When Congress introduced the Qualified Opportunity Zone (QOZ) program in 2017, it created a powerful incentive: investors could defer capital gains by reinvesting them into Qualified Opportunity Funds (QOFs). For many, this meant putting capital to work in underserved communities while managing near-term tax liabilities.Â
But with December 31, 2026, approaching, investors must plan carefully. On that date, any previously deferred gains become taxable—unless the investment is sold or disposed of earlier. Understanding how your QOF’s value at year-end could affect your tax bill is critical, especially if your investment hasn’t performed as expected.Â
Key Rule: What You'll Recognize in 2026
On December 31, 2026, the tax law requires you to recognize the lesser of:Â
- Your original deferred gain, orÂ
- The fair market value (FMV) of your QOF investment on that date, minus any basis you’ve accrued.Â
This means if your QOF investment has lost value, you could recognize less gain than originally deferred. However, if the investment has appreciated, you could still owe tax on the full deferred amount (less basis adjustments).Â
Understanding Basis Adjustment
By default, your initial tax basis in a QOF investment is zero. But depending on how long you’ve held the investment, you may be eligible for basis increases:Â
- 10% step-up: For investments held at least 5 years by the end of 2026.Â
- 15% step-up: For investments held at least 7 years—only available to those who invested by the end of 2019.Â
These adjustments directly reduce the gain you’ll recognize. For example, if you deferred $1,000,000 and are eligible for a 10% step-up, your recognized gain is capped at $900,000—assuming the FMV supports that.Â
When the FMV Works in Your Favor
If your QOF investment has declined in value, you may benefit further. Consider this scenario:Â
- Original gain deferred: $1,000,000Â
- FMV on 12/31/2026: $750,000Â
- Basis (with 10% step-up): $100,000Â
- Recognized gain: $750,000 – $100,000 = $650,000Â
Valuation Matters—and Documentation Is Key
Supporting a reduced FMV requires formal documentation. The IRS expects appraisals, valuation reports, or relevant market comparables—not informal estimates like Zillow. Consider engaging a valuation specialist to assess both the underlying assets and your specific ownership interest in the Fund. Discounts may apply for lack of marketability or minority ownership—further reducing FMV.Â
Next Steps: Proactive Planning for 2026
As the recognition date approaches, consider these actions:Â
- Confirm your eligibility for basis step-ups.Â
- Monitor your QOF’s fair market value regularly.Â
- Collect valuation documentation early.Â
- Plan for liquidity needs for the April 2027 tax payment.Â
Act Now to Optimize Your Outcome
The tax deferral benefits of the original Opportunity Zone investments will soon expire. But with clear planning, you can take control of your QOF tax outcome. For help evaluating your investment and preparing for the 2026 recognition event, the Aldrich team is here to support you.Â
