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

Updated August 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 provides transitional guidance addressing these questions. This guide provides a general overview of what the Notice says and the topics investors may wish to discuss with their tax advisers before year end.

Urban Catalyst does not provide tax, legal, or financial advice. The information below is general and educational in nature. This article discusses federal income tax treatment. State and local tax treatment may differ materially. For example, California does not currently conform to the federal Opportunity Zone gain-deferral and exclusion provisions, so a California taxpayer may recognize gain for California purposes even where federal treatment is deferred or potentially excluded. Every investor’s situation is different. Please consult your own tax professional regarding the laws applicable to your residence and 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 potential investor benefits. What the legislation did not fully address was the interaction between the original framework and the new one: questions such as whether gains recognized in 2026 could be reinvested, and how property acquired after 2026 for existing projects would be treated. The IRS released Notice 2026-40 on June 18, 2026 to address that gap, alongside an announcement that formal proposed regulations are forthcoming.

Notice 2026-40 provides current transitional guidance. Treasury and the IRS anticipate issuing proposed regulations containing rules similar to those in the Notice, and anticipate that eventual final regulations will apply to taxable years ending after the Notice was issued, although the proposed and final regulations may clarify or modify particular details.

The OZ 1.0 Deferred Gain Recognized on December 31, 2026 Generally Cannot Be Re-Deferred

Many practitioners had asked whether the remaining deferred gain from an existing OZ 1.0 qualifying investment that is mandatorily included in income for the taxable year containing December 31, 2026 — defined in the Notice as 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. This rule concerns the OZ 1.0 deemed included gain specifically, not other capital gains a taxpayer may happen to recognize on or around that date.

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 Potential 10-Year Tax Benefit Generally Remains Available

The Notice also confirms a point many investors have asked about: recognizing the deemed included gain in 2026 generally does not end an investor’s other potential Opportunity Zone tax treatment. 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 post-investment appreciation from gross income upon a later sale — provided the qualifying 10-year holding period and the other applicable requirements are satisfied. The 10-year holding period is a condition for this potential treatment, not an assurance of tax-free appreciation: the original deferred gain generally remains taxable under the rules described above, and the potential exclusion applies only to qualifying post-investment appreciation, and only if the investor, the investment, the QOF, the disposition, and the election each satisfy the applicable requirements.

Pre-2027 Gains May Qualify for OZ 2.0 Deferral

One significant clarification 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 and subject to the other applicable requirements. Whether a particular gain is an eligible gain, and when its 180-day period begins and ends, depends on the taxpayer, the entity, the type of gain, and the elections involved, and should be reviewed with a tax advisor.

Qualifying 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 (qualifying investments made after December 31, 2026)
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 exclusion of post-investment appreciation (qualifying 10-year hold)	Potentially available, subject to program rules and applicable requirements	Potentially available, subject to program rules and applicable requirements
Limitation on appreciation exclusion	Current regulations generally preserve the election for qualifying dispositions occurring before January 1, 2048	Basis is adjusted to fair market value on the earlier of a qualifying sale or exchange, or the date 30 years after the qualifying investment — capping the potential exclusion of appreciation at 30 years
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 qualifying 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. Not every post-2026 transfer of money into a QOF or existing project will necessarily constitute a qualifying investment.

When Property Acquired After 2026 Can Still Qualify for Existing OZ 1.0 Projects

The Notice introduces a rule that differs from what many practitioners had expected — and it is important to frame it precisely. Notice 2026-40 does not generally prohibit an existing QOF or project from receiving capital after 2026. It principally addresses whether property acquired after December 31, 2026 can qualify: tangible property acquired after that date 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 Notice also contains related treatment for stock and partnership interests acquired pursuant to a qualifying written plan.

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 how an existing OZ 1.0 project’s post-2026 property acquisitions would be treated under these rules.

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 topics investors may wish to discuss with their tax advisers following the Notice:

1. Planning for the 2026 recognition event. Since the deemed included gain generally cannot be re-deferred, estimating the potential federal and state 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 applicable 180-day investment period interacts with the January 1, 2027 start of OZ 2.0 for their particular gains and elections.
3. State tax treatment. How the investor’s state treats Opportunity Zone investments — California, for example, does not currently conform to the federal deferral and exclusion provisions.
4. Diligence on existing projects. For those considering post-2026 investments involving OZ 1.0 projects, how the project’s post-2026 property acquisitions would be treated, including whether a working capital safe harbor plan meets the Notice’s requirements.
5. Watching for proposed regulations. The Notice describes rules Treasury and the IRS anticipate proposing; particular details may be clarified or modified.

Frequently Asked Questions

Can the deemed included gain recognized under OZ 1.0 on December 31, 2026 be deferred again?

Generally, no. The Notice confirms that the deemed included gain — the remaining deferred gain from an existing OZ 1.0 qualifying investment that is mandatorily included in income for the taxable year containing December 31, 2026 — is not eligible for a second deferral election, because the original deferral election remains in effect.

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

Generally, no. Investors who continue to hold their QOF investment may remain eligible for the potential exclusion of post-investment appreciation upon a later sale, provided the qualifying 10-year holding period and the other applicable requirements are met. The holding period is a condition for this potential treatment, not an assurance of any tax outcome, and the original deferred gain generally remains taxable.

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, subject to the other applicable requirements. Whether a specific gain qualifies depends on individual facts and should be reviewed with a tax advisor.

When can property acquired after 2026 for an existing OZ 1.0 project continue to qualify as Opportunity Zone business property?

Generally in limited circumstances. Tangible property acquired after December 31, 2026 in a previously designated zone that is not redesignated generally must qualify under a working capital safe harbor plan meeting the Notice’s requirements, or as ordinary-course replacement or modernization property. The Notice does not generally prohibit an existing QOF or project from receiving capital after 2026; the rules address whether the property acquired qualifies.

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

No. It provides current transitional guidance. Treasury and the IRS anticipate issuing proposed regulations containing similar rules, although the proposed and final regulations may clarify or modify particular details.

The Bottom Line

Notice 2026-40 provides a roadmap for the transition from the original Opportunity Zone framework to the permanent program beginning in 2027. It closes one door — re-deferral of the OZ 1.0 deemed included gain recognized on December 31, 2026 — while confirming that the potential 10-year tax benefit generally remains available to investors who continue to hold and satisfy the applicable requirements, and that pre-2027 eligible gains may still qualify for OZ 2.0 deferral. Because much of the available relief depends on facts and actions occurring on or before December 31, 2026, an 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, and no offering is being made or identified by this article. This article discusses federal income tax treatment; state and local tax treatment may differ materially, and California does not currently conform to the federal Opportunity Zone gain-deferral and exclusion provisions. Potential tax benefits are subject to limitations, eligibility requirements, holding periods, and applicable tax regulations, which are subject to change; the 10-year holding period is a condition for potential favorable federal tax treatment, not an assurance of any outcome, and there is no guarantee of any particular tax result. IRS Notice 2026-40 is transitional guidance; Treasury and the IRS anticipate issuing proposed regulations containing similar rules, which may clarify or modify particular details. 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. 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. Prospective and current investors should consult their own tax, legal, and financial professionals regarding their particular circumstances.