IRS Notice 2026-40 and the Transition to Opportunity Zones 2.0: A Guide for Investors

Updated July 2026 • Educational resource from Urban Catalyst

As the Opportunity Zone program approaches its scheduled December 31, 2026 gain recognition date, investors and fund sponsors have been waiting for the IRS to explain how the original program will hand off to the new, permanent program created by the One Big Beautiful Bill Act (OBBBA) in July 2025. Notice 2026-40 is that explanation. This guide provides a general overview of what the Notice says and the topics investors may want to discuss with their tax advisors before year end.

Urban Catalyst does not provide tax, legal, or financial advice. The information below is general and educational in nature. Every investor’s situation is different. Please consult your own tax professional regarding your specific circumstances.

What Notice 2026-40 Is

The OBBBA made the Opportunity Zone program a permanent feature of the tax code, with new zone designations beginning January 1, 2027 and a revised set of investor benefits. What the legislation did not fully address was the interaction between the original program and the new one: questions such as whether gains recognized in 2026 could be reinvested, and whether existing projects could continue accepting capital. The IRS released Notice 2026-40 on June 18, 2026 to fill that gap, alongside an announcement that formal proposed regulations are forthcoming.

Because the Notice is transitional guidance rather than final regulation, the provisions described below may be modified before the rules are finalized.

The December 31, 2026 Gain Generally Cannot Be Re-Deferred

Many practitioners had asked whether the deferred gain recognized on December 31, 2026, sometimes called the “deemed included gain,” could be rolled into a new QOF investment and deferred again. The Notice confirms that the answer is generally no. Because the original deferral election remains in effect, the deemed included gain is not treated as eligible gain for a second deferral election.

For a general overview of how the 2026 recognition event works, including how the recognized amount is generally calculated, see our December 31, 2026 Opportunity Zone Tax Deadline Guide.

The 10-Year Benefit Generally Continues

The Notice also confirms a point many investors have asked about: recognizing deferred gain in 2026 generally does not end an investor’s Opportunity Zone benefits. A taxpayer who recognizes the deemed included gain on December 31, 2026 and continues to hold the QOF investment may still be eligible for the election under Section 1400Z-2(c), the potential exclusion of appreciation from gross income, upon a later sale, provided the 10-year holding period and other applicable requirements are satisfied.

Pre-2027 Gains May Qualify for OZ 2.0 Deferral

One of the most significant clarifications in the Notice: eligible gains realized before, on, or after December 31, 2026 may qualify for deferral if invested in a QOF on or after January 1, 2027, within the applicable 180-day investment period. Commentators have noted this could include certain late-2026 asset sales, K-1-reported gains from partnerships and S corporations (where owners may elect a 180-day period extending into 2027), certain installment sale gains, and Section 1231 gains. Whether a particular gain qualifies depends on individual facts and should be reviewed with a tax advisor.

Investments made after December 31, 2026 fall under the OZ 2.0 framework, which differs from the original program in several respects:

Feature	OZ 1.0 (original program)	OZ 2.0 (post-2026 investments)
Deferral period	Until sale, inclusion event, or December 31, 2026	Generally until sale, inclusion event, or 5 years after investment
Basis step-up on deferred gain	Up to 10% or 15% (holding-period dependent; no longer available for new investments)	Generally 10% after 5 years; 30% for qualified rural opportunity funds
Potential 10-year appreciation benefit	Available, subject to program rules	Available, subject to program rules
Zone designations	Expire December 31, 2028 (December 31, 2027 for Puerto Rico)	January 1, 2027 to December 31, 2036, with new designations every 10 years

Under the new framework, the five-year deferral period generally relates back to the date of each investment. An investor making a qualifying investment on May 1, 2027, for example, would generally recognize the deferred gain on May 1, 2032, absent an earlier sale or inclusion event.

New Rules for Adding Capital to Existing OZ 1.0 Projects

The Notice introduces a restriction that differs from what many practitioners had expected. Tangible property acquired after December 31, 2026 for use in a previously designated (OZ 1.0) zone that is not redesignated generally will not qualify as opportunity zone business property unless an exception applies.

The principal exception involves the working capital safe harbor. In general terms, the project must be operating under a written working capital safe harbor plan adopted on or before December 31, 2026, property acquisitions must be substantially consistent with that plan, at least 10% of the planned working capital must have been received by the qualified opportunity zone business by December 31, 2026, and at least 5% must have been expended, or committed under binding contracts, by that date. A second, narrower exception generally covers ordinary-course replacement and modernization property needed to continue an existing business.

For fund sponsors, this generally makes December 31, 2026 an important date for having plans documented and funded. For investors, it may be a useful diligence topic when evaluating whether an existing OZ 1.0 project can accept new capital after 2026.

