IRS Clarifies Rural Property Provisions for Qualified Opportunity Zone Investments

(Parker Tax Publishing October 2025)

The IRS issued guidance on qualified opportunity zone (QOZ) investments in rural areas as provided under the One Big Beautiful Bill Act (OBBBA) (Pub. L. 119-21). The guidance clarifies two important OBBBA provisions: (1) the application of the substantial improvement threshold for certain enhancements to property located in a QOZ that is comprised entirely of a rural area, and (2) the definition of "rural area." Notice 2025-50.

Background

The Tax Cuts and Jobs Act of 2017 (Pub. L. 115-97) added Code Sec. 1400Z-1 and Code Sec. 1400Z-2. Code Sec. 1400Z-1 outlines the process by which a population census tract located in the 50 states, the District of Columbia, or U.S. territories that is a low-income community is nominated to be a qualified opportunity zone (QOZ). Taxpayers who invest in QOZs receive certain tax benefits for their investments as an incentive to improve economic growth and job creation in these underserved communities. Notice 2018-48 and Notice 2019-42 list census tracts that were nominated in 2018, and were certified and designated as QOZs (2018 QOZs). The 2018 QOZs were based on census tracts and boundaries based on the 2010 Decennial Census. No census tract has been designated as a QOZ since the designations of the 2018 QOZs.

Under Code Sec. 1400Z-2, special rules are provided for capital gains invested in opportunity zones, including certain investment vehicles known as qualified opportunity funds (QOFs). A QOF is defined in Code Sec. 1400Z-2(d)(1) as any investment vehicle that is organized as a corporation or a partnership for the purpose of investing in qualified opportunity zone property (QOZP) and that holds at least 90 percent of its assets in a QOZP. Under Code Sec. 1400Z-2(d)(2), a QOZP includes, among other things, "qualified opportunity zone business property" (QOZBP). Property qualifies as QOZBP only if, among other requirements, the original use of the tangible property in the 2018 QOZ began with that eligible entity or that eligible entity substantially improves the property. Such tangible property is treated as substantially improved only if, during any 30-month period following the acquisition of the property (30-month period), additions to the basis of the tangible property in the hands of the eligible entity exceed an amount equal to 100 percent of the eligible entity's adjusted basis in the tangible property at the beginning of the 30-month period.

The One Big Beautiful Bill Act (OBBBA) (Pub. L. 119-21) amended Code Sec. 1400Z-2(d)(2) to modify the general substantial improvement threshold for improvements to property located in a QOZ that is comprised entirely of a rural area. The OBBBA amendment reduced the substantial improvement threshold for required additions to the basis for such property from 100 percent to 50 percent, effective July 4, 2025. Under OBBBA, a "rural area" means any area other than a city or town with a population greater than 50,000, and any urbanized area contiguous and adjacent to a city or town with a population greater than 50,000. The codification of the definition of "rural area" applies to amounts invested in QOFs after December 31, 2026.

Notice 2025-50

On September 30, the IRS issued Notice 2025-50. The Notice clarifies two important OBBBA provisions in Code Sec. 1400Z-2(d): (1) the application of the substantial improvement threshold for certain improvements to property located in a QOZ that is comprised entirely of a rural area, and (2) the definition of "rural area."

Notice 2025-50 applies to all tangible property located in a 2018 QOZ that is comprised entirely of a rural area that has been, or is in the process of being, substantially improved. The Notice provides that, for any determination made on or after July 4, 2025, as to whether any tangible property located in a 2018 QOZ comprised entirely of a rural area meets the substantial improvement test described in Code Sec.1400Z-2(d)(2)(D)(ii), the substantial improvement test is satisfied if the additions to basis with respect to such property in the hands of the QOF or a qualified opportunity zone business exceed an amount equal to 50 percent of the adjusted basis of such property at the beginning of the 30-month period described in Code Sec. 1400Z-2(d)(2). The IRS has determined that 3,309 of the QOZs designated in 2018 are comprised entirely of a rural area based on 2020 Decennial Census data and it lists them in the Appendix of Notice 2025-50.

For purposes of applying the substantial improvement test of Reg. Sec. 1400Z-2(d)(2) with respect to 2018 QOZs, Notice 2025-50 defines a "rural area" as any area other than (1) a city or town that has a population of greater than 50,000 inhabitants, and (2) any urbanized area contiguous and adjacent to a city or town described in Section 4.01(1) of Notice 2025-50.

Under Notice 2025-50, other than for Hawaii and Puerto Rico, whether a city or town has a population greater than 50,000 inhabitants is based on the 2020 Decennial Census. For Hawaii and Puerto Rico, whether their total number of inhabitants is greater than 50,000 is determined as a Census Designated Place with a resident population greater than 50,000 in the 2020 Decennial Census. An "urbanized area" means any Census-Bureau-designated urban area. According to Notice 2025-50, "contiguous" and "adjacent" are geographic terms referring to two or more areas that share either a common boundary or at least one common point.

For a discussion of the rules relating to qualified opportunity zone investments, see Parker Tax ¶116,500.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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