The Opportunity Zone substantial improvement test

The substantial improvement test is the route by which existing, previously used property becomes Qualified Opportunity Zone business property (QOZBP). Tangible property qualifies only if its original use in the zone begins with the Qualified Opportunity Fund (QOF) or Qualified Opportunity Zone Business (QOZB), or if the fund or business substantially improves it.^1,2 The second path is how a QOZB can buy and convert an existing building.

The statutory rule in §1400Z-2(d)(2)(D)(ii) is that property is substantially improved only if, during any 30-month period beginning after the date of acquisition, additions to the basis of the property in the hands of the QOF or QOZB exceed an amount equal to the adjusted basis of the property at the beginning of that 30-month period.¹ In practice, the business must more than double its investment in the building within 30 months.

No. Land is not required to be substantially improved, and the basis attributable to land is not counted in the test. Revenue Ruling 2018-29 and the final regulations both provide this rule: when a QOZB buys a building and the land under it, only the building's basis must be doubled.^4,3

Land still has to be used in a trade or business. The regulations include an anti-abuse rule for land that is bought and held mainly for speculation, or improved only insubstantially, with a significant purpose of achieving a tax result inconsistent with the program.^5,3 Raw land that a QOZB develops into a data center campus is not in that category. See buying land for an Opportunity Zone data center.

For property in a Qualified Opportunity Zone composed entirely of rural area, additions to basis over the 30-month period need only exceed 50% of the adjusted basis at the start of the period, rather than 100%.^9,10 Public Law 119-21 made the change, and it applies to determinations after July 4, 2025.^15,17

A rural area is any area other than a city or town with a population greater than 50,000 and any urbanized area contiguous and adjacent to such a city or town.^14,9 The IRS identified 3,309 currently designated zones that consist entirely of rural areas and qualify for the lower threshold.¹¹ Practitioners note that the change roughly halves the capital required: one example has a $1.5 million requirement falling to $750,000.^13,12

The lower threshold applies only where the whole zone is rural. A zone that includes part of an urbanized area does not qualify, even if the specific site is in open country. See rural Opportunity Zones and what a Qualified Rural Opportunity Fund is.

Illustrative assumptions: a QOZB buys an industrial building and its site for $12,000,000. An appraisal allocates $4,000,000 to land and $8,000,000 to the building. The 30-month period starts at closing.

Two cautions. The land and building allocation must be supportable, because a high building allocation raises the required spend and a low one invites challenge. And the additions must be capitalized to the building's basis, or qualify under the aggregation rules below; repairs and expenses do not count.^4,6

What generally counts: capitalized hard construction costs, capitalized soft costs such as architecture, engineering and permitting fees that are added to the building's basis, and other costs that must be capitalized under the normal tax accounting rules. What does not: deductible repairs, operating expenses, the cost of land, and costs added to the basis of separate assets that are not aggregated with the building. The test is applied property by property, so a QOZB that buys two buildings on unrelated parcels must pass it for each one.

Yes. The final regulations allow two kinds of aggregation.^6,7

• Asset aggregation: purchased original use assets count toward improving a non-original use building if they would otherwise be QOZBP, are used in the same trade or business, and improve the functionality of the building in the same or a contiguous zone.^6,8
• Building aggregation: buildings located entirely within one parcel described in a single deed, or on contiguous parcels described in separate deeds, can be treated as a single property for the test.^6,7

Aggregation does not remove the need for real physical work. Non-original use property must still be improved by more than an insubstantial amount, and the improvements must be part of the same business.⁶ The final regulations also confirm that the improvements do not have to be completed by month 30, so long as the additions to basis made during the period exceed the threshold.^4,5

Data center conversions usually clear the test easily, because power and cooling cost far more than the shell. Cushman & Wakefield puts all-in greenfield data center costs at $8.9 million to $23.3 million per MW, with power infrastructure the largest component.¹⁶ A converted warehouse bought for $8 million of building basis and fitted for 10 MW will normally spend many times that amount.

The timing risk is real. If transformers and generators have lead times near two years, the capitalized cost may land late in the window. Front-load structural and electrical work that can be capitalized early. A long-vacant building may avoid the test entirely by qualifying as original use; see the original use requirement and converting industrial buildings into data centers.