use it.
The fair market value limb protects investors whose fund loses value. If the investment is worth less than the deferred gain on the inclusion date, only the lower value, minus basis, is included.
Deferred gain keeps its original character when included, and is taxed under the rates for that inclusion year (26 CFR 1.1400Z2(a)-1(c)(1)). A deferred short-term gain is included as short-term gain.
Worked hypothetical
Hypothetical example
Suppose a calendar-year individual realizes a $1,000,000 long-term capital gain and invests $1,000,000 in a QOF on March 15, 2027, electing to defer the whole gain. The 5th anniversary is March 15, 2032, so the deferred gain is included on the 2032 return. Four cases:
- Standard fund, value up to $1,400,000. Basis after the step-up is $100,000 (10 percent of $1,000,000). Lesser of $1,000,000 and $1,400,000 is $1,000,000. Included gain: $1,000,000 minus $100,000 = $900,000.
- Standard fund, value down to $700,000. Basis is $100,000. Lesser of $1,000,000 and $700,000 is $700,000. Included gain: $700,000 minus $100,000 = $600,000.
- Rural fund, value up to $1,400,000. Basis after the 30 percent step-up is $300,000. Included gain: $1,000,000 minus $300,000 = $700,000.
- Rural fund, value down to $700,000. Basis is $300,000. Included gain: $700,000 minus $300,000 = $400,000.
At an assumed flat 20 percent rate, the standard-fund, value-up case owes $180,000 on the 2032 return instead of $200,000 on the 2027 return, and pays it five years later. In the first case, basis after inclusion is $1,000,000 ($100,000 step-up plus $900,000 recognized). Rates and values are assumptions for illustration, not projections.
If the same investor sold the QOF interest in 2030, before the 5-year mark, the deferral would end in 2030 and no step-up would apply, because the step-up requires a 5-year hold.
The 30 percent rural step-up
The larger step-up requires an investment in a Qualified Rural Opportunity Fund: a QOF that holds at least 90 percent of its assets in Opportunity Zone property whose use, or whose business, is in a zone made up entirely of rural area (section 1400Z-2(b)(2)(C)(i)). Fund assets are measured under rules similar to the semiannual 90 percent test. A rural area is any area other than a city or town with more than 50,000 people and any urbanized area contiguous and adjacent to such a city or town.
The 30 percent step-up applies only to amounts invested after December 31, 2026 (sec. 70421(c)(5)(A)). The statute does not say how a fund that drops below the rural threshold on one test date affects the step-up, and no guidance addresses it yet. See rural Opportunity Zones for how rural zones are identified.
How OZ 1.0 differs: one fixed date
For investments made on or before December 31, 2026, deferred gain must be included no later than the tax year that includes December 31, 2026 (Notice 2026-40, sec. 4.01(1)). Every OZ 1.0 investor shares that date, no matter when they invested. The same lesser-of formula applies.
The OZ 1.0 step-ups were 10 percent after 5 years and another 5 percent after 7 years, measured before the 2026 inclusion date (prior section 1400Z-2(b)(2)(B)(iii)-(iv)). OZ 2.0 has no 7-year step-up.
| Rule | OZ 1.0 (invested through Dec 31, 2026) | OZ 2.0 (invested after Dec 31, 2026) |
|---|---|---|
| Latest inclusion | Tax year that includes December 31, 2026 | Tax year that includes the 5th anniversary of the investment |
| Early inclusion | Inclusion event before that date | Sale, exchange or other inclusion event before the 5th anniversary |
| Step-up | 10% at 5 years, 15% at 7 years | 10% at 5 years, or 30% in a Qualified Rural Opportunity Fund |
| Amount included | Lesser of deferred gain or FMV, minus basis | Lesser of deferred gain or FMV, minus basis |
OZ 1.0 investors who recognize gain on December 31, 2026 keep their QOF interest and can still make the 10-year election on a later sale (Notice 2026-40, sec. 4.01(3)). The 2026 inclusion calculator estimates that bill, and the December 31, 2026 gain inclusion explains it.
State taxes may not follow
The step-up and deferral are federal. Some states do not follow them: North Carolina requires adding back deferred gain in the year of deferral, and California's Franchise Tax Board stated in 2019 that California does not conform. Check state tax conformity before relying on a state-level deferral.
This page explains how the rules work. It is not tax or investment advice, and the hypothetical figures are not projections. A tax adviser can model the timing for a specific gain.
Common questions
When is deferred Opportunity Zone gain taxed under OZ 2.0?
For amounts invested after December 31, 2026, deferred gain is included in income in the tax year that includes the earlier of the date the investment is sold or exchanged or the date 5 years after the investment was made. Notice 2026-40 adds that an inclusion event other than a sale also ends the deferral early.
How much deferred gain is taxed at the 5-year mark?
The smaller of the deferred gain or the investment's fair market value on the inclusion date, minus the investor's basis in the investment. Basis starts at zero and rises by 10 percent of the deferred gain (30 percent in a Qualified Rural Opportunity Fund) if the investment is held 5 years.
Is there still a 15 percent step-up for holding 7 years?
No. The extra 5 percent at 7 years existed only under the 2017 rules. OZ 2.0 has a single step-up at 5 years: 10 percent, or 30 percent for a Qualified Rural Opportunity Fund.
What is a Qualified Rural Opportunity Fund?
A Qualified Opportunity Fund that holds at least 90 percent of its assets in Opportunity Zone property used in, or businesses operating in, zones made up entirely of rural areas, measured under rules similar to the semiannual 90 percent test. Only investments in such a fund get the 30 percent step-up.
Do I lose the step-up if I sell before 5 years?
Yes. The step-up applies only to an investment held at least 5 years. A sale before then triggers inclusion of the deferred gain in that year with no basis increase.