Sandra F. O’Neill

The One Big Beautiful Bill Act (the “Act”) that President Trump signed into law on July 4th provides a number of enhanced tax incentives for investors in qualifying real estate and small businesses that will likely stimulate further investment in these areas. The Act expands incentives offered in Qualified Opportunity Zones to facilitate real estate renewal in lower income and rural areas. The Act also increases the tax-exemption for original investment in active small businesses, so called qualified small business stock. Below is a summary of these measures.

Qualified Opportunity Zones

A significant portion of the Act is devoted to the renewal and enhancement of the Qualified Opportunity Zone (“QOZ”) tax benefits created under President Trump’s Tax Cut and Job’s Act of 2017. The Act makes the QOZ capital gains deferral benefit (originally set to expire in 2026) permanent. It also beefs up the reporting requirements for QOZs. The 2026 sunset of the original capital gains deferral benefit deterred many from exploring QOZ investments. As a permanent measure, the provisions will likely be more useful to real estate investors.

Qualified Opportunity Zone Designation. Under the Act, every 10 years, state governors will propose new qualified opportunity zones, and the Treasury Secretary will certify these zones. Once certified, each census tract will remain a QOZ for 10 years beginning January first of the following year. The Act tightens the rules around which census tracts can qualify as a QOZ. The original law allowed a census tract to be part of the QOZ if it had a poverty rate of at least 20% or median family income did not exceed 80% of the applicable state or metropolitan area median family income. Under the Act, census tracts will qualify as QOZs only if median family income does not exceed 70% of the applicable state or metropolitan area median family income or if the tract has a poverty rate of at least 20%. The new rules deny QOZ treatment to census tracts qualifying based on the 20% poverty rate test if the tract’s median family income exceeds 125% of applicable state or metropolitan area median family income (a so-called “anti-gentrification rule”). The Act also eliminates the designation of tracts contiguous with low-income communities as QOZs and repeals the designation for all low-income communities in Puerto Rico.

Tax Benefit to Qualified Opportunity Funds. Under the Act, Taxpayers who reinvest gains from the sale of other investments (including stock) in Qualified Opportunity Funds (“QOFs”) can elect to defer their gains for five years (or if earlier, the year of the QOF disposition). QOFs are funds that invest in the QOZs described above. If the taxpayer holds the investment in a QOF for at least five years, their deferred gain is reduced by 10%. The deferred gain is reduced by 30% if the taxpayer invests in a newly-designated qualified rural opportunity fund. A rural area for purposes of the qualified rural opportunity fund is defined as any area other than a city or town that has a population of greater than 50,000 inhabitants or any urbanized area contiguous and adjacent to such a city or town.

The Act extends the original law’s tax exemption related to future gains from the sale of a QOF investment. The original rule applies: if a taxpayer holds his investment in a QOF for at least 10 years, the taxpayer will have no further gain (other than the deferred rollover gain) on the subsequent sale of the investment property. If a taxpayer holds his investment in a QOF for 30 years or more, the taxpayer’s gain is limited to the excess of the fair market value of the investment on the date of sale over the fair market value of the investment on the 30^th anniversary of the date of investment.

Enhanced Reporting. The Act requires annual information reporting by QOFs and qualified rural opportunity funds. The disclosures include: the value of assets held and the value of QOZ property held; detailed information about investments in QOZ stock or QOZ partnership interests, such as the number of residential units for real property holdings; and average monthly number of full-time equivalent employees for QOF trades or business in which the QOZ business property is held. The Act imposes penalties for failure to file these new returns of up to $10,000 for QOF returns and $50,000 for large QOF returns.

Qualified Small Business Stock

The Act separately expands the tax exemption for individual investments in qualified small business stock (“QSBS”). Prior to the Act, individual taxpayers received a significant capital gains tax exemption if they invested in the stock of businesses that met the QSBS requirements and held their QSBS shares for at least five years. On subsequent sale of the QSBS shares, these individual taxpayers could exempt from capital gains tax the greater of $10 million for each QSBS investment or 10 times the investor’s basis in the QSBS shares (the “Exclusion Cap”). The Act increases the Exclusion Cap on QSBS shares for individual investors to the greater of $15,000,000 for each QSBS investment or 10 times the investor’s basis in the QSBS (the “New Exclusion Cap”). The Act allows for inflation indexing of this New Exclusion Cap beginning in 2027.

The Act also expands the QSBS benefits by reducing the holding period required for capital gains exemption. A taxpayer will now be able to exempt 75% of New Exclusion Cap from capital gains tax if he holds QSBS stock for at least four years, or 50% of the New Exclusion Cap from capital gains tax, if he holds the QSBS stock for at least three years.

What is QSBS? QSBS is stock issued by a domestic (subchapter C) corporation whose assets are deployed in a “qualified trade or business.” A qualified trade or business is defined in the negative to exclude professional activities, consulting, athletics, brokerage services, banking, insurance, financing, leasing, investing, farming, mining, hotels, restaurants, and activities where the principal asset of the business is the reputation or skill of one or more of its employees. Technology companies and biotech companies usually qualify for QSBS treatment.

To qualify for the QSBS capital gains tax exemption, the individual taxpayer must invest cash, property, or services in exchange for shares issued directly by a qualifying corporation. A taxpayer’s purchase of shares from a party other than the corporation itself does not qualify for the QSBS capital gains tax exemption. Prior to the Act, a business would only qualify for QSBS treatment if the value of its gross assets did not exceed $50,000,000 before and at the time of stock issuance to the taxpayer. The Act increases the asset threshold for QSBS treatment to $75,000,000. As a result, taxpayers can now benefit from the QSBS treatment for investments in corporations with gross assets valued at up to $75 million at the time of stock issuance.

Upshot

The qualified opportunity zone changes generally take effect on January 1, 2027. The QSBS changes take effect in July 2025. The qualified opportunity zone tax benefits provide a permanent avenue for tax breaks with real estate investments in economically disadvantaged and rural areas that should entice new investors. The enhanced benefits to QSBS treatment should encourage investment in capital intensive businesses. The qualified opportunity zone gain exemption and QSBS capital gain exemption should also help continue to mobilize capital investment in real estate and technology, especially if interest rates decrease.

Sandra F. O’Neill is a shareholder in the Corporate Group at Sheehan Phinney.