Long-Term Relief for Existing Projects

The Notice pairs these limits with long-term relief. The forthcoming regulations are expected to include safe harbors allowing QOFs and their businesses to continue treating expired OZ 1.0 tracts as qualified zones for certain compliance tests, including property-use, gross-income, and intangible-property requirements, through December 31, 2047. Without this relief, many existing projects could have faced uncertainty once the original zone designations expire.

What Comes Next: New Zone Designations

Notice 2026-40 arrives as the OZ 2.0 designation process is underway. Under Rev. Proc. 2026-14, state governors nominate new census tracts for designation, and the Notice confirms that zones designated during 2026 will generally have a designation period running January 1, 2027 through December 31, 2036, with prior OZ 1.0 designations not counting against the new nomination cap.

We covered California’s nomination process and what it may mean for San Jose in California’s New Opportunity Zone Map Is Being Drawn Right Now, and the broader framework in What Opportunity Zones 2.0 Means for Investors.

Topics to Consider Discussing With a Tax Advisor

Every situation is different, but these are planning topics tax professionals are commonly discussing with Opportunity Zone investors following the Notice:

1. Planning for the 2026 recognition event. Since the deemed included gain generally cannot be re-deferred, estimating the potential liability and planning liquidity well before year end.
2. Timing of new gains. For investors expecting eligible gains in late 2026 or 2027, how the 180-day investment period interacts with the January 1, 2027 start of OZ 2.0.
3. K-1 and pass-through gains. Whether elections around the 180-day period for partnership or S corporation gains may extend an investment window into 2027.
4. Diligence on existing projects. For those considering post-2026 investments into OZ 1.0 projects, whether the project’s working capital safe harbor plan meets the Notice’s requirements.
5. Watching for proposed regulations. The Notice describes rules Treasury and the IRS intend to propose; final details may change.

Frequently Asked Questions

Can the gain recognized on December 31, 2026 be reinvested into a new Opportunity Zone fund?

Generally, no. The Notice confirms that the deemed included gain is not eligible for a second deferral election, because the original deferral election remains in effect.

Does recognizing the 2026 gain end the 10-year benefit?

Generally, no. Investors who continue to hold their QOF investment may remain eligible for the potential exclusion of appreciation upon a later sale, provided the 10-year holding period and other program requirements are met.

Can gains realized in 2026 be invested under the new OZ 2.0 rules?

Potentially, yes. Eligible gains realized before 2027 may qualify for deferral under OZ 2.0 if invested in a QOF on or after January 1, 2027 within the applicable 180-day period. Whether a specific gain qualifies depends on individual facts.

Can existing OZ 1.0 projects still accept new investment after 2026?

Generally only in limited circumstances. Property acquired after December 31, 2026 in a previously designated zone generally must qualify under a working capital safe harbor plan meeting the Notice’s requirements, or as ordinary-course replacement property.

Is Notice 2026-40 the final word on these rules?

No. It is transitional guidance, and Treasury and the IRS have announced that proposed regulations are forthcoming. Provisions may be revised before the rules are finalized.

The Bottom Line

Notice 2026-40 provides a roadmap for the transition from the original Opportunity Zone program to the permanent program beginning in 2027. It closes one door, re-deferring the December 31, 2026 gain, while confirming that the 10-year benefit generally survives the recognition event and that pre-2027 gains may still find their way into OZ 2.0 investments. Because much of the available relief depends on facts and actions occurring on or before December 31, 2026, the most important step for affected investors is a conversation with a qualified tax professional in the coming months.

Disclosures: Urban Catalyst and its affiliates do not provide tax, legal, or investment advice. This material is for informational and educational purposes only, is general in nature, and does not consider the specific circumstances of any individual investor. It is neither an offer to sell nor a solicitation of an offer to buy any security. Potential tax benefits are subject to limitations, eligibility requirements, and applicable tax regulations, which are subject to change; there is no guarantee of any particular tax outcome or consequence. IRS Notice 2026-40 is transitional guidance; forthcoming proposed regulations may modify the rules described herein. Investments in Opportunity Zone funds are speculative, illiquid, involve significant risk, and may result in partial or total loss of investment. Nothing herein describes the terms, status, or distribution policy of any particular fund or offering. Any offering of interests in an Urban Catalyst fund is made only to accredited investors by delivery of the fund’s Private Placement Memorandum and related offering documents. Prospective and current investors should consult their own tax, legal, and financial professionals regarding their particular circumstances. Third-party data referenced herein is believed to be reliable, but its accuracy and completeness cannot be guaranteed. Past performance is no guarantee of future results.