In California, Opportunity Zones Have Become A Partisan Tug Of War

As California Gov. Gavin Newsom pores over the stack of new bills that he may sign into law, there is one he won't see at all — an effort to bring California into conformity on opportunity zones.

The state's legislators last month failed to support Newsom’s plan to provide $100M annually for investors who invest in designated opportunity zones across the state. 

“We stand out," Kosmont Cos. President Larry Kosmont said. "There is still little support from the legislators for the opportunity zone program.”

The opportunity zones program, passed at the end of 2017, is a federal program aimed to spur economic development and job creation in 8,700 low-income communities nationwide. Investors who roll over their capital gains through a special fund in property or business long-term in designated zones receive certain tax benefits, including tax-free gains upon exiting that investment after 10 years.

In California, and the other nonconforming states, investors would be subject to those state’s capital gains tax. 

Opponents of the program claim it is another tax break for wealthy investors and that some investments in certain areas with heavy minority populations could lead to displacement of residents and gentrification.

Under the governor's plan, Newsom would have amended part of the state's tax code to align with the opportunity zone tax benefit but only to investors who created clean energy businesses and developed affordable housing.

It would also have allocated $100M a year to the state's Franchise Tax Board to disperse money in certain qualified opportunity zone funds to support those projects. 

Additionally, his plan would have added a reporting requirement for investors to gauge the effectiveness of the opportunity zone investment, something the federal government has yet to adopt.

California is one of four states, along with Massachusetts, Mississippi and North Carolina, that have not conformed to the full tax benefits set forth on the federal program, according to Novogradac & Co., a professional services firm. Corporations in Massachusetts are eligible for the opportunity zone tax benefits but not individuals.

Experts believe California’s lack of conformity will hurt opportunity zone investments flowing into the state and force investors to look at lower or no income tax states. 

California has one of the highest brackets of income tax at 13.3%, Kosmont said. This gives investors second thoughts on investing in California and could drive investments away from the state.

From January to August, there were 3,655 commercial real estate transactions made in designated opportunity zones in the Los Angeles-Long Beach-Anaheim metropolitan statistical area, according to commercial real estate data site Reonomy. There were 336 transactions in the San Jose-Sunnyvale-Santa Clara MSA.

Because the federal program does not have a reporting requirement for opportunity zone investments, it is unclear how many of these transactions are capitalizing on the federal program.

“California OZ investors are playing with 87 cents to a dollar, while the rest of the conforming or states with no state income tax are playing with 100 cents to a dollar,” Kosmont said.

It doesn’t mean investors aren’t investing in opportunity zones here, Kosmont said.

“The program just hasn’t exploded,” he said. "There's activity but it's still nascent. There are just fewer OZ deals being done."

Newsom has been bullish on the opportunity zone program, hoping that it could drive investments into energy projects that combat climate change. It might also spur the development of low-to-moderate income housing projects as the state deals with a severe housing crisis.

Yet there is still a belief from many state legislators, a majority of whom are Democrats, that the program only benefits wealthy investors.

"We don't have a strong enough lobby out there to promote the OZ program," Kosmont said. "A lot of legislators still don’t realize the upside."

CalOZ co-founders Kunal Merchant and Dave Smith said the state legislature's opposition to Newsom's opportunity zone plan stands in stark contrast to the rest of the country. CalOZ is a nonprofit trade organization that advocates for the opportunity zones program in the state.

"Many governors and state legislatures have implemented even more robust policy packages to further accelerate quality opportunity fund investments into their low-income communities," Merchant and Smith said in a statement after the legislature did not support Newsom's plan. "In nearly all of these cases, state policy efforts have enjoyed broad bipartisan political support, including from labor unions, housing advocates and other organizations whose California counterparts opposed Gov. Newsom’s plan."

Kosmont said although the state failed to pass a bill conforming California to the program, he still has hope.

State Treasurer Fiona Ma recently appointed a dozen housing and economic development experts to the new Housing, Economic Development, Jobs and Opportunity Zone Ad Hoc Committee.

The committee, which includes philanthropist Priscilla Chan; Fontana Acquanetta Warren, Fontana' mayor; a Building Industry Association executive and other industry players, will be responsible for coming up with creative strategies to ramp up housing production and economic development, among other things.

Ma has been a big proponent of the opportunity zone program, going up and down the state discussing its benefits. However, she had told Bisnow previously that more lobbying from the commercial real estate sector needs to be done to see this program through. 

A Bisnow request to interview Ma was not replied to as of press time.

In the interim, a slower game plan has emerged to tackle the housing crisis. Newsom has said he wants builders to build 3.5 million housing units by 2025. Wildfires continue to ravage and destroy homes in the state, further hurting housing stock.

Proponents point to both of those factors as reasons why California needs to remain competitive in the business environment by nurturing investment. Kosmont said opportunity zones could be a big help, particularly if the Department of the Treasury and the Internal Revenue Service release a new set of regulations in December. More clarity from the federal government could help the opportunity zone program in the state.  

"I am optimistic that they’ll figure it out. But I'm not optimistic it will be a full compliance effort for all projects," Kosmont said. "It’s going to take some legislative compromise."