Opportunity Zone Tax Coming Due: Deferred Gain and Form 8997

What comes due at the end of the deferral, and where is it reported?

Every opportunity zone investment made before January 1, 2027 and still held on December 31, 2026 triggers tax on its remaining deferred gain on that date. The gain goes on the return for the year that includes that date, the one filed in the following spring. Notice 2026-40, section 4.01, confirms that the law change in Public Law 119-21 did not move this date for earlier investments.

The included gain keeps the character of the gain you deferred: short-term stays short-term and long-term stays long-term, as the Form 8949 instructions state. It is taxed at the capital gains rates for that character, up to 20% for long-term gain, plus any state tax. You report it on Form 8949 and on Form 8997, Part III. The IRS's early release draft of the next Form 8997 adds a section for gain recognized because the deferral period ended. Use the final form and instructions when they are released.

Three things make a case harder than it looks:

• A fund that is a partnership or S corporation. The value test is a hypothetical taxable sale; in a partnership, that sale counts your share of fund debt.
• Missing Forms 8997. A year with no report creates a rebuttable presumption that an inclusion event happened that year.
• No cash. The tax is due with or without a distribution from the fund.

Gather your Forms 8949 and 8997 since you invested and the fund's year-end value, capital and debt figures; the full list is under What should I gather?

A CPA can figure the inclusion from the fund's figures, rebuild missing Forms 8997 and plan the payment; see fund investor tax services.

I skipped Form 8997 in some years, or the IRS says my fund was not qualified: is my deferral at risk?

It can be. Under 26 CFR 1.1400Z2(a)-1(d)(2), a year with no annual report creates a rebuttable presumption that an inclusion event happened that year. An inclusion event is an event, such as a sale or gift, that ends the deferral early. Until you rebut the presumption, the IRS may treat the deferred gain as taxable in the year you skipped, not on December 31, 2026.

You rebut the presumption by making the report, or by showing the IRS that no inclusion event occurred. The regulation and the Form 8997 instructions do not say how a late report is made. One way is an amended return (Form 1040-X) for each missed year, with a completed Form 8997. Each year's Form 8997 must show the holdings at the start of the year, any events during the year and the holdings at year end, so the years must agree with each other.

A separate problem arises when the IRS says the fund itself was not a qualified opportunity fund. A fund certifies itself each year on Form 8996. If the fund missed that, investors can receive IRS notices saying the fund's employer identification number on their Forms 8997 is not linked to a certified fund. In private letter ruling 202324006, a fund in that position asked for, and received, more time to make its certification under the Treasury's late-election relief rules. A letter ruling applies only to the taxpayer who asked for it. The fund's side of that fix is covered in setting up a qualified opportunity fund.

If a fund actually loses its status, that is itself an inclusion event under 26 CFR 1.1400Z2(b)-1(c)(1)(iv). Ask the fund for its Form 8996 filings before you answer any notice.

How is the amount figured?

The amount you include is the smaller of two figures, less your basis from the holding-period increases:

1. the remaining deferred gain, or
2. the fair market value of the investment on December 31, 2026.

That is the rule in 26 CFR 1.1400Z2(b)-1(e)(3). Your starting basis in the investment is zero, so the basis that counts here is the increase you earned by holding it.

The two increases come from 26 CFR 1.1400Z2(b)-1(g)(2) and the IRS's opportunity zone questions and answers, Q5. Form 8997 uses special gain code G for the 5-year increase and H for the 7-year increase.

When the fund is a partnership or S corporation

For a fund that is a partnership or S corporation, the second figure is not the plain value. Under 26 CFR 1.1400Z2(b)-1(e)(4), you include the smaller of:

• the remaining deferred gain less the basis increases, or
• the gain you would recognize on a fully taxable sale of your interest at fair market value.

A partner's taxable sale counts the partner's share of fund debt as part of what the partner receives. Your basis also includes that debt share, but it is reduced by losses passed through on your Schedules K-1, such as depreciation, and by distributions. When losses have pulled your basis down, the hypothetical gain can be much larger than the cash value of your interest. A drop in value then may not lower the inclusion as much as you expect. For how basis works, see how partnerships are taxed.

My fund lost value: who sets the value, and what supports a lower number?

