Does an opportunity zone investment get the same treatment in a state that does not conform?

How California declines, and why the 2025 conformity act did not change it

California's personal income tax does not adopt the Internal Revenue Code wholesale. It adopts particular parts by reference, as of a specified date, except as otherwise provided, and leaves unadopted what it does not reach. RTC section 18031 generally incorporates the federal rules for determining gain or loss on a sale, beginning with IRC section 1001. Nothing in the incorporating statutes adopts sections 1400Z-1 and 1400Z-2, the deferral election, the inclusion rule, and the ten-year election. Those provisions have no California operation, not because California aimed a decoupling statute at them, but because the incorporating statutes never reached them.

Senate Bill 711, the Conformity Act of 2025, enacted October 1, 2025, moved California's specified date of conformity from January 1, 2015 to January 1, 2025, for taxable years beginning on or after January 1, 2025, as the Franchise Tax Board's conformity page and its analysis of the bill describe. That advance alone could have let the opportunity zone basis adjustments in through the general basis statute. IRC section 1016(a)(38), added in 2017 and sitting among the incorporated gain and loss provisions, directs basis adjustments "to the extent provided in subsections (b)(2) and (c) of section 1400Z-2." The act instead added RTC section 18036(e), which makes section 1016(a)(38) inapplicable for California purposes. The Senate Revenue and Taxation Committee's conformity chart for the bill describes the addition as continuing nonconformity to the federal opportunity zone provisions, and the Franchise Tax Board's analysis lists the opportunity zone item under "Not Conform."

The Franchise Tax Board's published positions match. The 2025 instructions for Schedule D (540) state that California "does not conform to the deferral and exclusion of capital gains reinvested or invested in qualified opportunity zone funds under IRC Sections 1400Z-1 and 1400Z-2," direct the taxpayer to "enter the entire gain amount in column (e)," and add: "If, for California purposes, gains from investment in qualified opportunity zone property had been included in income during previous taxable years, do not include the gain in the current year income." The 2025 Form 100 booklet lists the same deferral and exclusion among the federal provisions to which California law does not conform, so a corporate investor stands where an individual does.

Two features of this structure matter. Because the nonconformity runs through non-incorporation rather than an addback schedule, no California modification reverses in a later year; the Schedule D instruction not to report the gain a second time is the only state-side acknowledgment that the federal inclusion is coming. And because California's specified date of January 1, 2025 precedes the July 2025 federal act that made the program permanent, and section 18036(e) disables section 1016(a)(38) whatever its content, California's position reaches the restructured program for post-2026 investments on the same terms as the original one.

The two ledgers: federal basis and California basis from the election to the exit

The investor carries two basis figures in the same asset for the whole holding period, and they do not reconcile until the interest is sold. A California resident sells stock in 2020 for a $2,000,000 capital gain, invests the full $2,000,000 in a qualified opportunity fund within 180 days, and makes the federal election. The fund interest is sold in 2031 for $3,200,000.

Federal ledger. The election removes the $2,000,000 from 2020 federal gross income (IRC section 1400Z-2(a)(1)). Federal basis in the fund interest starts at zero (section 1400Z-2(b)(2)(B)(i)). At five years, in 2025, basis increases by ten percent of the deferred gain, $200,000 (section 1400Z-2(b)(2)(B)(iii)); a 2020 investment does not reach the seven-year increase before December 31, 2026. On that date the deferred gain is included in income, measured as the lesser of the deferred gain or the interest's fair market value, less basis (section 1400Z-2(b)(1)(B) and (b)(2)(A); Treas. Reg. section 1.1400Z2(b)-1(b) and (e)), and basis increases by the amount included (section 1400Z-2(b)(2)(B)(ii); Treas. Reg. section 1.1400Z2(b)-1(g)). If the interest is worth at least $2,000,000 then, $1,800,000 is included and federal basis becomes $2,000,000. On the 2031 sale, after a ten-year hold, the investor elects under section 1400Z-2(c) to treat basis as equal to fair market value, and the $1,200,000 of appreciation produces no federal gain.

California ledger. There is no election. The $2,000,000 is California taxable income in 2020, reported in full on Schedule D (540). California basis in the fund interest follows the ordinary cost basis rule incorporated through section 18031, with no reduction to zero, because section 1400Z-2(b)(2)(B) is not incorporated, and no later adjustment, because section 18036(e) disables section 1016(a)(38). No Franchise Tax Board pronouncement states this in words. It is the result the statutes produce, and it is the only result consistent with the Schedule D instruction to report the entire gain in the year of sale, since reporting the gain and then denying basis for the amount reported would tax the same dollars twice. California basis is therefore $2,000,000 from 2020 forward. Nothing happens in 2025 or on December 31, 2026, and the instruction not to include the gain again applies to the federal inclusion. On the 2031 sale, California gain is $3,200,000 less $2,000,000, or $1,200,000: the appreciation federal law excludes is California taxable gain in full, taxed to a resident as gain on an intangible.

