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The Basics of Solar Tax Credits. Forrest Milder 617-345-1055 fmilder@nixonpeabody.com. Herb Stevens 202-585-8811 hstevens@nixonpeabody.com. © 2008. 1 – Solar Tax Credits. Solar credit is an investment tax credit (or ITC) Based on cost of facility Usually taken all in one year

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the basics of solar tax credits

The Basics of Solar Tax Credits

Forrest Milder617-345-1055fmilder@nixonpeabody.com

Herb Stevens202-585-8811hstevens@nixonpeabody.com

© 2008

1 solar tax credits
1 – Solar Tax Credits
  • Solar credit is an investment tax credit (or ITC)
  • Based on cost of facility
  • Usually taken all in one year
  • Generally only available for new property (there’s an 80% test)
  • Mostly: depreciation over 5 years
2 overview of etcs
2 – Overview of ETCs
  • Energy Tax Credits are generally 30% of “facility” cost (e.g., transmission lines and substations are not eligible for the ITC)
  • Includes Photovoltaic (PV) Concentrated Solar Power (CSP) & fuel cells
  • Must generate electricity, heating, cooling, hot water, or fiber-optic lighting. Sale of elec. is not required
2 overview of etcs cont d
2 – Overview of ETCs (cont’d)
  • Usually taken in the year the facility is “placed in service”, but can sometimes use “progress expenditures” over more than one year
  • Possible recapture for 5 years (100% in first year, 80% in second year, etc.)
  • Called “Energy Tax Credits” in Section 48 of Tax Code
  • Applies to property placed in service before December 31, 2016
3 need for an owner
3 – Need for an Owner
  • No “sales” of credits. They are generally claimed by the owner of the facility which makes an “investment” in a partnership or LLC, or, if the developer wants “out”, the facility could be sold
  • No government ownership
  • Sometimes, a lease is used, and the tenant claims the credits (note: “anti-depreciation” for tenant). A lot like HTC.
3 need for an owner cont d
3 – Need for an Owner (cont’d)
  • Lengthy documents detail the relationship – addresses investment timing, allocating credits, distributing cash, and withdrawal of the investor
  • Usually: 5+ year relationship with investor
4 allocations
4 – Allocations

Developer

Investor

  • IRS has elaborate rules for allocating the credits among the parties
  • ITCs follow the “profits” of the owner
  • This is NOT the same as LIHTC(they follow depreciation)
  • Wide range of ratios possible, not just 99-1

1%

99%

Partnership

Solar Facility

5 sharing cash and credits
5 – Sharing Cash and Credits
  • They don’t have to be shared in the same way
  • IRS might treat cash distributions as a share of profits or gross sales and re-allocate the credits
  • Must track capital accounts
  • Might be able to use debt, management or development fees to get cash to developer
6 need for a forecast
6 – Need for a Forecast
  • Shows how credits and cash go to the investor and the GP
  • Must be done by someone who knows syndication (otherwise, there may be very unwieldy projections)
  • Remember that Allocations are different from LIHTC
  • Pricing is often based on IRR, not cents per dollar of credit
7 placed in service pis
7 – Placed In Service (“PIS”)
  • When to start claiming credits – it’s not based on when the investor comes in.
  • If investor gets in late, ETC may be lost (possible 3-month lease exception)
  • ETC may be able to use “progress expenditures” to get credits earlier, and higher rate
7 more on placed in service cont d
7– More on Placed in Service (cont’d)

When is a facility placed in service?

  • Usually when completed, with licenses and after pre-operational testing
  • “Daily operation” can matter
  • Acquired property must be delivered and ready to use; mere purchase is not enough
8 other subsidies
8 – Other Subsidies
  • Bonds and “subsidized energy financing” generally reduce federal credits on a pro rata basis
  • State programs usually don’t reduce solar credit, but may be taxable, e.g., state grants
  • IRS keeps attacking state tax credits
9 technical rules
9 -Technical Rules
  • Almost all investors are corporations because of “At Risk” and “Passive Loss” Rules
  • Basis reduction of 50% of ITC, meaning less depreciation
  • Profit motive – But compare Rev. Proc. 2007-65 (for wind) with Reg. 1.42-4 (for LIHTC)
  • AMT is eliminated, effective for years beginning after October 3, 2008.
10 flips puts and calls
10 – Flips, Puts, and Calls
  • Once you’ve gotten the investor IN, you need a way to get it OUT.
  • Flip – reduce the investor’s percentage to make it cheaper to buy him out
  • Put – The investor can get out for a small amount. Less used in energy deals
  • Call – The developer can buy out the investor for fair market value
11 puerto rico solar tax credit
11 -Puerto Rico Solar Tax Credit
  • Puerto Rico enacted legislation in August 2008 to provide a corporate or individual taxpayer with a credit for acquiring and installing "solar electric equipment."
  • The credit is allowed against the taxpayer's Puerto Rico income tax.
  • Through fiscal years 2008-09, the credit amount is 75% of the cost of the equipment and installation.
  • During fiscal years 2009-10 and 2010-11, the credit is 50% of the cost of the equipment and installation.
  • During fiscal year 2011-12 and beyond, the tax credit is limited to 25% of the cost of equipment and installation.
12 combining lihtc and solar
12 - Combining LIHTC and Solar
  • Project can qualify for both
  • 2008 Act requires States to take account of energy efficiency in the QAP
  • Remember that bonds can be a problem
  • Remember that LIHTC and Solar are allocated among partners differently (so watch out for contingent fees)
combining lihtc and solar cont
Combining LIHTC and Solar (cont.)
  • Solar credits reduce LIHTC basis (illustration follows)
  • Solar also offers rapid depreciation to investor --5-yr MACRS (Only 5-yr S/L if bond-financed). Also, unlike the real estate, solar is eligible for 50% “bonus” depreciation in 1st year (must be PIS in 2008).
  • Crucial to track capital accounts and “minimum gain” – the accelerated depreciation may drive investors negative very early; debt structure will be important
example solar and housing credits
Example: Solar and Housing Credits

