For taxpayers with Opportunity Zone investments under the original program, the deferral window closes on December 31. Any capital gain deferred into a Qualified Opportunity Fund must be recognized as income this year, regardless of whether the investment has been sold or produced any cash to cover the tax. That gap between when the gain is taxed and when cash is actually on hand can create a liquidity crunch, and it’s worth getting ahead of before year-end.
It’s worth remembering that OZ 1.0 carried significant tax advantages along the way. Beyond deferring the original gain, the program offered a 10% basis step-up after five years, and an additional 5% after seven years, for a total 15% reduction in the gain now coming due for the earliest investors. And once an OZ investment reaches the full 10-year mark – starting in 2028 – appreciation on that investment itself is free of federal capital gains tax when sold.
Start with the size of that deferred gain. The law allows a reduction if the fund’s current fair market value has fallen below the original investment. This isn’t automatic and requires a current appraisal. Taxpayers should request a current valuation from their fund sponsor now, since a lower valuation directly reduces the taxable gain.
Loss harvesting elsewhere in the portfolio can serve as a helpful offset. Because the OZ gain is being recognized as a specific, known amount this year, this is a good year to look harder than usual at underperforming positions in taxable accounts, including ones that might otherwise be held for strategic or sentimental reasons. Realized losses can offset the gain dollar for dollar, and any excess carries forward.
Charitable giving can help too, though the vehicle matters. Because charitable deductions reduce overall adjusted gross income rather than targeting capital gains directly, gifting blunts the broad tax impact of the recognized gain. Taxpayers holding appreciated securities outside the OZ structure can donate them to a donor-advised fund to claim a fair market value deduction while eliminating capital gains tax on the gifted shares, while direct cash gifts offer the highest deduction ceiling (up to 60% of AGI) if maximum deduction capacity is needed this year.
A charitable remainder trust is another tool worth considering for taxpayers holding other appreciated assets they had already planned to sell or transfer. Funding a CRT can generate an income tax deduction and spread additional gain recognition over time, which may help offset the concentrated hit from the OZ gain landing this year. This works best when structured well in advance of year-end, so it’s worth raising with a CPA now rather than in December.
Timing of other income matters too. Taxpayers with some control over when they realize income, such as a bonus, a business distribution, or the exercise of other equity, may want to model whether shifting income out of 2026 helps manage the combined effect of ordinary income and the OZ gain on their marginal bracket, the 3.8% net investment income tax, and any state-level surtaxes.
For those in higher-tax states, review state treatment separately from federal. Not every state conformed to the original deferral. California, for example, required tax on the gain years ago, while other states allowed the deferral to run through the same 2026 endpoint. Taxpayers who have moved states since investing should confirm which state’s rules actually apply.
Finally, liquidity planning shouldn’t wait until the return is filed. Some taxpayers expected to fund the tax bill through a refinancing of the underlying project, and slower refinancing activity in this rate environment means that plan may fall through, leaving a liquidity crunch right when the payment is due.
Looking ahead, a new and permanent OZ 2.0 program begins in 2027, with states redrawing designated communities every 10 years, stricter qualification rules, and new reporting requirements. Gains invested into these new funds will see a 10% basis step-up after five years, with rural investments eligible for 30%. Taxpayers generating new gains in late 2026 have a 180-day window to consider OZ 2.0 once it opens. Section 1031 exchanges cannot be used to roll an Opportunity Zone (OZ) investment into another fund, and deferred gains under OZ 1.0 cannot be rolled over into OZ 2.0 to avoid recognition at year-end 2026.
Households with OZ gains coming due at the end of the year should flag this for their tax professional and work prior to year-end and collaborate with your wealth manager to help offset realized gains.
Sources: https://www.wsj.com/personal-finance/taxes/long-delayed-tax-bill-comes-due-for-opportunity-zone-investors-1c81969a
Weekly Commentary
Opportunity Zone Deadline Approaches: Is Your Tax Plan Ready?