You do. No IRS form sets the value of your fund interest, and the regulations do not prescribe a valuation method for this inclusion. The value you use is your position, and you need records that support it if the IRS asks.

Ask the fund for:

• a statement of the fair market value of your interest at December 31, 2026, and how the fund reached it;
• your capital account statement at the same date;
• for a partnership, your share of fund liabilities and your basis, so the hypothetical-sale figure can be checked.

A lower value helps only when it is lower than the deferred gain less the basis increase. Where the figures are close, or the value is disputed, the choice of value carries real tax risk and is worth professional review.

Did an inclusion event, such as a sale, gift, distribution or refinance, already make the gain taxable?

Possibly. The deferral ends early on an inclusion event, and the regulations list many. The common ones for individual investors:

The refinance case catches investors who never sold anything. Example 11 in 26 CFR 1.1400Z2(b)-1(f) shows a partner who receives a cash distribution funded by a loan allocated to another partner. The distribution exceeds that partner's basis, so the excess is included that year. Any gain already included through an earlier event is not included again on December 31, 2026.

At death, the deferred gain passes with the investment. It is taxed to whoever holds the investment because of the death, the estate or the heir it passes to, at a later inclusion event, under (c)(4)(iii), or on December 31, 2026 if that comes first, because the investment stays a qualifying investment in that holder's hands under (c)(4)(iv). An estate that still holds the interest on that date reports the gain on its own income tax return. For the heir's basis and the year-of-death Schedule K-1, see inheriting a fund interest.

I invested through a partnership or S corporation: who reports the inclusion?

It depends on who made the deferral election. If a partnership elected to defer its own gain and made the fund investment, the partnership includes the gain and passes it to its partners on Schedule K-1, under 26 CFR 1.1400Z2(a)-1(c)(7). The same applies when partners contributed their fund interests to a partnership: the partnership recognizes the gain on December 31, 2026 and allocates it to the partners whose gain it was (example in 26 CFR 1.1400Z2(b)-1(c)(6)(ii)(D)). An S corporation that made the election reports the gain to its shareholders the same way, under 26 CFR 1.1400Z2(a)-1(c)(9).

If the partnership did not elect, and you invested your own share of a gain shown on your Schedule K-1, the election was yours. You report the inclusion on your own Forms 8949 and 8997.

If a Schedule K-1 that carries the inclusion arrives late, see late fund tax forms.

The fund pays no cash: how do I pay, and do my estimates need to change?

The tax is due with your return whether or not the fund distributes anything. Plan the cash before the return due date.

To avoid the estimated tax penalty, your payments generally need to reach 90% of this year's tax or 100% of last year's tax. The prior-year figure rises to 110% if last year's adjusted gross income was over $150,000, as Publication 505 explains. Meeting the prior-year test can protect you from the penalty even when the inclusion makes this year's tax much larger.

If you do not meet that test, the annualized income installment method may help. The Form 2210 instructions name a large capital gain late in the year as a reason to use it, and the last annualization period runs through December 31. Income that arises on December 31 then falls into the installment due January 15, 2027. How the two methods work is covered in estimated tax payments.

If you cannot pay in full, the IRS offers payment plans, but penalties and interest keep accruing until the balance is paid.

Does my state tax it, and what if I moved?

It depends on the state. California does not follow the federal deferral. Its Schedule D (540) instructions tell taxpayers to report the entire gain in the year it arose, and not to include it again in a later year if it was already taxed for California. A California resident who deferred federally may therefore owe no California tax on the federal inclusion.

Other states follow the federal deferral or not under their own laws; check each state you lived in. If you moved between the year you invested and the inclusion, one state may have taxed the gain when it arose and another may tax the inclusion, or neither may. Verify with both states before you file. Which states your fund's Schedules K-1 require is covered in state returns for fund investors.

Do I keep filing Form 8997 after the inclusion?

Yes. You file Form 8997 with your timely return, including extensions, for every year you hold a qualifying investment (a fund investment made with deferred gain), under the form's Who Must File instructions. After the inclusion, the investment remains a qualifying investment and your deferral election stays in effect, as Notice 2026-40, section 4.01(2), states.

Skipping the form later carries the same risk as before: a rebuttable presumption of an inclusion event in that year.

Can I defer the included gain again in a new opportunity zone fund?

