California leads the nation with the largest opportunity to establish a business as a Qualified Opportunity Zone Business (QOZB) in the country. With over 879 designated census tracts in 57 counties, California investors are incentivized to establish business operations in these designated locations in exchange for deferred tax treatment on capital gains.
What is a Qualified Opportunity Zone Business and the Legislative History?
A Qualified Opportunity Zone Business is a business that meets the criteria set forth under the Tax Cuts and Jobs Act of 2017. With this bill, over 8700 “opportunity zones” were identified as economically distressed regions, in need of growth and revitalization. Governors of all 50 states, the District of Columbia, and 5 U.S. Territories identified these areas, which were later confirmed by the U.S. Treasury and deemed Opportunity Zones under U.S law. Investors who establish businesses in these regions are able to receive preferential tax treatment if they meet the QOZB guidelines and maintain regulatory compliance.
The first enacted statute surrounding “Designation” of Opportunity Zones was effective as of December 22, 2017, and labeled as 26 U.S.C.A. § 1400Z-1. However, that statute was amended as of February 9, 2018 and added clause § 1400Z-1(b)(3), the “Special Rule for Puerto Rico.” The added subsection stated that Puerto Rico will now have designated Opportunity Zones.
The second enacted statute surrounding “Special Rules for Capital Gains invested in Opportunity Zones” was effective as of December 22, 2017, and labeled as 26 U.S.C.A § 1400Z-2.
California and QOZBs
As the most populous state in the country, California has the largest number of Opportunity Zones when compared to any other state or territory in the United States. While California participates in the Opportunity Zone program at the federal level, it does not conform at the state level. California makes no distinction between short term and long term capital gains. All gains are taxed as regular income. Depending on an individual’s tax bracket, that could be anywhere from 1 to 13.3 percent.
At the Federal Level, investors in QOF can see some of these Opportunity Zone benefits:
- A tax deferral until 2026
- Any taxable gain may be deferred until December of 2026, or until interest of the fund is sold or exchanged, whichever comes first. Has to be within 180-day period of the sale or exchange of assets.
- Step-up in tax basis of 10% or up to 15% of deferred gains
- Investors who use a QOF and retain their investment throughout the five year holding period may recognize a 10% step up after five years and an additional 5% after seven years. In order for the taxpayer to recognize a full 15% step-up, the investment needed to be made by December 31, 2019, in order to hold a full seven year term and maximize the tax benefit at this rate.
- No tax on appreciation
- Investors choosing to hold their investment in a QOF for up to 10 years realize the maximum benefit when the cost basis of the property is equal to the fair market value of the date of sale or exchange.
Industries that Thrive in California
According to the Governor’s Office of Business and Economic Affairs, the following industries comprise the majority of business operating in the State of California. It has the 5th largest Gross Domestic Product in the world. California also ranks #1 in new business start-up ventures, and as a result, is #1 in its rank when it comes to access to venture capital funding. A list of the top industries found in California are listed below:
- Aerospace and Defense
- Film and Television
- Wood Product and Biomass
- Agriculture and AgTech
- High Tech
- Zero Emission Vehicles
- Climate and Clean Energy
When establishing a small business in the state of California, Opportunity Zones should be considered as viable locations for investment. The QOZB framework is an investment tool that offers investors opportunities to defer, reduce or exclude federal capital tax gains entirely, depending on the length of time the investments are held.
Opportunity Zone Success in California
There are several Opportunity Zone businesses and funds that have proven to be successful in California. Two examples include: a transformed vacant movie theater turned into a multi-use building with a trendy indoor golf facility as its first tenant, and the other is a former junkyard, cleared and revitalized into an apartment building with low-income housing. Both examples illustrate the diversity in utilizing qualified opportunity funds to establish qualified opportunity zone businesses to reinvigorate local economies in California.
Urban Putt funded by QOF Urban Catalyst
Urban Catalyst has been recognized as one of the Top 10 Opportunity Funds in Forbes’ OZ 20.
After successfully raising $131 million to fund its first project, Paseo, Urban Catalyst has secured its first tenant, Urban Putt. Urban Catalyst is hoping to revitalize downtown San Jose, California and has transformed a long-time dormant movie theater into a mixed use retail project. Urban Putt is described as “an indoor golf/restaurant/miniature bar” hoping to attract millennials, nearby San Jose State University students, corporations who offer team-building events and families looking for weekend entertainment. With creativity and innovation, Urban Catalyst is taking what was once a vacant Camera 12 movie theater and revitalizing the area for mixed-use business in downtown San Jose.
If you would like more information about owning and operating a Qualified Opportunity Zone Businesses in the state of California, our QOZB Expert Team is available to help you. Contact us today.