OZ Fund Structuring: Qualifying Investments, the 90% Test, and QOZB Requirements

Key Takeaways

What Is a Qualified Opportunity Fund

A Qualified Opportunity Fund is a corporation or partnership organized to invest in Qualified Opportunity Zone property. The concept was created by IRC Section 1400Z-2, enacted as part of the Tax Cuts and Jobs Act of 2017, and permanently extended by the One Big Beautiful Bill Act (OBBBA) signed July 4, 2025. A QOF is the exclusive vehicle through which investors access OZ tax benefits — deferral, basis step-up, and the 10-year exclusion of appreciation from taxable income.

Unlike LIHTC partnerships or New Markets Tax Credit allocatees, a QOF does not require government approval or a competitive allocation. It is self-certified by the fund manager on IRS Form 8996 (Qualified Opportunity Fund), filed annually with the fund's tax return. This self-certification model is intentionally low-friction, but it shifts compliance risk to the fund. If the fund fails the 90% asset test in any testing period, the IRS imposes a monthly penalty. There is no grace period for a missed 90% test, but limited relief exists: a reasonable-cause exception, a 6-month exclusion for newly contributed cash, a 12-month window to reinvest sale proceeds, and a one-time 6-month cure for a lower-tier QOZB.

For institutional CRE, the QOF is typically a limited partnership or multi-member LLC that holds one or more Qualified Opportunity Zone Business (QOZB) entities underneath it. The fund-level entity is where investors place capital. The QOZB-level entities hold the real estate. Getting this two-tier architecture right determines whether the fund's investments actually qualify — and whether investor capital gains receive the statutory benefits.

Entity Selection and Self-Certification

A QOF must be an entity classified as a corporation or a partnership for federal income tax purposes (including a multi-member LLC taxed as a partnership). An S corporation is classified as a corporation and Form 8996 attaches to Form 1120-S, so S corporations are eligible entities. A limited partnership or LLC taxed as a partnership offers three advantages:

• Pass-through taxation. Partnership income, losses, and deductions flow through to investors. No entity-level tax. This is essential because OZ investors are typically high-net-worth individuals or taxable entities that need the capital gains deferral at the individual level.
• Allocation flexibility. Partnership agreements allow custom allocation of income, gain, loss, and cash flow among partners — enabling GP/LP structures, preferred returns, and promote waterfalls that mirror standard CRE fund economics.
• Admission and redemption mechanics. Partners can be admitted at different times (each with their own 180-day investment window and holding period) without disrupting the fund's compliance status.

Self-certification happens by filing IRS Form 8996 with the fund's annual tax return. The form requires the fund to report its total assets, the value of qualifying OZ property, and whether it met the 90% test for each semi-annual testing period. Separately, IRC Section 6039K (added by the OBBBA) requires every QOF to file an annual return for taxable years beginning after July 4, 2025, with asset values, NAICS codes, residential unit counts, employee counts, and census tract detail for each investment.

There is no pre-approval, no allocation award letter, no state agency review. The fund simply declares itself a QOF on its first tax return and maintains compliance going forward. If it later fails, penalties apply retroactively to the testing period in which the failure occurred.

The 90% Asset Test

The defining compliance requirement for a QOF is the 90% asset test: at least 90% of the fund's total assets must be Qualified Opportunity Zone Property, measured on two semi-annual testing dates. The two testing dates are the last day of the sixth month and the last day of the taxable year. For a calendar-year fund, that means June 30 and December 31.

The 90% threshold is calculated as the average of the two semi-annual measurements. If the fund holds 85% qualifying assets on June 30 and 95% on December 31, the average is 90% — it passes. If the average falls below 90%, the fund faces a penalty.

Penalty calculation

The penalty for failing the 90% test is calculated monthly. For each month in which the fund falls below 90%, the penalty equals:

Shortfall Amount × Federal Underpayment Rate × (1/12)

The shortfall amount is the dollar amount by which the fund's qualifying assets fall below 90% of total assets. As an illustration at the 7% underpayment rate in effect for the fourth quarter of 2026 (the rate resets quarterly), a fund with $50M in total assets and only $40M in qualifying property (80% instead of 90%) would face a monthly penalty of approximately $29,167, or $350,000 annualized, on the $5M shortfall.