*Plus 5-year MACRS (and **Plus S/L depreciation 50% bonus depreciation if PIS in 2008)

13 pricing solar credits
13 - Pricing Solar Credits
  • Solar is often priced based on IRR, not cents per credit dollar, because (i) all credits in one year, plus (ii) rapid depreciation mean (iii) a different pricing model than applies to LIHTC.
  • The Most likely purchaser is the owner of the LIHTC project, so there may not be competitive bidding for the credits
14 technical rules
14 - Technical Rules
  • Bonds reduce the ETC. So, pay attention to LIHTC projects that are 51%+ bond-financed (May be able to “trace” the bond proceeds and allocate them away from the solar, so as to maximize the ETC. See PLR 200820011)
  • Placed-in-service date can be different for panels than for housing units. You can’t “warehouse” the ETC, so it’s important to have the investor ready (or already in)
  • If solar qualifies for LIHTC, it can qualify for the 130% boost too (if project is in DDA or QCT)
more technical rules
More Technical Rules
  • Tax Exempt Use Rules – If there’s a tax-exempt partner, make sure that its share of the deal is a “qualified allocation” or use a Section 168(h)(6) electing entity.
  • Profit motive should not be necessary because of Section 1.42-4 of the regulations that applies to LIHTC deals (But consider “lease pass-through” structures in which the panels are leased to a different investor which only takes the credits)
15 things to remember solar and lihtc
15 - Things to Remember -- Solar and LIHTC

ETC Issues

  • LIHTC and Solar are allocated among partners differently (so watch out for contingent fees and other proxies for profits that can screw up the ETC)
  • May be able to delay incentive fees to year 6 to avoid risk that fees will be treated as profits during recapture period
things to remember solar and lihtc cont
Things to Remember – Solar and LIHTC (cont)

LIHTC Issues

  • If residents are charged, then solar is “commercial” and not eligible for the LIHTC
  • Utility Allowance rules (1.42-10) hadn’t required that cost savings from solar-provided electricity be taken into account. So: permitted tenant rents are lower than they “should” be. (Illustration follows). But: recent changes allow a building owner to hire a qualified professional to calculate utility allowances taking into account “systems” and “appliances”.
16 utility allowance illustration
16 - Utility Allowance Illustration
  • Assume total permitted rent is $1000, and utility allowance is $75. So, tenants can only be charged $925 by the landlord
  • Suppose solar panels would reduce utility cost by $25. So, instead of $75, we expect the actual utility cost to be $50/mo.
  • Using $1000 permitted rent, landlord should be able to charge $950 (because utility allowance should be reduced from $75 to $50), but 1.42-10 doesn’t require the utility allowance to take renewables into account. Instead, it may be “stuck” at $75
  • So landlord doesn’t get the benefit of the $25 savings; instead, he still charges $925, the tenants only pay $50 for utilities, and their total expenses go down from $1000 to $975
17 solar for housing without the lihtc
17 - Solar for Housing without the LIHTC
  • Solar panels can be added later by an LIHTC partnership (without getting low income credits for the solar), or
  • The panels could be owned by an unaffiliated owner and either:
    • (i) this owner could lease the panels to the LIHTC partnership,

or

    • (ii) this owner could sell power to the partnership or its tenants
  • But consider the loss of the LIHTC (generally 80+% of costs). It is much larger than the ETC (30% of costs)
  • Having a separate owner typically avoids bond tracing rules (if applicable) and may avoid contingent fee issues
nmtc solar investment structure
NMTC/Solar Investment Structure

Leverage Fund

NMTC Equity

Leverage Loan

NMTC Investor

Leverage Lender

NMTC Equity

99.99%

NMTC CDE

Solar Tax Credit Investor

Solar Equity

Solar Credits

Loan

Solar Equity

Solar Project Owner

Master Tenant

49% Interest

Solar Credit Pass-through to Master Tenant

thanks
Thanks

Forrest Milder

and

Herb Stevens