The Qualified Opportunity Zone (QOZ) program is entering a pivotal transition period, with some legacy incentives expiring this year and a redesigned framework set to take effect next year. Whether investors participated in the first wave of QOZs or are evaluating the renewed possibilities, understanding how these changes affect tax outcomes, investment timelines and portfolio strategy could be more important than ever.
Let’s review the experience with QOZs so far, then break down what has changed and how that might impact investors looking to position themselves effectively.
What are QOZs, QOFs and their tax benefits?
The Tax Cuts and Jobs Act (TCJA) of 2017 established QOZs to encourage sustained investment in economically distressed communities. A key incentive to QOZ investors was the potential for tax deferral: By reinvesting capital gains on the sale of appreciated assets into a Qualified Opportunity Fund (QOF), an investor could defer the resulting tax liability until the QOZ investment was sold or December 31, 2026—whichever came first. Additionally, investors who held their QOF investments for at least five years received a 10% step-up in basis on the deferred gain, and those who held for at least seven years received a 15% step-up, effectively reducing the amount of gain recognized upon the expiration of the deferral period.
QOFs have functioned as mostly real estate investment entities that are required to hold at least 90% of their assets within designated QOZs. An additional incentive for investing in QOFs has been the potential exclusion from federal capital gains tax on any appreciation of the QOF investment itself, provided it’s held for a minimum of 10 years.
With the tax deferral period concluding on December 31, the appeal of QOFs for new investors has diminished. While earlier investors could take advantage of the full deferral period, new investments made at this point would be eligible for tax deferral only through the end of this year.
Consider the potential benefits of active tax management
How does the OBBBA impact QOZs?
Not only is the existing deferral window closing in 2026, the One Big Beautiful Bill Act (OBBBA) of 2025 is poised to significantly reshape the QOZ rules beginning in 2027. The OBBBA extends tax‑deferral opportunities while introducing new constraints and incentives—particularly for rural investments. In addition to making the QOZ program permanent, the OBBBA introduces several major changes for investments starting on or after January 1, 2027:
QOZs will be updated in July 2026 with stricter criteria for designation, then QOZs will redesignated every 10 years thereafter based on current census data.
Capital gains deferred through investment in a QOZ will be recognized on the fifth anniversary of the investment, rather than on a fixed date.
QOFs will continue to receive a 10% step-up in basis after five years, and the potential for exclusion from federal tax on QOF appreciation will remain available for investments held for at least 10 years. However, gain elimination is now limited to 30 years, at which point the basis step-up is frozen at the fair market value on the 30th anniversary of the investment.
The OBBBA introduces new Qualified Rural Opportunity Funds (QROFs), which are designed to encourage investment in rural communities. QROFs must hold their investments entirely in rural QOZs and will receive a more generous 30% step-up in basis after five years. QROFs will also be subject to lower requirements for “substantial improvement” than other QOZs.
What does this mean for investors?
For existing investors in QOZs, capital gain deferral will expire this December 31, which leaves less than a year to plan for the associated gain realization and the associated tax implications.
Starting in 2027, investors who missed the first wave of QOZ investing will get a second chance to defer capital gains by reinvesting those gains into a QOF. The renewed window could be especially useful for direct indexing investors whose portfolios have grown “locked-up” over time, with large unrealized gains and smaller opportunities for loss harvesting, as we’ve discussed before.
By intentionally realizing gains, an investor can reset their cost basis and then redirect those gains into a QOZ investment. That funding can come from outside the direct indexing account, or by withdrawing an amount equal to the realized gains and reinvesting the remaining proceeds. This strategy may also help bring accounts with high tracking error back in line with their benchmarks—particularly when those accounts hold highly appreciated securities originally transferred in from prior investments.
The bottom line
Investors navigating today’s shifting tax landscape may choose to pay close attention to the QOZ again, as this program that has quietly shaped capital gains planning for nearly a decade enters a materially different phase. As these shifts unfold, investors may find value in reassessing how QOZs could fit within their broader tax and allocation decisions in the years ahead.
Parametric and Morgan Stanley Investment Management do not provide legal, tax or accounting advice or services. Investors should consult with their own tax or legal advisors prior to entering into any transaction or strategy.
This is not a recommendation to invest in a Qualified Opportunity Fund. All investments are subject to risk, including the risk of loss. The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Parametric and its affiliates disclaim any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Parametric are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Parametric strategy. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Past performance is no guarantee of future results. All investments are subject to the risk of loss. Prospective investors should consult with a tax or legal advisor before making any investment decision. Please refer to the Disclosure page on our website for important information about investments and risks.
03.13.2028 | RO 5288398