Mallon FitzPatrick
For taxpayers with Opportunity Zone investments under the original program, the deferral window closes on December 31. Any capital gain deferred into a Qualified Opportunity Fund must be recognized as income this year, regardless of whether the investment has been sold or produced any cash to cover the tax. That gap between when the gain is taxed and when cash is actually on hand can create a liquidity crunch, and it’s worth getting ahead of before year-end.
It’s worth remembering that OZ 1.0 carried significant tax advantages along the way. Beyond deferring the original gain, the program offered a 10% basis step-up after five years, and an additional 5% after seven years, for a total 15% reduction in the gain now coming due for the earliest investors. And once an OZ investment reaches the full 10-year mark – starting in 2028 – appreciation on that investment itself is free of federal capital gains tax when sold.
Start with the size of that deferred gain. The law allows a reduction if the fund’s current fair market value has fallen below the original investment. This isn’t automatic and requires a current appraisal. Taxpayers should request a current valuation from their fund sponsor now, since a lower valuation directly reduces the taxable gain.
Loss harvesting elsewhere in the portfolio can serve as a helpful offset. Because the OZ gain is being recognized as a specific, known amount this year, this is a good year to look harder than usual at underperforming positions in taxable accounts, including ones that might otherwise be held for strategic or sentimental reasons. Realized losses can offset the gain dollar for dollar, and any excess carries forward.
Charitable giving can help too, though the vehicle matters. Because charitable deductions reduce overall adjusted gross income rather than targeting capital gains directly, gifting blunts the broad tax impact of the recognized gain. Taxpayers holding appreciated securities outside the OZ structure can donate them to a donor-advised fund to claim a fair market value deduction while eliminating capital gains tax on the gifted shares, while direct cash gifts offer the highest deduction ceiling (up to 60% of AGI) if maximum deduction capacity is needed this year.
A charitable remainder trust is another tool worth considering for taxpayers holding other appreciated assets they had already planned to sell or transfer. Funding a CRT can generate an income tax deduction and spread additional gain recognition over time, which may help offset the concentrated hit from the OZ gain landing this year. This works best when structured well in advance of year-end, so it’s worth raising with a CPA now rather than in December.
Timing of other income matters too. Taxpayers with some control over when they realize income, such as a bonus, a business distribution, or the exercise of other equity, may want to model whether shifting income out of 2026 helps manage the combined effect of ordinary income and the OZ gain on their marginal bracket, the 3.8% net investment income tax, and any state-level surtaxes.
For those in higher-tax states, review state treatment separately from federal. Not every state conformed to the original deferral. California, for example, required tax on the gain years ago, while other states allowed the deferral to run through the same 2026 endpoint. Taxpayers who have moved states since investing should confirm which state’s rules actually apply.
Finally, liquidity planning shouldn’t wait until the return is filed. Some taxpayers expected to fund the tax bill through a refinancing of the underlying project, and slower refinancing activity in this rate environment means that plan may fall through, leaving a liquidity crunch right when the payment is due.
Looking ahead, a new and permanent OZ 2.0 program begins in 2027, with states redrawing designated communities every 10 years, stricter qualification rules, and new reporting requirements. Gains invested into these new funds will see a 10% basis step-up after five years, with rural investments eligible for 30%. Taxpayers generating new gains in late 2026 have a 180-day window to consider OZ 2.0 once it opens. Section 1031 exchanges cannot be used to roll an Opportunity Zone (OZ) investment into another fund, and deferred gains under OZ 1.0 cannot be rolled over into OZ 2.0 to avoid recognition at year-end 2026.
Households with OZ gains coming due at the end of the year should flag this for their tax professional and work prior to year-end and collaborate with your wealth manager to help offset realized gains.
Sources: https://www.wsj.com/personal-finance/taxes/long-delayed-tax-bill-comes-due-for-opportunity-zone-investors-1c81969a
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