Opportunity Zones and A Possible 2026 Tax Surprise

The 2016 Tax Cut and Jobs Act introduced a new provision to the Code - the qualified opportunity zone – sometimes called an “OZ.” I suspect that there was some humor while drafting the legislation, as here is the Code section:

         26 U.S. Code § 1400Z-1 – Designation

(a)      Qualified opportunity zone defined

For the purposes of this subchapter, the term “qualified opportunity zone” means a population census tract that is a low-income community that is designated as a qualified opportunity zone.

Yep: 140 OZ.

There are different technical terms in this area; For example, “QOZ business property” would include tangible business property; “QOZ business” would include an active trade or business where substantially all of the tangible property is QOZ business property; and “QOZ Fund” would be an investment vehicle – can be a corporation but usually a partnership – used to pool funds for investment in OZs.

For this post we will use the generic term “OZ.”

BTW, if you are presently in an OZ, there is a tax event in 2026 that you must be aware of. We will discuss the issue below.

Let’s discuss the following topics: 

     (1)          What are OZs?

(2)          Pre-2027 OZs

(3)          Post-2026 OZs

(4)          Gains reported through Schedule K-1

(5)          Another tax form

(6)          An example

What are OZs?

Introduced with the Tax Cut and Jobs Act of 2017, OZs were and are an effort to redirect private capital into historically overlooked economic areas. These areas (“zones”) were identified by the individual states and thereafter certified by the Treasury Secretary, a process which stretched into 2019.

There are – in general – two ways to invest in an OZ: a direct investment in a trade or business that operates within an OZ or in real estate located within an OZ; or an indirect investment via a fund which does the same.

Remember that an OZ’s purpose is to generate new investment. An intuitive example is starting a new business in an OZ zone. Buying an existing business can also work, but you must be willing to spend at least as much on new assets as you are spending to buy the existing assets.  Real estate can certainly work, but just buying an existing building or raw land will not suffice. The Code wants to see substantial improvement of the existing real estate. You are either renovating or building new if you want to OZ.

OZs have been compared to Section 1031 tax-free exchanges, but they actually operate quite differently. For example, to obtain the full benefit of a Section 1031, one has to reinvest (at least) the full sales price of the real estate sold. OZs are very different: one has to reinvest only the gain portion of the proceeds, not the total proceeds.

EXAMPLE: Let’s say you sell a building for $12 million with a gain of $3.5 million.

If you want a (full) Section 1031 like-kind exchange, you will have to invest at least $12 million (and meet other requirements) in replacement real estate.

If you want a (full) OZ, you will have to invest $3.5 million in an OZ-located business, real estate, or a fund that does that for you.

You see what powers the OZ: you must have a capital gain somewhere on your return. It does not matter what type of taxpayer you are. An individual, decedent, corporation, trust or estate will qualify – as long as you have capital gain as an admission ticket.

BTW your OZ investment must be equity. It cannot be debt back to you, much to the disappointment of tax planners nationwide.

And you have 180 days after the sale date to get the investment done. You cannot invest before the sale date. A Section 1031 can do that but not an OZ.

The driving force behind OZs are two potential tax breaks: one a tax deferral and the other an outright tax exclusion. These two can vary depending upon whether one invested in 2026 or earlier or invests in 2027 and later.

Pre-2027 OZs

(1)          The tax deferral

a.     Taxes on the underlying sale are not payable until December 31, 2026 (or when you sell the OZ, if earlier).

b.    There is a bonus for holding on to the OZ.

                                       i.     Only 90% of the gain will be taxable if you hold for at least 5 years.

                                     ii.     That changes to 85% if you hold for at least 7 years.

1.    COMMENT: I doubt that we will see many 7-years as the rules were not finalized until 2019.

c.     If you have a pre-2027, you will owe tax on December 31, 2026, unless you sold the property previously.

                                       i.     If you haven’t sold, you may want to start freeing-up cash for tax.

 (2)          The tax exclusion

a.     This one is tricky: all gain AFTER the original sale AND before December 31, 2047 is tax-free IF you hold the replacement property for at least 10 years.

                                       i.     Yep, the 2047 throws me too. I presume the 2047 has something to do with how the CBO scored the tax bill.

                                     ii.     If not sold by then, one steps-up basis in the property to its December 31, 2047 fair market value.

                                   iii.     Let’s be frank: all we are after is to hold for at least 10 years. 2047 is an after-thought, if it is even a thought.

b.    Example: You sell something in 2026 for a $1 million gain. You reinvest the $1 million and sell the replacement property 11 years later for a $2 million gain (totaling $3 million in gains over the transaction cycle - congrats). You will pay tax on the $1 million in 2026 – no one escapes 2026. You however will not pay tax on the subsequent $2 million, as you would have held the replacement property for the (actually, more than) required 10 years.