What counts as Qualified Opportunity Zone Property

Three categories of assets satisfy the 90% test:

1. Qualified Opportunity Zone Stock. Stock in a domestic corporation that is a QOZB, acquired by the QOF after December 31, 2017, at original issuance solely in exchange for cash.
2. Qualified Opportunity Zone Partnership Interest. A capital or profits interest in a domestic partnership that is a QOZB, acquired after December 31, 2017, solely in exchange for cash.
3. Qualified Opportunity Zone Business Property (QOZBP). Tangible property used in a trade or business of the QOF, acquired by purchase after December 31, 2017, whose original use in the zone commences with the QOF or which the QOF substantially improves, and where substantially all of the use of the property is in a qualified opportunity zone during substantially all of the QOF's holding period.

For property acquired after December 31, 2026, the December 31, 2017 date is replaced by the January 1 start date of the zone's designation period.

Options 1 and 2 hold QOZB interests rather than real estate directly. This is the two-tier structure, and it provides operational and compliance advantages.

The Two-Tier QOF / QOZB Structure

In a single-tier structure, the QOF holds real property directly and must satisfy both the 90% asset test at the fund level and all the QOZBP requirements (original use, substantial improvement, location) for each property. In a two-tier structure, the QOF holds equity interests in one or more QOZBs, and the QOZB entities hold the real estate.

The two-tier architecture addresses several structural problems:

• Compartmentalization. Each property sits in its own QOZB LLC, and each QOZB is tested separately. If one QOZB fails a compliance test (say, the property is partially located outside the zone boundary), the value of the QOF's interest in that QOZB drops out of the 90% numerator, while the QOF's other QOZB interests are unaffected. The regulations also let the QOF count an interest if the entity was a QOZB for at least 90% of the QOF's holding period, and allow a one-time 6-month cure.
• Capital deployment timing. The fund can acquire QOZB interests as properties are identified, without having to deploy 90% of capital on day one. As long as the QOZB interests collectively meet the 90% test on the semi-annual testing dates, the fund is compliant.
• Disposition flexibility. Individual properties can be sold by selling the QOZB interest or having the QOZB sell the property, without unwinding the fund structure. This matters for 10-year hold planning.
• Mixed investor timelines. Different investors enter the QOF at different times (each within their 180-day window). The two-tier structure allows the fund to accept new capital and deploy it into new or existing QOZBs without disrupting existing investors' holding periods.

QOZB requirements

A QOZB must satisfy four tests. QOZB status is determined at the end of the QOZB's taxable year and applies for that entire year. The QOF's stock or partnership interest qualifies only if the entity is a QOZB for at least 90% of the time the QOF holds the interest:

Table 1. The four QOZB qualification tests. The 70% test measures tangible property owned or leased by the QOZB. The sin business exclusion eliminates specific asset types entirely.

The critical distinction: the QOF has a 90% test (fund-level), and the QOZB has a 70% test (entity-level). The QOF's 90% test looks at the value of its QOZB interests. The QOZB's 70% test looks at the tangible property inside the QOZB. Both must be satisfied: the QOF at each semi-annual testing date, the QOZB as of the end of each of its taxable years.

The Substantial Improvement Test

For existing buildings (as opposed to ground-up development on vacant land), a QOF or QOZB must substantially improve the property within a 30-month period beginning after acquisition. Under the Treasury Department's final regulations (T.D. 9889, 85 Fed. Reg. 1866, Jan. 13, 2020), the standard rule requires additions to basis that exceed the property's adjusted basis at the start of the 30-month period, effectively doubling the investment in the building.

Crucially, the substantial improvement test applies to the building only, not the land. If a fund acquires a property for $8M — $3M allocated to land and $5M to the building — the improvement requirement is $5M in building improvements within 30 months. The land basis is excluded from the calculation.

How the test works in practice

The 30-month period can begin any time after the date the QOF or QOZB acquires the property. Improvement costs are measured by additions to basis: capital expenditures that are added to the depreciable basis of the property, not operating expenses or maintenance. Soft costs (architecture, engineering, permitting) count toward the improvement threshold if they are capitalized into the building's basis rather than expensed.

For ground-up construction on vacant land, the substantial improvement test does not apply. The property has no existing structure, so the "original use" of the building begins with the QOF. Original-use property automatically qualifies as QOZBP without needing to meet the doubling threshold.

