How investors should prepare for the 2026 Opportunity Zone inclusion event

For Opportunity Zone (OZ) investors, December 31, 2026 marks a tremendous tax milestone. Investors who deferred eligible gains by investing in Qualified Opportunity Funds (QOFs) generally must recognize their remaining deferred gains by the end of 2026 – known as an “inclusion event” – even if they continue to hold their QOF investments.

The resulting tax liability could be substantial, and it may arise without a corresponding cash distribution from the QOF. Investors shouldn’t assume that the amount originally deferred will necessarily equal the amount recognized in 2026 though. The calculation accounts for the remaining deferred gain, the QOF interest’s fair market value (FMV) on December 31, 2026, and applicable basis adjustments.

With the 2026 inclusion event approaching, investors should focus on three areas:

• Determine the deferred gain that remains.
• Evaluate the value of your QOF interest.
• Plan for the resulting tax liability.

QOF tax rules: a refresher

The Tax Cuts and Jobs Act of 2017 established OZs to encourage investment in designated economically distressed communities. The law provided tax incentives for investors who invested eligible gains in QOFs.

Gain deferral

An investor generally could defer an eligible gain by investing the corresponding amount in a QOF within 180 days of the transaction generating the gain. For example, assume an investor generated a $100,000 capital gain in 2018 and invested $100,000 in a QOF within the required 180-day period. The investor would defer recognition of the $100,000 gain rather than recognize it in 2018.

That deferral, however, was temporary. For legacy QOF investments, investors generally must recognize the deferred gain on the earlier of an applicable inclusion event or December 31, 2026.

Basis increases

The QOF rules also provided investors with potential basis increases based on the length of time the QOF investment was held.

Under the original rules:

• After five years, the investor could receive a 10% basis increase with respect to the deferred gain.
• After seven years, the investor could receive an additional 5% increase, for a total 15% basis increase.

For example, a $100,000 deferred gain could result in $10,000 of additional basis after five years and $15,000 after seven years. Those basis increases reduce the amount of deferred gain ultimately recognized.

*Illustrative only. Assumes the investment remains outstanding through December 31, 2026, and applicable basis adjustments are available.

The 2026 inclusion event

For a qualifying investment that remains outstanding through December 31, 2026, investors generally must include the remaining deferred gain in their taxable income for 2026. An earlier inclusion event, such as a transaction that terminates or reduces the qualifying investment, can accelerate gain recognition.

This inclusion event creates a potential liquidity issue. The 2026 recognition is a deemed or “cashless” inclusion event: the investor will recognize taxable income this year without necessarily receiving a corresponding cash distribution from the QOF to pay the resulting tax.

The potential 10-year benefit

The 2026 inclusion event is separate from the OZ benefit available to investors who hold a qualifying QOF investment for at least 10 years. Subject to applicable requirements, an investor holding for at least 10 years may elect to adjust the QOF investment’s basis to its FMV when it’s sold or exchanged. This can effectively exclude any federal capital gain attributable to the QOF investment’s appreciation. 

Investors should therefore distinguish between the original deferred gain, which generally must be included in income in 2026, and subsequent appreciation in the QOF investment, which may be eligible for exclusion when the investment is ultimately disposed of after satisfying the 10-year holding period.

Determining the 2026 inclusion amount

The next question: How much gain will actually be recognized in 2026?

For legacy QOF investments, the inclusion amount is generally the lower of:

1. the remaining deferred gain, or
2. the FMV of the qualifying QOF investment as of December 31, 2026

over the taxpayer’s adjusted basis in the QOF investment.

This “lower of” rule is important for investors whose QOF investment has declined in value. It generally prevents an investor from recognizing more deferred gain than the value of the QOF interest at the end of 2026. In other words, if the QOF interest is worth less on December 31, 2026 than the gain amount originally deferred, the lower value can limit the gain subject to the 2026 inclusion, reducing tax liability.

The inclusion amount formula

Inclusion amount = [Lesser of (1) remaining deferred gain, or (2) FMV of the QOF interest on December 31, 2026] – adjusted basis in the QOF investment

Part (1) of this formula is straightforward, but how is the FMV of the QOF interest in Part (2) determined? 