 (3)          Tax planners are a tricky lot

a.     Can one rollover the gain otherwise taxable at December 31, 2026 and defer the tax one more time?

                                       i.     In the preceding example, that would be the $1 million.

b.    The IRS was clear, blunt, and concise: NO!

                                       i.     No two bites at the same apple.

                                     ii.     The cite for the tax nerds is IRS Notice 2026-40.

Post-2026 OZs  

 (1)          The big change is getting rid of that one-size-fits-all-tax-recognition-date (of December 31, 2026). The new rules say that you will owe tax on the deferred gain on the 5^th anniversary of when you invested the gain.

a.     Makes more sense to me. I suspect that the original December 31, 2026 date had more to do with Congress being unsure whether the Code section would even be renewed.

 (2)          You still have the 10% gain exclusion if you hold the OZ for at least 5 years.

 (3)          However, there is no longer a 15% exclusion.

 (4)          Congress replaced that 2047 nonsense with a 30-year anniversary of the investment date.

a.     Once again, do not get caught-up here. What we are after is to hold for at least 10 years.

 (5)          Congress provided a specialized break for rural OZs.

a.     The 10% gain exclusion is 30% instead.

b.    Rural is described (generally) as 50,000 people or less.

Gains reported through Schedule K-1

One has 180 days to invest capital gains into an OZ.

How does that rule work when the capital gain is reported via a Schedule K-1?

If you sell an asset personally, you are (likely) aware of the sale and its sale date. You can more easily work with the 180-day window.

A sale through a passthrough entity (a partnership or S corporation, for example) can be more problematic. The passthrough may do an excellent job of alerting one of the sale and gain; it is equally likely that it may not. Take a partnership that extends its return, for example. As the tax preparer for a partner, my first knowledge of that gain may occur in September when the extended K-1 arrives. That would – without some relief – eliminate an OZ roll as a viable planning option.

So the Regulations provided relief.

First, the passthrough entity itself may decide to reinvest into an OZ. If so, then the 180 days begins with the exact date of sale. This would, of course, take the passthrough owners out of it.

Second, the entity may decide not to directly invest and instead distribute the gain to its passthrough owners. Each owner can decide whether or not to invest, as one owner does not bind another. However, if one does invest, when does the 180-day window start?

The passthrough owner has three options:

(1)          The actual date of the sale (of course);

(2)          The last day of the passthrough entity’s taxable year (most likely December 31);

(3)          The unextended due date of the passthrough entity return (most likely March 15).  

I am leaning toward Option (3) as my default.

Another tax form

There has to be a capital gain to power an OZ, so expect your return to include a Schedule D (where capital gains are reported) and perhaps Form 8949 (providing supplemental detail to the Schedule D).

Reinvest the gain into an OZ and you will add this beauty to your tax return:  

It has four parts, and you will attach (and update) the form each year as the OZ goes through its life cycle - from acquisition to disposition.

An example

Let’s walk through what happens depending on whether one has a pre-2027 or post-2026 OZ.

EXAMPLE: You have a $7.5 million sale with a gain of $1.5 million.

Pre-2027 

          (1)          You sold in 2025.

(2)          You bought the OZ in 2026.

(3)          The $1.5 million gain can be deferred only until December 31, 2026. Sorry.

(4)          There is no 10% or 15% exclusion, as you hit the gain recognition date (December 31, 2026) well before any 5- or 7-year anniversary.

a.     Had you sold and bought in 2019, however, you would qualify for the 7-year 15% exclusion.

(5)          However, the 10-year exclusion is still possible. You would keep the OZ, pay the tax in 2026 and hold it for (at least) 10 years. If you do, any further gain (that is, beyond the $1.5 million you already paid tax on) would be tax-free.  

Post-2026 

          (1)          You sell in 2027.

(2)          You buy the OZ in 2027.

(3)          Tax on the $1.5 million is deferred for 5 years. You will not pay tax until sometime in 2032.

(4)          You will get a 10% exclusion at the 5-year anniversary, meaning that only $1,350,000 of the gain will be taxable. (The 10% becomes 30% if you reinvest in a rural OZ).

(5)          Same as the pre-2027, the 10-year exclusion is possible.  

Closing thoughts  

There are some nice tax features to an OZ, but remember that we are talking about investments. Not all investments make sense to all investors. An OZ might appeal to a business owner recognizing a large capital gain upon the sale of his/her business. An OZ would not appeal to a well-maintained older CPA who sold his practice via a 5-year compensation-as-purchase arrangement.  

