The Change
The federal Opportunity Zones (OZ) program, established in 2017 to incentivize long-term investment in distressed communities, is undergoing significant revisions scheduled to take effect in 2026. While the core concept of tax benefits for investing capital gains in designated low-income zones remains, the structure and attractiveness of these benefits are poised to shift. Stakeholders have a compressed timeline to capitalize on the program's current, more advantageous iterations before new rules are implemented.
Specifically, the program's benefits, which include deferring tax on prior gains, reducing the tax on the reinvested gain, and eliminating tax on appreciation of the new OZ investment if held for 10 years, have tiered expiration dates for the initial capital investment. The deadline to make qualifying investments that receive the full 10-year capital gains step-up benefit is December 31, 2026. However, newer proposals and anticipated rule adjustments for 2026 suggest a potentially reduced incentive structure going forward, effectively creating an accelerated decision-making period for current participants and prospective investors.
Who's Affected
Investors (VCs, angel investors, portfolio managers, real estate investors): Individuals and entities with significant capital gains looking for tax-advantaged investment vehicles will find the decision-making window shrinking. The current OZ benefits are generally available for capital invested by December 31, 2026, to receive the full 10-year lock-up benefit on appreciation. For those aiming to maximize the 10-year holding period benefit, the effective deadline to invest is much sooner, requiring substantial planning and deployment of capital in 2025 and early 2026. Investors should reassess their capital allocation strategies to ensure they can meet these timelines if they wish to utilize the existing program benefits.
Real Estate Owners & Developers: Developers planning projects within Opportunity Zones must now grapple with the uncertainty and potential diminishment of investor appetite under the revised 2026 framework. The current OZ program has been a significant driver for development in eligible areas. With changes on the horizon, securing pre-development funding and construction financing may become more challenging. Developers should re-evaluate project pro formas, factoring in potentially higher costs of capital or lower investor demand. Projects slated for groundbreaking in late 2025 or 2026 need to solidify their funding structures now to benefit from the current OZ incentives.
Entrepreneurs & Startups: Businesses operating or seeking to operate within federally designated Opportunity Zones may experience future impacts on their funding landscape. The OZ program has directed significant capital towards small businesses and startups in these areas. If the program's attractiveness is reduced post-2026, these ventures could face decreased access to a unique pool of patient, tax-motivated capital. Entrepreneurs should consider accelerating fundraising efforts if they were relying on OZ investors and explore alternative funding mechanisms.
Second-Order Effects
The potential reduction or alteration of the Opportunity Zone program's incentives in 2026 could lead to a dampening of investment in designated areas. This decreased investment could slow down the pace of new business formation and job creation within these zones, potentially exacerbating existing economic disparities. In Hawaii, where land is scarce and development costs are high, a reduction in a significant federal investment catalyst like the OZ program could disproportionately impact projects that were marginally viable under the existing incentive structure. This could lead to fewer new housing units or commercial spaces being developed, further constraining supply and potentially increasing rental costs for both residential and commercial tenants. The ripple effect could see limited economic growth in OZ areas, impacting local employment opportunities and the broader tax base.
What to Do
For Investors:
- Act Now: If you have unrealized capital gains and were considering Opportunity Zone investments, accelerate your plans. The deadline to make crucial investments to capture the full 10-year appreciation benefit is December 31, 2026. However, to allow for proper due diligence and fund deployment, aim to commit capital by mid-2026 at the latest, with December 31, 2025, being a critical internal target to maximize planning and selection opportunities.
- Review Structure: Analyze your current portfolio and tax liabilities. Determine the amount of capital gains eligible for OZ investment and the potential tax benefits of doing so under the current rules. Consult with tax advisors and financial planners to optimize your investment structure.
- Due Diligence: Thoroughly vet any Opportunity Zone funds or direct investment projects available. Understand the specific development plans, management teams, and projected returns, considering both the OZ benefits and the underlying investment fundamentals.
For Real Estate Owners & Developers:
- Act Now: If you have projects planned in Opportunity Zones that rely on OZ investment for funding, prioritize securing commitments from investors by December 31, 2025. This deadline ensures that your necessary capital is invested before potential program changes reduce investor interest or alter the economics.
- Re-evaluate Pro Formas: Update your project financial models to reflect a scenario with potentially fewer or less advantageous OZ investors, and consequently, a higher cost of capital. This will help you understand the minimum viable returns needed to attract investment under new conditions.
- Explore Alternatives: Begin exploring alternative financing options and incentives, such as local or state economic development programs, New Markets Tax Credits, or traditional debt financing, in anticipation of a potentially less robust OZ market.
For Entrepreneurs & Startups:
- Watch: While immediate action might not be required for all, monitor legislative developments and official pronouncements regarding the OZ program changes. Understand how these changes might affect the availability of capital for businesses in OZ areas.
- Accelerate Fundraising (If applicable): If your startup is in an OZ and you were planning to raise capital from OZ funds, consider accelerating your fundraising efforts. Aim to engage with potential investors before the end of 2025 to present your current growth trajectory and funding needs under the existing program rules.
- Diversify Funding: Explore diversifying your funding sources beyond OZ investors. Build relationships with a broader range of venture capitalists, angel investors, and strategic partners who may invest based on the company's fundamentals rather than solely on tax incentives.
