The White House by legislative or administrative action intends to expand tax policy with respect to renewable energy. Two areas under consideration by the Administration are (i) Senators Coons (D-Del.) and Jerry Moran’s (R-Kan.) bill to expand the ability of master limited partnerships (MLPs) to invest in renewables by treating renewable energy income as “good” income for purposes of the 90 percent qualifying income test and (ii) permitting solar projects to be “qualifying” assets for real estate investment trusts (REITs). The MLP bill is discussed in the blog post below of March 13.
Heather Zichal, deputy assistant to the President for energy and climate change, made these comments yesterday. The strategy is apparently based on a political judgment that an energy bill would be unlikely to garner sufficient support to be enacted; therefore, changes to tax policy are seen as a viable second choice.1
With respect to REITs, the White House may not need to wait for Congress. As widely reported, Renewable Energy Trust Capital, Inc. has filed a private letter ruling request with respect to utility scale ground mounted solar being effectively “real property” for purposes of the REIT rules. That ruling was expected at the end of January, but there has yet to be a public report of it being issued.
The Coons-Moran MLP bill is a good first step in expanding the ability of renewable energy developers to raise equity in the public markets. When that bill is reintroduced in this Congress, it would be helpful if it also provided that tax-exempt unit holders of the MLP would not trigger any reduction in the accelerated depreciation or tax benefits available to projects in which the MLP has an interest.2 Addressing the tax-exempt unit holder point that would enable MLPs to execute transactions with tax equity investors to monetize tax credits and accelerated depreciation that are of little benefit to their unit holders, who are typically individuals subject to the passive activity loss and at-risk rules. For an explanation of those rules applicability to individual taxpayers, please see [Hunting Unicorns, Project Perspectives].
It is important to note that neither the MLP nor the REIT expansion would solve the problem of the renewable energy industries shortage of tax equity investors; neither would change or be a substitute for the energy tax credits that have been the foundation of renewable energy in the United States to date.
The initiatives above are worthy policy changes, but there also technical issues that the Administration in short order could address in notices, revenue rulings or regulations that would meaningfully facilitate renewables investment:
- The investment tax credit rules require that the taxpayer that claims the investment tax credit owns the project before it is "placed in service" (i.e., commercially operational). The rule does not apply in production tax credit transactions and it has a limited scope in the Treasury cash grant program. Further, for sale-leaseback investment tax credit transactions, the lessor is permitted to enter the transaction anytime within the first three months following placement in service. It would be helpful to expand the three-month rule to include flip partnerships,3 pass-through leases4 and service contracts5 in which the party that developed the project has a continuing role in the transaction.
- The investment tax credit rules require recapture of the investment tax credit if there is a transfer of the project in the first five years.6Such rules in the Treasury cash grant program were limited to transfers to tax-exempt entities; further, the rules are inapplicable in production tax credit transactions. The following clarifications would expand the market for tax equity investors willing to be exposed to recapture risk:
- Exempt foreclosures by a lender from triggering recapture. Concern that a lender will foreclose and trigger recapture results in many tax equity investors declining to invest in levered projects; however, leverage often is a key component of the optimal capital structure.
- Provide that a change in the allocation of tax attributes among partners does not result in recapture. This hampers the partnership agreements from being drafted in a manner that produces the optimal economics for the projects.
- The investment tax credit rules generously provide that the tax credit may be claimed prior to placement in service for qualified production expenditures (QPEs). Please click here for a discussion of QPEs generally. The investment tax credit for QPEs is rarely claimed, because tax equity investors prefer to invest once the project is substantially constructed. That leads to the following questions: if a developer incurs $100 of QPEs and forms a partnership with a tax equity investor that invests $1 during construction period, may the tax equity investor with its $1 investment be allocated the 30 percent tax credit for the $100 of QPEs? An accommodating answer to this question could encourage more tax equity investors to make capital contributions during construction, which is a time projects have a critical need for capital.
- Residential solar is growing rapidly and has the potential to grow even faster. As few homeowners want to pay for solar panels out of pocket, leasing is a common solution. The term of the leases is often 25 years. The primary guidance on leasing is the leveraged leasing ruling guidelines which, are almost four decades old,7 but such guidelines are not easily applied to today’s residential solar leases. It would encourage tax equity investors to enter the market if residential solar leases could be provided their own safe-harbor that was more in line with market expectations than the leveraged lease ruling guidelines. Further, some homeowners request to prepay their solar leases, as they may have money in the bank earning interest at a lower rate than the leasing company will charge them. Providing guidance on permissible prepayments would encourage more tax equity investors to participate in these common transactions.
As the White House appears to have decided to use tax policy to promote renewable energy, the renewable energy industry should seize this opportunity to address not only large legislative issues, like MLP, but also technical rules that hinder the expansion of the tax equity market and would require little, if any, of the President’s political capital to resolve.
1 Ari Natter, Official Says White House Seeking Changes To Tax Policy to Benefit Renewable Energy, Daily Tax Rep. G-9 (Apr. 9, 2013).
2 See I.R.C. §§ 50(b)(4)(A), 168(h)(6).
3 E.g., Rev. Proc. 2007-65, , 2007-45 I.R.B. 967.
4 See I.R.C. § 50(d)(5) (referencing old § 48(d)).
5 See I.R.C. § 7701(e).
6 See I.R.C. § 50(c).
7 Rev. Proc. 2001-28, 2001-1 CB 1156 (substantially re-issuing Rev. Proc. 75-21, 1975-1 C.B. 715), so these guidelines are fundamentally unchanged since 1975.