Under the Tax Cuts and Jobs Act of 2017, investors are permitted to defer the taxation of recognized capital gains by reinvesting those gains in one or more Qualified Opportunity Funds (QOF). These funds were created to promote long-term investment in designated Opportunity Zones – communities identified as needing economic development and revitalization. 

While the program offered meaningful tax incentives, the deferral of capital gains was always temporary. The deferred gain must be recognized upon the earlier of an “inclusion event” or Dec. 31, 2026, at which time the investors are treated as though they disposed of their QOF investment for tax purposes. 

For investors who have retained their QOF investments, the Mandatory Gain Inclusion Date of Dec. 31, 2026 is rapidly approaching. It is important to note that the recognition of deferred gain will occur even if the investor maintains their investment in QOF beyond that date.

Understanding how the mandatory inclusion amount is calculated – and how fair market value (FMV) is determined – can materially affect investor outcomes.

The gain recognized generally reflects the difference between the investor’s adjusted tax basis in the QOF interest and the amount realized, which is typically the lesser of the original deferred gain or the fair market value of the investor’s QOF interest as of Dec. 31, 2026. As a result, if the value of the investment has declined since the original deferral, the taxable gain may be limited by the lower FMV of the interest.

Basis adjustments and holding period considerations

Certain investors may benefit from basis adjustments tied to their holding period in the QOF. Investors who held their interests long enough were eligible for incremental basis increases designed to permanently exclude a portion of the originally deferred gain from taxation. A five-year holding period (measured from the date the QOF interest was acquired) provides a 10% basis increase, while a seven-year holding period provides a 15% basis increase. 

These adjustments permanently exclude a portion of the deferred gain from taxation, meaning longer-tenured investors generally face lower tax exposure than those who invested later in the OZ program.

Despite the upcoming recognition event, the program’s long-term incentive remains intact. Investors who continue to hold their QOF investments for at least 10 years may still elect to step up the basis of their investment to fair market value upon a future disposition, allowing appreciation after the original investment to be excluded from federal capital gains tax.

Why fair market value matters more than ever

Recent legislation has permanently codified Opportunity Zones and expanded reporting obligations for QOFs. As the Dec. 31, 2026, Mandatory Gain Inclusion Date approaches, the determination of FMV has taken on increased importance for Opportunity Zone investors. While QOFs periodically report asset values for compliance purposes, investors ultimately must determine the fair market value of their specific QOF interests when calculating the amount of deferred gain that must be recognized.  

Because the value of a QOF interest depends on a range of factors – including the performance of the underlying investments, current market conditions, and the rights (or lack of) associated with the ownership interest – the resulting valuation can have a meaningful impact on the investor’s tax liability. In situations where the reported value materially limits the gain recognized, the valuation approach may also attract greater scrutiny.

What does fair market value mean?

The IRS defines fair market value as the price at which property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell, and both having reasonable knowledge of relevant facts. 

Applying this concept to QOF interests requires consideration of both the value of the underlying assets and the characteristics of the ownership interest itself. While the economic performance of the underlying projects often drives overall value, the attributes of the investor’s position – such as control rights, liquidity, and structural restrictions – can also influence the price a hypothetical buyer would be willing to pay.

Market conditions, asset-level volatility, and valuation discounts

In many Opportunity Zone structures, the primary driver of value is the underlying real estate held within the QOF. Changes in property-level performance, financing conditions, and broader capital market dynamics can therefore have a meaningful effect on the value of the fund.

Because these investments are frequently financed with significant leverage, even relatively modest changes in the value of the underlying assets can produce disproportionate changes in the value of the equity held by investors. As a result, even small shifts in capitalization rates, operating performance, or financing costs may translate into meaningful changes in the net asset value of the fund and the corresponding value of the investor’s ownership interest.

Given this relationship, a credible and well-supported valuation of the underlying real estate assets often represents a critical component of determining the fair market value of a QOF interest.
Beyond the economics of the underlying assets, the characteristics of the ownership interest itself may also influence value. QOF interests are typically privately held, illiquid, and represent minority ownership positions within a larger fund structure.

A discount for lack of control may therefore be appropriate where minority investors lack the ability to influence key decisions such as asset sales, refinancing, distributions, or overall investment strategy. In addition, a discount for lack of marketability may reflect the practical limitations associated with selling a privately held interest in a fund where no active secondary market exists.

Together, these considerations – asset-level performance, capital structure dynamics, and ownership-level characteristics – play an important role in determining the fair market value of a QOF interest.  

Planning implications

The Dec. 31, 2026 Mandatory Gain Inclusion represents a defining moment for Opportunity Zone investors. For many investors, the inclusion will result in a significant taxable event, and importantly, this recognition may occur without a corresponding liquidity event. In other words, investors may be required to recognize and pay tax on deferred gains even if the underlying QOF investment has not been sold and no cash distributions are available to fund the resulting tax liability.

As a result, investors and fund sponsors should begin evaluating whether current internal valuations appropriately reflect fair market value and whether those values are consistent with the positions ultimately reported for tax purposes. Given the potential impact of valuation assumptions on taxable outcomes, the determination of fair market value will play a central role in shaping the final tax consequences of the inclusion event.

At the same time, the upcoming recognition event should not be viewed solely through the lens of valuation. The determination of fair market value is only one component of the broader tax implications. Investors should view the approaching inclusion date as an opportunity to evaluate their overall tax posture in advance of the recognition year.

From a planning perspective, investors may benefit from coordinating with their tax advisors to assess strategies that could help manage the resulting taxable income. This may include evaluating the timing of capital losses, accelerating deductions, utilizing available credits, or otherwise aligning tax attributes with the 2026 recognition event.

Given the complexity of many Opportunity Zone structures – and the potential magnitude of deferred gains being recognized – investors may find it beneficial to engage with qualified tax professionals, including CohnReznick tax specialists, who can evaluate these considerations holistically. A coordinated approach that incorporates valuation analysis alongside broader tax planning may help ensure that investors are positioned to navigate the 2026 inclusion event in a thoughtful and tax-efficient manner.