Working Capital Safe Harbor

The working capital safe harbor allows a QOZB to hold cash and cash equivalents (which would otherwise be nonqualified financial property) without violating the 5% financial property limit, provided three conditions are met:

1. Written plan. The QOZB must have a written plan that identifies the working capital as being held for the acquisition, construction, or substantial improvement of tangible property in the OZ.
2. Written schedule. The plan must include a schedule showing that the working capital will be spent within 31 months.
3. Compliance with schedule. The QOZB must substantially comply with the written schedule.

The 31-month window is tight for complex CRE developments. A ground-up multifamily project with 18 months of entitlement, 16 months of construction, and a 6-month lease-up period runs 40 months from capital deployment to stabilization. The safe harbor, however, tests when the designated cash is spent, not when the project stabilizes. Lease-up months do not count, but the 34 months of spending (18 + 16) still exceed 31 unless delay waiting on a complete governmental application applies or a second application covers the excess. Delay caused by waiting on governmental action on an application that is complete, such as an entitlement approval, does not cause a failure of the safe harbor.

The regulations (T.D. 9889) allow a business to benefit from multiple overlapping or sequential applications of the safe harbor, for a total of up to 62 months. Each application must independently satisfy the written plan, written schedule, and consistent-spending requirements, the cash from an expiring 31-month period must have been spent in accordance with its plan, each application must include a substantial amount of working capital assets, and the subsequent infusions must form an integral part of the plan covered by the initial period. A business in a federally declared disaster zone may receive up to an additional 24 months. Practitioners also use phased capital calls that deploy cash only when the schedule can be met, and bridge financing that holds cash outside the QOZB until needed.

OBBBA 2025: OZ 2.0 Changes

The One Big Beautiful Bill Act, signed July 4, 2025, permanently extended the Opportunity Zone program and introduced several changes that directly affect fund structuring:

Permanent extension

The program was set to expire at the end of 2028 (when current zone designations lapse). The OBBBA made the program permanent with rolling 10-year zone designations. The first determination date was July 1, 2026, and a new one follows each July 1 ten years later. A State's chief executive officer nominates tracts during a 90-day determination period (extendable by 30 days), Treasury certifies the nominations, and each designation takes effect on the following January 1 and remains in effect for 10 years. Designations certified in 2026 therefore take effect on January 1, 2027.

Qualified Rural Opportunity Funds (QROFs)

The OBBBA created a new fund category for investments in rural areas, along with a separate rural rule for substantial improvement:

• 30% basis step-up. For investments made after December 31, 2026, QROF investors receive a 30% basis step-up at the 5-year mark (vs. 10% for other QOF investments under OZ 2.0). A QROF is a QOF that holds at least 90% of its assets in qualifying property in a qualified opportunity zone comprised entirely of a rural area, measured under rules similar to the 90% test.
• 50% substantial improvement threshold. This rule is separate from QROF status. Property in a qualified opportunity zone comprised entirely of a rural area needs improvements of only 50% of adjusted basis (vs. 100% for other OZ property), effective July 4, 2025. This makes acquisition-rehab deals more viable in rural zones.

Enhanced reporting requirements

Beginning with taxable years beginning after July 4, 2025, QOFs must file the annual return required by IRC Section 6039K, at the time and in the manner the Secretary prescribes. The statute lists:

• Total assets and QOZ property held on each 90% test date
• For each QOZB investment: NAICS codes, census tracts, and the value of owned and leased tangible property
• Approximate number of residential units for real property
• Approximate average monthly number of full-time equivalent employees
• Each person who disposed of an investment in the QOF during the year

These reporting requirements signal the Treasury Department's intent to measure community impact more rigorously. IRS forms and instructions govern the form and timing of the return. Fund managers should build reporting infrastructure now.

Elimination of 7-year basis step-up

For investments made after December 31, 2026, the OBBBA eliminated the additional 5% basis step-up that investors received at the 7-year holding mark. Only the 5-year step-up of 10% remains (or 30% for QROFs).

Under the pre-2027 statute, gain deferred by an OZ 1.0 investment is included on December 31, 2026, or on an earlier sale. The 10% step-up required a five-year hold, so an investment made by December 31, 2021. The additional 5% required a seven-year hold, so an investment made by December 31, 2019. A new investment made in 2026 receives neither step-up and is taxed on the deferred gain as of December 31, 2026. For investments made after December 31, 2026, the fixed date is replaced by a rolling one: the deferred gain is included on the earlier of the sale or exchange of the investment or the date 5 years after the investment was made.

