This is the last of our three-part article series outlining some of the most important incentives available to those interested in investing in solar energy. In this article, we’ll outline the steps and qualifications required to become a solar tax credit investor.
How can I invest in solar and what do I need to do to qualify as a solar tax credit investor?
The Section 48 commercial Solar Investment Tax Credit is non-refundable and non-transferable, making it somewhat challenging to be sure to comply with all of the various accounting and legal implications of the tax code. For this reason, we highly recommend potential solar tax credit investors work closely with their accountants and legal counsel to ensure they can recognize the value of the investment tax credit and any associated depreciation deductions.
While the IRS’s formal rules are somewhat light for such a robust tax investment market, the accepted practice is to classify income from solar projects to third-party owners as “passive income.” This 2010 brief from Novogradac can be quite helpful to accountants and potential investors. This analysis still stands today, though the Build Back Better Act currently before Congress does contemplate shifting the rules to make it more accessible. Unfortunately, there is no guarantee the Act will pass as is, nor that these credits will become more accessible.
The most critical questions for potential solar tax credit investors are:
- Do I have a large amount of passive income that can be offset by solar tax credits and depreciation expense deductions?
- Am I exempt from the passive loss limitation, and do I have a significant federal tax bill that I can offset with solar tax credits and depreciation?
How do I qualify as a solar tax credit investor?
To qualify as a solar tax credit investor, you must meet one of these three following categories:
- Be a C Corporation with a substantial federal tax bill that can be offset
- Be actively engaged in the business of commercial real estate
- Have enough taxed passive income to offset the value of the tax credit and deprecation tax value.
How do C Corporations benefit from solar tax investments?
C Corporations are not subject to the passive loss limitation. For instance, some of the largest energy tax credit investors include such recognizable corporations as Google, Apple, Walmart, Berkshire Hathaway, and many others.
Because the solar ITC and depreciation expense deduction are not refundable, C Corporations investing in solar still must have federal tax bills to offset the solar tax benefits. If you know, or are a leader of a C Corporation, it’s a good practice to ask your tax advisor if you have any tax liability that could be offset by investing in solar energy.
I work in commercial real estate. Can I qualify as a solar tax credit investor?
Like C Corporations, individuals or other entities engaged in the business of commercial real estate are not subject to the passive loss limitation. These investors can offset all of their income, regardless of whether their income is classified as active or passive, through the Solar Investment Tax Credit and associated depreciation. To be actively engaged in the business of commercial real estate generally requires that one generates 51% of their income from commercial real estate activities and spends 750 hours each year doing so. Individuals should consult their legal and accounting advisors to ensure they qualify and are not subject to the passive income limits. Owners of solar companies are one example of individuals that typically fall within this category but often don’t expect to do so.
How else can I qualify as a solar tax credit investor?
The third category of potential solar investors are those who have a significant amount of taxable solar income. Typically, this would include owning a large number of apartments that generate rent or similar income without meeting the qualifications to be actively involved in commercial real estate. For instance, an apartment owner that generates $1 million of net taxable rental income and has a 25% effective tax rate would face a $250,000 tax bill for that year from their passive income. The maximum value that investor could recognize from the non-refundable solar tax credit and depreciation would be limited to that $250,000 of tax on the passive income.
Whether you have some experience or are brand new to solar, Avisen Legal has extensive experience in structuring solar partnerships that mobilize investments in solar in order to benefit investors, benefit property owners, increase the reliability of our electric system, and meet urgent climate goals.
I can likely monetize the solar tax benefits. How would I invest?
The most frequent vehicle for individual or small corporate solar tax equity investors is via a Limited Partner interest in a Special Purpose Entity LLC, an “SPE.” A tax equity investor often contributes between 35% and 50% of a total project cost to the SPE as a Limited Partner. The General Partner is usually responsible for the development, procurement and construction of the project – via contracts with the SPE – and for managing all of the customer contracts such as PPAs and Leases for the SPE.
The SPE’s Operating Agreement gives the tax equity investor the right to claim their pro rata portion of the tax benefits on their own taxes, and the General Partner also agrees to provide to the solar investor a small annual dividend or a small percentage of operating cash flows. The General Partner usually takes care of all of the annual accounting tasks, including issue K-1s to the Limited Partners.
As discussed in the earlier articles in this series, the Operating Agreement often includes a “put” option for the Limited Partner tax equity investors to sell their interest in the SPE at the end of the 6-year tax credit compliance and depreciation deduction period. That sale is usually at a Fair Market Value formula that is at a very small percentage of the original investment by the tax equity investor.
How risky is a tax equity investment?
The main risks to solar tax equity investors come from trying to sidestep the requirements to claim the ITC and solar depreciation. Once the structure is set up properly, and so long as the tax equity investor does not try to exit the partnership during the first 6 years or transfer its interest to an otherwise unqualified investor during that same period, the tax equity investment itself faces very little outside risk to being able to claim the tax credit and depreciation deductions. Solar tax equity investments have proven to be quite secure and risk-mitigated investments over the past 15 years, and there is little reason to believe anything will change in terms of this risk.
If you’re interested in adding a solar development to your residential or commercial property or would like additional information about the incentives available to you, please contact Jeremy Kalin and he will be in touch with more information soon.