Chairman Elon Musk and Chinese officials were at a signing ceremony Tuesday in Shanghai.
Construction will begin in the near future once Tesla is granted permits to build the factory.
Musk said production would begin in two to three years after that and eventually increase to 500,000 vehicles a year. City officials said the factory would be the biggest foreign investment to date in Shanghai.
The move also makes Tesla the first fully foreign-owned automaker in China.
The Associated Press contributed to this report.