This is a longer-term investment. The Code is straightforward about this with its 5-year, 7-year and 10-year thresholds.   

Be sure to consider state taxes. We have discussed the federal tax considerations, but your individual state may or may not follow the federal rules.  

Do not overlook the routine tax reporting of an OZ. If you start an OZ business as a single-member LLC, for example, you will be filing a Schedule C with your annual personal return. If the LLC is instead owned by a partnership in which are a partner, then you will report the K-1 every year on Schedule E. Yes, the December 31, 2026/5-year/7-year/10-year stuff is also out there, but that is in addition to the routine annual reporting.  

And remember: if you already own an OZ, hopefully your tax advisor has been in contact about (a) whether the December 31, 2026 deadline matters to you and (b) if it does, how much it matters. If this is you, you likely have deferred taxes due for 2026.

Does An Offer In Compromise Survive A Taxpayer’s Death?

Today we will discuss offers in compromise:

§ 301.7122-1 Compromises.

(e) Acceptance of an offer to compromise a tax liability.

(1) An offer to compromise has not been accepted until the IRS issues a written notification of acceptance to the taxpayer or the taxpayer's representative.

Let’s talk about Jacqueline Farwell.

She had gotten herself into a tax mess for years 2008 through 2011, 2013 and 2015. The IRS had recorded a lien for almost $120 grand.

 She was deep into medical care and quickly burning thorough cash. She requested a CDP hearing and proposed an offer in compromise for $100.

COMMENT: We are so accustomed to the pennies-on-the dollar nonsense on radio and late-night television that we forget that real offers exist. Take an elderly person with diminishing assets, severe expenses, minimal or no likelihood to earn again and the IRS might accept $100. What the IRS won’t accept is a 40-something skipjack with plenty of earning power but an impaired sense of personal responsibility.

In February 2020 the IRS examiner requested updated financial information.

Farwell died in March 2020.

Nobody said anything.

In April 2020 the examiner told Farwell’s attorney that she advised accepting the offer.

Nobody said anything.

In September 2020 the IRS sent a letter that it had accepted the offer.

Nobody said anything.

Mind you, the IRS did not realize that Farwell was dead.

COMMENT: There may be reasons why the estate stalled - perhaps disagreement among the heirs, a delay in hiring lawyers, deciding who would have tax power of attorney. Still, it is … odd. I can see the IRS feeling manipulated.

In November 2020 the IRS realized her death and pulled the offer.

The estate asked Appeals to reinstate the offer. The IRS refused, arguing that mutual mistakes – not telling the IRS, for example - were made.

Off to Tax Court they went.

Our question is: does an offer in compromise survive the death of the taxpayer who requested it?

The estate argued that Regulations prevented the IRS from reopening the matter unless there was false information, concealment, or mutual mistake. The estate had that September letter and had no intention of giving it back.

COMMENT: Partially true. The IRS was prevented from reopening in the event there had been offer and acceptance.

The Code is not clear what happens when the taxpayer dies before acceptance. The Internal Revenue Manual however is.

5.8.7.5 (04-24-2025)

Termination of Consideration

1.      Consideration of an offer must be terminated upon the death of a single proponent. See IRM 5.8.10.4, Deceased Taxpayers and Estates. The date of termination is the taxpayer's date of death and the date used for the TC 482. If the taxpayer’s date of death is prior to the offer submission, refer to IRM 5.8.10.4.1, Death of a Taxpayer. Offers that are terminated do not receive appeal rights. See IRM 5.8.10.4.1, Death of a Taxpayer, for instructions on actions to take when advised that one party to a joint offer has died.

The estate was not impressed. The Internal Revenue Manual does not have the force of law, it hissed.

True, noted the Court, but it was in line with the statute and Regulations.

But we have a letter from the IRS accepting the compromise, the attorney whinged.

The letter was sent in error - one the estate contributed to - and the IRS was not bound by the error.

The attorney returned to the mutual mistake exception, arguing that mutual mistake was impossible as one of the parties was deceased.

The IRS repeated: look at Section 7122. An offer has to be accepted. Any extant powers expired when Farwell died, and there was a period after the death before an attorney was hired and a new power filed. A dead person cannot accept.

The IRS knew about Farwell’s terminal illness. You are accomplice to this, the attorney shrilled.

Methinks the attorney was losing it.

The IRS pointed out the obvious: have the estate submit its own offer in compromise. Farwell’s individual offer would wrap up, and the two sides could move to the estate’s offer. There is a whiff of common sense here ….

NO!! bayed the attorney.

Why? I presume that assets remained in the estate. Enough assets that the estate did not want to part with them.

Let’s return to Section 7122 at the top of this blog.

Requirement one: was there a written notice?