Common Mistakes

These errors show up repeatedly in QOF formation and compliance — some are fatal, others are merely expensive:

• Deploying capital before the fund is organized. A QOF must be an entity organized for the purpose of investing in QOZ property. If you acquire property first and then form the QOF, the property was not "acquired by purchase" by the QOF. The timing sequence is: form the entity, fix the QOF's first effective month (reported on Form 8996 with the first tax return), and receive investor capital only in or after that month. Investments made before the entity's first month as a QOF are non-qualifying.
• Confusing the 90% test with a one-time test. The 90% test is semi-annual and ongoing, and it is measured as the average of the two testing-date percentages. A fund that sells a property and holds the proceeds in non-qualifying assets can pull the average below 90% in a later year. Sale proceeds are treated as qualifying if reinvested within 12 months and held in cash, cash equivalents, or debt instruments with a term of 18 months or less until then. Compliance is perpetual, not point-in-time.
• Ignoring the 31-month working capital constraint. A development schedule can run longer than 31 months from capital call to stabilization. Holding $20M in cash inside a QOZB without a qualifying safe harbor plan turns that cash into nonqualified financial property, potentially failing the 5% test and disqualifying the QOZB. Plan for the 62-month maximum from the start by documenting each application of the safe harbor.
• Failing the substantial improvement test by excluding soft costs. Architecture, engineering, and permitting fees count toward the improvement threshold if capitalized. A sponsor that tracks only hard construction costs against the doubling requirement can discover at the 30-month mark that it is short. Build the soft cost inclusion into your improvement tracking from day one.
• Assuming the two-tier structure isolates failures. In either structure, a property or QOZB that stops qualifying drops out of the QOF's 90% numerator. The two-tier structure adds separate entity-level testing, the 90%-of-holding-period safe harbor, and the one-time 6-month cure, at the cost of additional entities and QOZB-level compliance tracking.
• Missing the land exclusion in the substantial improvement test. The improvement must exceed 100% (or 50% for property in a rural zone) of the building's adjusted basis, not the total purchase price including land. Getting this wrong means the sponsor may over-improve or under-report compliance.
• Not planning for the 2026 transition. Existing OZ 1.0 investors face a mandatory gain recognition event on December 31, 2026, as specified in IRC Section 1400Z-2(b)(1). Funds should be advising investors now on the tax impact, potential reinvestment into OZ 2.0 QOFs, and valuation strategies.

How to Model It

A properly built OZ fund model needs compliance tracking alongside the financial pro forma. Here's what the workbook should contain:

Fund-Level Compliance Tab

Semi-annual asset test calculation: total fund assets on each testing date, broken into qualifying (QOZB interests, QOZBP) and non-qualifying (cash, receivables, other). The 90% test result, and if failing, the shortfall amount and penalty calculation. This tab should have a row for every June 30 and December 31 over the fund's projected life.

QOZB-Level Compliance Tab (one per property)

The 70% tangible property test: unadjusted cost basis of all tangible property, with OZ-located QOZBP broken out. The 50% gross income test. The 5% nonqualified financial property test. Working capital safe harbor tracking: amount designated, written plan date, 31-month expiration date, and actual spend schedule against the plan.

Substantial Improvement Tracker

Purchase price allocation (land vs. building), adjusted building basis at acquisition, cumulative improvement expenditures by month (hard costs and capitalized soft costs), 30-month deadline, and compliance percentage (current spend / required threshold). This tab should flag when the fund is within 6 months of the deadline and below 75% of the improvement target.

Investor-Level Waterfall

Each investor's entry date, 180-day window, deferred gain amount, holding period start date, 5-year step-up date, 10-year FMV exclusion date, and projected after-tax returns under multiple exit scenarios. For OZ 1.0 investors, include the December 31, 2026 recognition event and the tax liability calculation.

Related Articles

This article is part of the Opportunity Zones underwriting series. Each article covers a distinct aspect of OZ deal structuring and investor economics:

• OZ Fund Structuring — Qualifying investment requirements, the 90% asset test, and QOZB compliance (this article).
• Investor Returns and Tax Deferral — Capital gains deferral mechanics, the December 2026 recognition event, and after-tax IRR analysis.
• Exit Timing and Disposition — The 10-year hold requirement, FMV election mechanics, and disposition planning.
• Development vs Acquisition — Original use vs. substantial improvement, vacant land rules, and choosing the right project type.