IRS Clarifies Rural Qualified Opportunity Zones

On Sept. 30, the IRS issued Notice 2025-50, which provides guidance regarding certain changes to the rules regarding QOFs enacted by the One Big Beautiful Bill Act (OBBBA). Specifically, the notice identifies 3,309 rural areas within qualified opportunity zones (QOZs) designated in 2018 and provides much-needed guidance around the requirements to qualify for the reduced 50% substantial improvement requirement of previously used property.

Background

The QOF provisions originally were enacted by the Tax Cuts and Jobs Act of 2017 (TCJA). A QOF is an investment vehicle organized as a corporation or a partnership for the purpose of investing in QOZ property. A taxpayer can elect to temporarily defer and potentially partially exclude capital gains from gross income to the extent that the taxpayer invests the amount of those gains in a QOF. The U.S. Department of the Treasury designated certain low-income community population census tracts as QOZs in 2018. The OBBBA amended these provisions to provide added benefits for investments in QOZs that qualify as rural areas.

One of the requirements for property held by a QOF to be QOZ property is that either the original use of the property within a designated opportunity zone must commence with the QOF, or the QOF must substantially improve the property. Under the TCJA, property is treated as substantially improved only if, during any 30-month period following the date that the property is acquired, additions to the basis of the property in the hands of the QOF exceed 100% of the basis of the property at the beginning of such 30-month period (known as the 100%-of-basis requirement). The relevant Treasury regulations provide that the 100%-of-basis requirement applies only to the basis of the improvements on the property, excluding the basis of the land itself.

Notice 2025-50

For QOZ property located in a rural area, the OBBBA reduces the 100%-of-basis requirement to a 50%-of-basis requirement. This change means that for QOZ property that was previously used, additions to the basis of such property in the hands of the QOF are required to exceed only 50% of the basis of the property at the beginning of the relevant 30-month period. This reduced 50%-of-basis requirement is applicable for any substantial improvement determination that is made regarding QOZ property located in a rural area on or after July 4, 2025 (the date of enactment of the OBBBA).

Crowe observation

Unlike many of the other new opportunity zone provisions contained in the OBBBA that are not effective until 2027, the lower 50%-of-basis requirement is effective for substantial improvement determinations made on or after July 4, 2025, meaning that taxpayers already can take advantage of this beneficial rule. The lower 50%-of-basis requirement can mean the difference between an investment in an opportunity zone being economically viable or not.

The OBBBA defines a rural area as “any area other than (I) a city or town that has a population of greater than 50,000 inhabitants, and (II) any urbanized area contiguous and adjacent to a city or town described in subclause (I).” Some uncertainty exists regarding the proper interpretation of the terms “urbanized area” and “contiguous and adjacent” for this purpose.

Notice 2025-50 defines the term “urbanized area” as any area designated as an urban area by the 2020 census and the term “contiguous and adjacent” to mean geographic terms referring to two or more areas that share either a common boundary or at least one common point.

In addition to these definitions, the notice specifically enumerates 3,309 census tract numbers as rural areas.

The notice specifically states that it does not provide any guidance regarding the forthcoming round of opportunity zone nominations, certifications, and designations authorized by the OBBBA, which it says Treasury and the IRS will address in the future.

The notice’s guidance as to what constitutes a rural area and the definition of “contiguous and adjacent” provide taxpayers with more certainty regarding opportunity zone tracts that qualify for the reduced 50%-of-basis requirement.

Looking ahead

QOFs that have already purchased previously owned opportunity zone property in a rural area and have begun or will begin the 30-month substantial improvement period now can calculate their required improvements based on the lower 50%-of-basis requirement. For QOFs that are contemplating acquiring such a property, the financial modeling or underwriting for the property can use the more beneficial 50%-of-basis requirement to determine the amount of capital improvements that will be required to be made for the property within a 30-month period in order to be QOZ property. Taxpayers should consult their advisers to evaluate how the OBBBA changes to opportunity zones impact existing and future opportunity zone planning.