Maybe, possibly, perhaps that September letter, although one would be hard-pressed to argue that it had been sent to taxpayer’s representative.

Requirement two: was there acceptance of said notice?

No. Farwell had passed away. The estate had not yet named a new power. There was no one who could represent the estate at that instance.

The IRS won.

Our case this time was Estate of Jacqueline R. Farwell, U.S. Tax Court, No. 11555-22L, T.C. Memo 2026-95.

Personal Liability for Estate Taxes

 

Here is a greeting card for a bad day:

… the Internal Revenue Service … determined that the … Estate of Georgia M. Spenlinhauer (estate) is liable for an estate tax deficiency of $3,984,344.”

In general, when I see estate tax numbers of this size, I presume that there are hard-to-value assets. The estate will argue that the assets are illiquid, near unmarketable, and that it would be fortunate to get a thousand or two thousand dollars for them. The IRS of course will argue that the real numbers approach the GDP of many small countries. The Court will often decide somewhere between and call it a day.

Let me see what was at play.

• Whether the estate timely elected an alternative valuation date;
• Whether the estate may exclude $200,000 pursuant to a qualified conservation easement; 
• Whether the value of (yada, yada) was $5.8 million or $3.9 million.

So far it looks like another valuation pay per view Friday night fight.

• Whether the petitioner is liable as transferee for the estate tax deficiency.

That was unexpected.

What happened here?

In February 2005, Georgia Spenlinhauer passed away at the age of ninety-five. She appointed her son as executor. After paying expenses and specific bequests, the son/executor received the residue of the estate. Probate was closed in March 2009.

The executor/son requested and received an extension for the estate tax return until May 2006.

The accountant cautioned the executor/son that he did not have expertise in estate taxation and did not prepare or file estate tax returns as part of his practice.

As a practitioner myself, I get it. The executor/son had to find another practitioner – attorney or CPA – who did estate work.

The executor/son decided not to file an estate return.

COMMENT: I believe we have pinpointed the genesis of the problem.

In 2013 the executor/son filed for bankruptcy.

Through the bankruptcy proceeding, the IRS learned that he had never filed a tax return on behalf of the estate.

In 2017 he finally filed that estate tax return.

The return was audited.

In January 2018, the IRS disagreed with the numbers. It wanted money. It issued a Notice of Deficiency.

Of course.

In March, the IRS made a jeopardy assessment against the estate.

COMMENT:  Whoa! A jeopardy assessment usually indicates that the IRS suspects concealed assets or otherwise anticipates that a taxpayer will make collection difficult. Jeopardy makes the tax, penalty, and interest immediately due and payable. The IRS is authorized to begin immediate collection, without the usual taxpayer safeguards baked into the system.

A jeopardy assessment is not routine, folks.

Did I mention that the IRS was also simultaneously pursuing the assessment against the executor/son personally? Why? Because he had drained the estate to zero with the distribution to himself.

This would not turn out well. There are certain elections - such as an alternate valuation date - that must be made on a timely-filed return. Filing 11 years late is not a timely filing. There were the usual valuation disputes (I can use municipal assessment amounts as asset values! No, you cannot!). There was even a self-cancelling promissory note that got added to the estate (to the tune of $850 grand).

COMMENT: I have not seen a self-cancelling note in a moment. The attorneys worked hard on this estate.

A brutal audit adjustment involved certain litigation fees on an estate asset. The Court decided that the litigation benefited the executor/son and not the estate itself, meaning the estate could not deduct the fees. There went a quick half million dollars in deductions.

Yep, up the asset values, disallow certain deductions. The estate was going to owe - a lot.

And penalties.

The executor/son protested the penalties. To be fair, he had to. His argument?

He had relied on his accountant.

The same accountant who told him that he did not do estate work.

You gotta be kidding, said the Court. They approved the penalties in a hot minute.

There were no assets left in the estate, of course. How was the IRS to collect?

Oh no.

Oh yes.

The executor/son had exhausted the estate by distributing assets to himself. He had transferee liability to the extent of the assets distributed.

Personal liability.

This was not the routine valuation case that I first expected. This instead was closer to a Greek tragedy.

But why? The estate was large enough to obtain creative legal advice. A reasonable person must have suspected that there would be tax reporting, which work was beyond the skill set of the family’s regular accountant. Heck, the accountant was clear that he did not practice in this area. Rather than seek out another accountant (or attorney) with that skill set, the executor/son did … nothing.

Granted, the tax was the tax, whether the return had been timely filed or not. The additional weight was the penalties and interest. What were the penalties? I saw them near the beginning ….

$524,520.

Wow.

Our case this time was Estate of Spenlinhauer v Commissioner, T.C. Memo 2025-134.