No. Notice 2026-40, section 4.01(2), says gain included on December 31, 2026 cannot be deferred again, under the old or the new rules, because the original election is still in effect.

Gain from an earlier inclusion event is different. Under section 4.03, if you sell your fund interest before the deferral ends, the gain included because of that sale can be deferred again by investing within 180 days of the sale. The portion sold then loses its 10-year benefit. If you reinvest before January 1, 2027, the new investment's gain is still included on December 31, 2026. Only a reinvestment on or after January 1, 2027, within the 180 days, defers it under the new 5-year rule.

Gain invested on or after January 1, 2027 follows the amended rules, with a 5-year deferral period. Whether a new gain should go into an opportunity zone fund or a 1031 exchange is covered in like-kind exchange or opportunity zone fund.

Does the 10-year exclusion survive the inclusion?

Yes. Notice 2026-40, section 4.01(3), says that because the election stays in effect, you may still elect on a later sale, after holding at least 10 years, to treat your basis as the investment's fair market value. That election can exclude the appreciation from tax. You must meet the holding period and the other requirements through the date you sell. The exclusion is federal. California does not follow it, so a California resident still reports the appreciation on the California return when the investment is sold.

Your basis also rises by the amount you include, under 26 CFR 1.1400Z2(b)-1(g)(1), so the same gain is not taxed twice. For investments made before January 1, 2027, a zone's designation ending does not by itself block the election for sales on or before December 31, 2047, under 26 CFR 1.1400Z2(c)-1(c).

When the fund later sells its property and sends a final Schedule K-1, see final fund tax form.

What should I gather?

• Each Form 8949 showing the deferral (code Z) and every Form 8997 filed since you invested.
• The fund's name, employer identification number and the date of each investment.
• Fund statements: year-end value at December 31, 2026, capital account, share of liabilities and basis.
• Every Schedule K-1 since you invested, and records of any distribution, gift, transfer or sale.
• The fund's Form 8996 confirmation, and any IRS notice about the fund.
• Last year's return, for the estimated tax safe harbor.

Example

These scenarios use round, illustrative figures in US dollars. Each assumes the fund allocated no income or loss and made no distribution unless stated.

A fund that lost value, with no debt

In November 2019, an investor put a $1,000,000 stock gain into a real estate fund organized as a limited partnership with no debt. On December 31, 2026, the interest is worth $600,000.

• Held at least 7 years: basis increase of 15%, or $150,000.
• First figure: $1,000,000 deferred gain less $150,000 = $850,000.
• Second figure: taxable sale at $600,000, less basis of $150,000 = $450,000.
• The investor includes $450,000, not $850,000, as long-term capital gain if the stock gain was long-term.
• If all of it is taxed at the 20% long-term rate, federal income tax on it is $90,000, before any state tax.

The fund pays no cash, so the investor pays the tax from other funds.

A fund with debt and depreciation losses

In October 2019, an investor put a $200,000 gain into a partnership fund. The investor's share of fund debt is $300,000, and the investor has been allocated $250,000 of depreciation losses. On December 31, 2026, the interest is worth $100,000.

• Basis: $300,000 debt share + $30,000 increase (15%) − $250,000 losses = $80,000.
• Hypothetical sale: $100,000 value + $300,000 debt relief − $80,000 basis = $320,000.
• First figure: $200,000 − $30,000 = $170,000.
• The investor includes $170,000. Using the plain value instead ($100,000 less the $30,000 increase) would give $70,000, which is too low: the debt the investor would be relieved of counts as sale proceeds.

Different for you?

• Several funds, missing Forms 8997 or a value you need to defend: fund investor tax services.
• Your Schedules K-1 come after April 15: late fund tax forms.
• You need to size estimated payments: estimated tax payments.
• Your fund's K-1s show several states: state returns for fund investors.
• You have a new gain to place: like-kind exchange or opportunity zone fund.
• You run the fund and it missed Form 8996: setting up a qualified opportunity fund.
• You inherited the fund interest: inheriting a fund interest.
• You lived in Canada or another country when you made the gain, or live there now: the other country may tax it at a different time; see cross-border tax services.
• The fund sold its property: final fund tax form.
• You hold many fund investments: choosing a CPA for many fund investments.