Lined up, the ledgers show the trade. Federal law defers tax on $1,800,000 from 2020 to 2026, permanently excludes the $200,000 basis increase, and eliminates tax on $1,200,000 of appreciation. California taxes $2,000,000 in 2020 and $1,200,000 in 2031, with no state offset in either year. The mismatch runs through any interim event as well: a partial sale before 2026 is a federal inclusion event measured against low federal basis and a California sale measured against full cost basis, and a distribution that federal law treats as an inclusion event may be a return of basis for California purposes.

The record behind the California ledger is thinner than the federal one. Federal law generates paper at each step, including the annual Form 8997 and the inclusion computation; California generates none after the year-of-sale return. The proof of California basis is the 2020 Schedule D (540), already six years old, and it is the document a California examination of the exit gain will ask for.

December 31, 2026 at the state level

For every election on an investment made before 2027, federal law includes the deferred gain in the taxable year that includes December 31, 2026, unless an earlier inclusion event occurs (IRC section 1400Z-2(b)(1)). The 2025 federal act left that date in place for earlier investments and, for amounts invested after December 31, 2026, substituted a deferral running five years from the investment, a basis increase of 10 percent, or 30 percent for a qualified rural opportunity fund, after five years, and a ten-year election capped at 30 years (IRS Notice 2026-40, sections 4.01, 4.02, and 5.02). The library's companion article covers that calendar.

In California the date produces no income, because the gain was California income in the year of the original sale. It does produce two kinds of state work.

The first is the return. The Schedule D (540) instruction to omit gain previously included for California purposes is the authority for the adjustment, and the omitted amount is reconciled to the amount reported in the year of sale rather than assumed equal to the federal inclusion, because the federal figure is net of the basis increases and may be limited by fair market value while the California figure was the gross gain. An investor who reported $2,000,000 to California in 2020 and sees $1,800,000 included federally in 2026 removes the $1,800,000 and documents that it is a component of the $2,000,000 already taxed.

The second is the credit for taxes paid to another state, where the timing gap matters. A California resident whose 2020 gain arose from real property in a conforming state faces it directly. That state deferred along with federal law and can tax the gain as nonresident source income in 2026, when federal law includes it, since the regulations give included gain the same attributes in the year of inclusion it would have had without deferral (Treas. Reg. section 1.1400Z2(a)-1(c)(1)(i)). California taxed the same gain in 2020. RTC section 18001 allows a resident a credit for net income taxes paid to another state on income sourced there and also taxed by California, limited on Schedule S by the share of California tax that the double-taxed income represents. The 2025 Schedule S instructions address the year gap: "Other state income taxes which are paid to the other state do not necessarily have to be in the same year, as long as the taxes relate to the same transaction." That sentence supports a credit on these facts. The instructions also allow a claim for refund attributable to taxes paid to another state within one year from payment to that state or within the general statute of limitations, whichever expires later, which points toward claiming the credit on the 2020 return; they do not address this pattern specifically, and no Franchise Tax Board pronouncement resolving which year carries the credit was located. Where the source state itself allows California residents a credit for California tax, California allows none, and the timing question moves to that state's rules.

A nonresident invested in a fund holding California property is in the mirror position, and the answer turns on what is sold. A nonresident's income from intangible personal property is not California source unless the property has acquired a business situs in the state (RTC section 17952), and a fund interest is an intangible, subject to the look-through questions the library's article on a nonresident's sale of a partnership interest addresses. Where a partnership fund sells the California property and passes the gain through, the nonresident partner's distributive share is California source income, taxed with no deferral, no basis increase, and no ten-year exclusion, whatever the home state does.

How a conforming state differs

A state that conforms keeps one ledger. Massachusetts's corporate excise is the example: the Department of Revenue's TIR 19-7 (June 17, 2019) explains that it "generally conforms to the Code as currently in effect, except where expressly decoupled," so a corporate investor that invested before 2026 deferred, took zero basis, and follows the federal inclusion and ten-year rules. The state picks up the 2026 inclusion when federal law does, and no state basis figure exists apart from the federal one.

