The Department of the Treasury (Treasury Department) and the Internal Revenue Service (IRS) have released Notice 2025-50, providing eagerly awaited guidance on provisions introduced by the One, Big, Beautiful Bill Act (OBBBA), Public Law 119-21, 139 Stat. 72. This notice specifically addresses two key areas amended by the OBBBA: a modified "substantial improvement" test for property in certain Qualified Opportunity Zones (QOZs) and the definition of a "rural area" for purposes of applying this new test. The guidance is crucial for practitioners advising clients with investments in Qualified Opportunity Funds (QOFs) that hold property in designated rural QOZs.

Purpose and Legislative Background of the Notice

The impetus for Notice 2025-50 is the OBBBA’s amendment to Internal Revenue Code (Code) § 1400Z-2. The Qualified Opportunity Zone program was originally established by the Tax Cuts and Jobs Act (TCJA), Public Law 115-97, which added §§ 1400Z-1 and 1400Z-2 to the Code. Those sections established the framework for designating low-income community census tracts as QOZs and created tax incentives for investing in them through a QOF.

One of the central requirements for tangible property to qualify as qualified opportunity zone business property (QOZBP) is that either the "original use" of the property in the QOZ commences with the QOF or a qualified opportunity zone business, or the entity "substantially improves" the property. Under the TCJA’s original framework, substantial improvement required that additions to the property’s basis exceed 100 percent of the adjusted basis within any 30-month period after acquisition.

Section 70421(c)(4)(C) of the OBBBA amended § 1400Z-2(d)(2)(D)(ii) to create a more lenient standard for properties located in QOZs that consist entirely of a "rural area". For these specific properties, the OBBBA reduced the substantial improvement threshold from 100 percent to 50 percent of the adjusted basis. Simultaneously, § 70421(c)(2) of the OBBBA added a definition of "rural area" to the Code under § 1400Z-2(b)(2)(C)(ii). Notice 2025-50 was issued to provide clarifying guidance on both of these OBBBA amendments.

Guidance on the Substantial Improvement Test for Rural Areas

The notice clarifies the application of the new, lower substantial improvement threshold. It applies to tangible property located in a QOZ designated in 2018 (a "2018 QOZ") that is comprised entirely of a rural area, as defined in the notice.

The central piece of guidance states that for any determination made on or after July 4, 2025, the substantial improvement test under § 1400Z-2(d)(2)(D)(ii) is met if, during the 30-month testing period, the additions to the basis of such property exceed an amount equal to 50 percent of the property’s adjusted basis at the beginning of that period.

Effective Date: This modified test is effective for any substantial improvement determination made on or after July 4, 2025, which coincides with the effective date of the OBBBA amendment itself.

Defining "Rural Area" for 2018 QOZs

A significant portion of the notice is dedicated to defining "rural area," a term that now carries substantial weight for QOZ investors. The OBBBA added § 1400Z-2(b)(2)(C)(ii) to the Code, which 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)". This definition is identical to the one in § 343(a)(13)(A) of the Consolidated Farm and Rural Development Act of 1961 (the "Con Act"), codified at 7 U.S.C. 1991(a)(13)(A).

However, the IRS notes a critical challenge in applying this definition. The U.S. Census Bureau, whose data is foundational for these classifications, changed its methodology following the 2020 Decennial Census. Previously, the Census Bureau distinguished between "urban clusters" (fewer than 50,000 people) and "urbanized areas" (50,000 or more people). The 2020 methodology eliminated this distinction, now classifying all such locations simply as "urban areas" based on housing unit and population density thresholds.

This change created an interpretive issue, as the statutory definition of "rural area" explicitly uses the term "urbanized area". The IRS looked to the United States Department of Agriculture (USDA), which uses the same Con Act definition for its rural development programs, for a path forward. The USDA, obligated to use the most recent census data, determined that it could no longer rely on 2010 census data and has since adopted the 2020 Decennial Census methodology.

Following a broadly similar approach, the IRS provides the following definitions for applying the substantial improvement test to property in the 2018 QOZs:

A "city or town that has a population greater than 50,000 inhabitants" is defined as an incorporated city or town with a resident population over 50,000 based on the 2020 Decennial Census. For Hawaii and Puerto Rico, this is determined using Census Designated Places.
An "urbanized area" is defined as any Census-Bureau-designated urban area. This effectively equates the statutory term "urbanized area" with the 2020 Census term "urban area" for this purpose.
"Contiguous" and "adjacent" are defined as geographic areas that share a common boundary or at least one common point.

Based on this methodology and the 2020 Decennial Census data, the Treasury Department and the IRS have determined that 3,309 of the 2018 QOZs are comprised entirely of a rural area. A complete list of these census tracts is provided in the Appendix to Notice 2025-50.

It is important to note that the OBBBA definition of rural area adopted in § 1400Z-2 does not include certain additional statutory provisions found in 7 U.S.C. 1991(a)(13)(D) through (I). Therefore, while the IRS methodology is similar to the USDA’s, it does not correspond in all respects. This notice applies only to the 2018 QOZs; guidance on future QOZ nominations authorized by OBBBA will be addressed separately.

Prepared with assistance from NotebookLM.