The Basics of Solar Tax Credits

Forrest Milder617-345-1055

fmilder@nixonpeabody.com

Herb Stevens202-585-8811

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

• Generally only available for new property (there’s an 80% test)

• Mostly: depreciation over 5 years

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 (cont) -- Overview of ITCs

• 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

• Called “Energy Tax Credits” in Section 48 of Tax Code

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-depre-ciation” for tenant). A lot like HTC.

3 (cont) -- Need for an Owner

• Lengthy documents detail the relationship – addresses investment timing, allocating credits, distributing cash, and withdrawal of the investor

• Usually: 5+ or 10+ year relationship with investor

4 -- Allocations

•IRS has elaborate (inscru-table?) 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

Partnership

Developer Investor

1% 99%

Solar Facility

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

•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

7 -- The Biggest Problem

•Congress keeps renewing the credits in one and two year extensions

•For most facilities placed in service in 2009 and later, ITCs revert to 10%

•Discourages technology development

•Discourages building of facilities

•This leads to important “placed in service” tests.

8 – Placed In Service (“PIS”)

– If credits aren’t extended, PIS matters – to get the higher 30% rate for ITCs

– When to start claiming credits – it’s not based on when the investor comes in.

– If investor gets in late, ITC may be lost (note 3-month lease exception)

– ITC may be able to use “progress expenditures” to get credits earlier, and higher rate

8 (cont) -- More on Placed in Service

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

9 -- Other Subsidies

• Adverse Interaction with other Federal Credits

• Bonds and “subsidized energy financing” generally reduce federal credits. (Full reduction)

• State programs usually don’t reduce solar credit, but may be taxable, e.g., state grants)

• IRS keeps attacking state tax credits

10 -- 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)

11 -- 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. Unpopular in energy deals

•Call – The developer can buy out the investor for fair market value

12 -- Combining LIHTC and Solar

• Project can qualify for both

• States may give extra points in the QAP

• Solar credits reduce LIHTC basis

• Remember that bonds can be a problem

• Remember that LIHTC and Solar are allocated among partners differently (so watch out for contingent fees)

Examples: Solar and Housing Credits

9% Housing Credit 4% Housing Credit

Solar Panel Cost $1,000,000 $1,000,000

Solar Credit at 30% $300,000 $150,000 assumes 50% tax-exempt debt

Housing Credit Basis(reduced by ½ solar credit)

$850,000 $925,000

Credit Percentage (assumed)

81% 35%

Housing Credit $689,000 $324,000

Total Credits $989,000 $474,000

Thanks!

Forrest Milder

and

Herb Stevens