The FMV interest refers to the taxpayer’s equity interest, not the taxpayer’s pro rata share of the fund’s net asset value (NAV). The FMV should be substantiated by obtaining a contemporaneous qualified valuation of the property’s value on December 31, 2026. 

Why valuation matters

Some investors may dismiss the need for an appraisal simply because the fund has appreciated in value. This may overlook a potential opportunity. Consider a QOF that has increased to roughly 1.2 times the original investment. Paying for an appraisal may initially seem unnecessary. A deeper analysis, however, might uncover significant tax savings.

Appraisals commonly include discounts on the property’s value, such as discounts for lack of control, lack of marketability, or transfer restrictions. When supported by the facts, the fund’s NAV can potentially be reduced by 10% to 30%. For example, a QOF investment worth $1.20 for every $1 invested would have a value of $0.90 for every $1 invested after a hypothetical 25% discount.

Hypothetical example

In 2020, John Doe realizes a $1 million capital gain on real property and immediately reinvests the $1 million in a QOF, deferring the gain. After holding the investment for five years, he qualifies for a 10% basis increase, giving him $100,000 of basis. 

By December 31, 2026, assume John’s pro rata share of the QOF’s NAV is $1.2 million. A qualified appraisal determines that a 30% discount is appropriate based on the characteristics of John’s QOF interest (e.g., lack of control).

*Illustrative only

This hypothetical example illustrates why investors should not automatically equate NAV with their individual QOF interest’s FMV. A qualified valuation may significantly affect the inclusion calculation when supported by facts and applicable valuation principles.

Planning for the 2026 tax liability

Since most QOF investments are held through pass-through entities, the resulting tax implications generally flow through to individual taxpayers. Investors should therefore consider the following items before the end of 2026 to prepare for and manage the looming deferred gain that becomes taxable this year: 

1. Review estimated tax payments: Investors should evaluate whether their 2026 estimated tax payments adequately account for the QOF gain expected to be recognized. Depending on their circumstances, investors may need to increase their 2026 estimated tax payments to reflect the QOF gain. Alternatively, investors may be able to rely on the prior-year safe harbor rule by paying 110% of their 2025 tax, then paying any remaining 2026 tax by April 15, 2027. This should be carefully analyzed with a tax advisor. 
2. Review QOF investments for valuation opportunities: Investors should review their QOF investments for potential valuation opportunities, as discussed above.
3. Harvest unrealized investment losses: Investors should review their current security holdings to identify any unrealized losses that could be harvested (sold) before the end of 2026. These recognized losses could then, in turn, offset their 2026 scheduled QOF gains. Investors need to be mindful of the “wash sale” rules and avoid repurchasing the same security within 30 days before or after the sale that triggers the loss.
4. Explore other tax-aware investment opportunities: Investors may explore other investment strategies that generate tax losses, including specific long/short separately managed accounts. These products warrant further investment and tax ramification considerations.

Prepare now

Investors should act now to understand their remaining deferred gain, available basis adjustments, the value of their QOF interests, and the resulting tax liability. These evaluations should be conducted by trusted tax and wealth management advisors who can facilitate qualified valuations.

With the potential for a substantial tax bill this year without a corresponding cash distribution, proactive planning can help investors identify valuation and tax-planning opportunities before year-end. The time to prepare for the 2026 inclusion event is now — not when the tax bill arrives.

About our authors

Mary O’Connor, ASA, CRE, CMI, CFE, manages Sikich’s Forensics and Valuation Services. She specializes in appraising non-taxable assets for litigation and corporate transactions, particularly regarding property tax. She has provided consulting and expert witness testimony in federal, state and local jurisdictions for wide-ranging and complex property tax cases. Mary.OConnor@sikich.com

Jim Brandenburg, CPA, MST, possesses extensive experience and knowledge in corporate and partnership tax law, mergers and acquisitions, and tax legislation. His expertise includes working with owners of closely held businesses to identify tax planning opportunities and assist them in implementing these strategies. Jim.Brandenburg@sikich.com

Amber Koesling, M.S. Accounting, specializes in real estate and construction taxation. A graduate of Southern New Hampshire University, she is committed to lifelong learning and building strong, long-term client relationships through personalized service and technical expertise. Amber.Koesling@sikich.com