Including Bonus Depreciation Enhancements and Key Legislative Changes

Blake Christian, HCVT Tax Partner

May 13, 2025

Opportunity Zone Program 1.0 (2017-2026)

The Opportunity Zone (OZ) program, introduced under the Tax Cuts and Jobs Act of 2017, was designed to encourage economic development and job creation in distressed communities through significant tax incentives. Investors can defer and potentially eliminate capital gains taxes by investing in Qualified Opportunity Funds (QOFs). The OZ Program legislation was actually crafted under the Obama Administration and has been sponsored and supported by both Democrats and Republicans; however, the Biden Administration effectively ignored the OZ program during his term.  Since its inception, the program has evolved considerably, with legislative updates refining its application.

The OZ Program was designed, with input from a variety of billionaires, economic development experts and creative legislators.  The objectives of the program include: 1) Attracting funds into one of the over 8,700 underserved communities where poverty levels and unemployment are above average. 2) Encourage taxpayers with a large concentration of assets to liquidate all or a portion of those assets, thereby triggering a tax gain that can be deferred (for federal and the vast majority of states) for a period of time if timely reinvested into a Qualified Opportunity Zone Fund (QOF).   3) Rewarding long-term investors with tax-free gains on exit for federal (and the vast majority of states) provided the taxpayer follows the relatively flexible OZ Program guidelines and reinvests the capital gains into a real estate project or operating business within one or more of the 8,764 current OZ federal census tracts.  Every state (including those not adopting the program) has OZ census tract eligible for OZ investing.  The higher the population the more OZ census tracts.  Therefore, California, Florida and New York have the largest number of OZ-eligible census tracts. To explore where these tracts are located, you can view the National Opportunity Zone Map provided by Novogradac. 

May 2025 Draft Ways & Means OZ 2.0 Legislation

The House introduced their first draft of OZ 2.0 legislation on May 12, 2025, and the House Ways & Means Committee will be evaluating the draft and will undoubtedly be making changes.  In summary, the OZ legislative proposal winds down the current OZ program after 2026 and the OZ 2.0 will become effective January 1, 2027 – with new census tracts designated (including a focus on rural census tracts), re-introduction of the 5-year 10% basis increase, eligibility to utilize up to $10,000 annually of ordinary income to fund a QOF, additional OZ Fund reporting and other fine-tuning.  The current proposal does not include many proposals advanced by the OZ community, but the general extension and expansion of the program is a major step for Congress and the OZ Program.

1. Full Bonus Depreciation Reinstated for QOF Assets

While not part of the OZ legislation, the House has also introduced improved Bonus Depreciation, which is helpful for OZ Investors.  Starting on page 184 of the bill, full bonus depreciation (100%) is reinstated for assets placed in service in tax years beginning after December 31, 2024.

• Section 179 expense increased from $1 million to $2.5 million.
• Property acquisition limit increased from $2.5 million to $4 million. This benefits both QOF direct investments and QOZBs acquiring eligible tangible property.

2. Expanded Opportunity Zone Designations – Round Two

A new round of OZ designations will allow states to nominate additional tracts, prioritizing rural areas:

• New designations effective from January 1, 2027, through December 31, 2033.
• Contiguous tracts are not eligible under this new wave.
• Designation authority rests with state governors, with federal oversight and limitations on total designations.
• A minimum of 33% of new census tracts must be designated as rural.

3. “Substantial Improvement” Test Relaxed for Rural QOF Projects

To spur investment in rural zones, the substantial improvement requirement for building improvements is reduced from 100% to 50%.

• Especially impactful for multi-family and light commercial rehabs, where capex needs were previously a barrier to qualification.

4. Redefined “Low-Income Community” Standards

Section 1400Z-1(c)(1) is amended to broaden qualifying areas:

• Changes the threshold in IRC §45D(e)(1)(B) from 80% to 70% of median family income relative to the surrounding area.
• With a more restrictive modification to the definition of "low-income community," it is projected that the number of overall census tracts may decrease by 25% or more.
• Excludes certain “adjacent” higher-income census tracts that previously qualified, tightening the program’s focus.

5. New $10,000 QOF Eligibility for Ordinary Income

Opportunity Zones 2.0 permits up to $10,000 in ordinary income per taxpayer (lifetime limit) to be sheltered via investment into a QOF.

• Previously, limited to capital gains only, this opens the door for broader participation, particularly among middle-income investors and wage earners.
• The 10% basis increase after 5 years is not applicable to Ordinary Income investors, but federal tax-exemption after a 10-year hold is allowed.

6. 10% and 30% Basis Step-Ups Restored and Expanded

The original 10% basis increase (for 5-year investments) is reinstated for contributions made after 2026 and before 2034. The OZ 1.0 15% basis adjustment for the 7-year hold period has not been brought back in the House version.

• An enhanced 30% basis step-up applies for qualifying rural OZ investments, improving exit economics.
• This rewards longer-term rural investors and partially offsets the capital gain inclusion.

7. Extension of Gain Deferral Period to 2033

Investments made in the new round of zones after December 31, 2026, will defer recognition of the original capital gains until December 31, 2033.

• The prior deferral deadline was December 31, 2026 under current OZ 1.0.
• Allows planning flexibility for both investors and fund managers under the extended investment window.

8. Winding Down of Initial OZ Designations

The original 2017 OZ census tracts remain in effect only through December 31, 2026, unless renewed or supplemented.

• This means investors must act quickly to take advantage of the initial zones before the cutoff date.
• Some “transition” rules may apply for active investments already in place.

9. Strict New Disclosure and Compliance Requirements

Opportunity Zones 2.0 introduces tougher penalties and expanded disclosures for QOFs and QOZBs:

• Enhanced reporting of social and economic outcomes.
• Failure to comply may result in stiff penalties, disqualification, or audit scrutiny.
• Likely includes electronic filings, annual statements, and beneficiary impact reporting.

10. Election Mechanics Clarified for New Designations

Section 1400Z-2(a)(2)(B) has been updated to allow for proper election treatment for contributions made into newly designated zones.

• Investors may now make separate elections depending on whether contributions are made pre-2027 or post-2026, aligning with the dual-zone framework.
• Critical for structuring tiered or staggered investments across both designation periods.