Conformity is to a Code date, though, and a state whose reference date precedes July 4, 2025 conforms to the original statute, whose section 1400Z-2(a)(2)(B) bars an election "with respect to any sale or exchange after December 31, 2026." Read literally, such a state offers no deferral for a sale in 2027 or later until it advances its date. A state that conformed for the original program is therefore not assumed to conform for the new one.

Two states that reach California's result by other routes

Massachusetts split the answer by tax and then changed it twice. For the personal income tax under chapter 62, which then followed the Code as amended on January 1, 2005, TIR 19-7 stated that deferred gain "must be recognized in the year of the sale or exchange for Massachusetts personal income tax purposes" and that the federal basis adjustments "do not apply in calculating any future gain." That is the California pattern through 2021. The fiscal year 2023 budget (St. 2022, c. 126, sections 30 and 189) advanced the chapter 62 Code date, and TIR 23-5 (March 1, 2023) announced conformity to section 1400Z-2 for tax years beginning on or after January 1, 2022, acknowledging that "a chapter 62 taxpayer may have a different tax basis in their QOF interest" because of the earlier rule. The TIR does not say how the 2026 federal inclusion or a later ten-year election applies to an investor who elected in 2019, reported the gain to Massachusetts that year, and holds a Massachusetts cost basis. One reading is that the cost basis absorbs the 2026 inclusion and the ten-year election applies going forward; the TIR does not adopt it, and the 2019 Massachusetts return is the proof either way.

The second change came in 2026. St. 2026, c. 101, sections 7, 14 and 45, as described in the Department's working draft TIR on the fiscal year 2026 supplemental budget (posted June 23, 2026 for public comment), provides that for taxable years beginning on or after January 1, 2026 a qualified opportunity zone includes "only areas located entirely within the Commonwealth," and the Department's 2025 return instructions describe the add-back as reaching investments made after January 1, 2026 in zones outside Massachusetts. TIR 26-4 (June 23, 2026) shows chapter 62 not adopting the 2025 federal amendments and the corporate excise adopting them from 2027. The add-back reaches corporate excise taxpayers as well as individuals, so any Massachusetts investor in an out-of-state zone now faces the California pattern again.

North Carolina reaches California's result through an addback schedule, explicit enough to answer questions California leaves to inference. N.C. Gen. Stat. section 105-153.5(c2)(5) requires an addition of the gain that would be included federally "without regard to section 1400Z-2(a) of the Code," and adds that the adjustment "does not result in a difference in basis of the affected assets for State and federal income tax purposes." Subdivision (c2)(6) allows a later deduction of gain included federally under section 1400Z-2(a) "to the extent the same income was included in the taxpayer's North Carolina taxable income in a prior taxable year," the state-side reversal at the 2026 inclusion. Subdivision (c2)(7) requires an addition of the gain that would be included "but for the step-up in basis under section 1400Z-2(c) of the Code," which taxes the appreciation at the exit. North Carolina keeps no separate basis; it adjusts the federal result at each event. The economics match California's; the compliance differs.

"Nonconforming" therefore describes an outcome, not a method, and the method sets the paperwork: non-incorporation leaves state basis to the taxpayer's records, an addback schedule leaves it to the federal computation plus a modification, and a mid-stream change leaves a transition the agency has acknowledged and not resolved.

Practice notes

An investor who made a federal opportunity zone election while resident in a nonconforming state holds a state basis equal to the amount invested, and the proof is the state return for the year of the original sale, which is worth preserving with its workpapers now rather than reconstructing at the exit; an examiner working from federal Form 8997 figures starts from zero basis unless shown the statutory route. The federal inclusion in the 2026 taxable year comes off the California return through the Schedule D (540) adjustment, reconciled to the gross gain reported in the year of sale. Where the original gain arose from real property or a business in a conforming state, the other-state credit, and which California year carries it, is a question for resolution soon after the source state's 2026 tax is paid, because the one-year refund window runs from that payment. A Massachusetts investment is dated by election year and zone location: elections before 2022 carry a Massachusetts cost basis and an unresolved transition, and investments after January 1, 2026 in zones outside Massachusetts draw an add-back. North Carolina history is tracked as modifications to the federal computation, with the (c2)(6) deduction in 2026 and the (c2)(7) addition at the exit. For a new investment under the restructured federal program, the state analysis comes before the investment, since California's 2025 statute and fixed Code dates elsewhere can leave the state benefit at zero. G&G State Tax Group provides state conformity and basis analysis for opportunity zone investors alongside its state and local tax practice.