Monetizing Solar Energy Investments: How Developers Leverage Tax Credits and IRA Incentives

Like other tax credit incentives, many developers do not have a large enough tax liability to take advantage of the tax benefits of acquiring and installing solar energy property. As a result, they seek to monetize the energy tax credit incentives. 

Typically, this has been done by attracting tax equity investors. In return for their investment, investors receive an allocation of tax credits and the bonus depreciation generated on the solar equipment. The Inflation Reduction Act (IRA) created new ways for for-profit and tax-exempt entities to monetize solar credits. 

Financing Structures for Renewable Energy Investment Property 

Over the years, multiple structures have been employed to finance renewable energy investment property. Still, the most common are direct ownership through a partnership, sale-leaseback agreements, and lease pass-through structures. 

Direct Ownership Through a Partnership 

A common structure for combining solar with the Low-Income Housing Tax Credit (LIHTC) is the direct investment partnership. In the past, solar credit resulted in a reduction on the LIHTC-eligible basis. Since the IRA has eliminated the LIHTC eligible basis reduction, (see IRC 50(c)(3)(C)), it is anticipated that most LIHTC investors will be willing to pay for the solar credits as well. 

Deals in QCTs that are entitled to the 130% eligible basis boost for a 9% tax credit will deliver significantly more LIHTCs as a consequence of the solar energy property. Even 4% bond deals will benefit — though they do not get the 130% boost, and there can be a reduction to the amount of energy credits when the property is financed with tax-exempt bonds. 

Keep in mind, now that solar credits no longer reduce LIHTC-eligible basis, it can be problematic whenever an LIHTC investor does not want to purchase the solar credits. The reason is that solar credits are allocated based on each partner’s profits percentage, whereas LIHTCs must be allocated in the same manner as depreciation; thus, a developer/general partner will have a tough time convincing an LIHTC investor to consent to specially allocating solar credits inside an LIHTC partnership. 

Sale-Leaseback Agreements 

Under a sale-leaseback, the developer sells the solar equipment to the equity investor, who then leases it back to the developer. As the equipment owner, the investor/lessor claims the credits and takes the depreciation. The developer/lessee assumes all costs, expenses, and liabilities from using the equipment (i.e., the lease is “net”). At the end of the lease term, the lessor expects to sell the equipment or re-lease it under a net lease. 

One drawback of the sale-leaseback structure is it ordinarily requires extensive documentation, including a participation agreement (setting forth certain terms and conditions of each party's participation in the transaction), a lease, a loan agreement, a security agreement, one or more trust agreements (owner trust and/or security trust), and a tax indemnification agreement. 

Additionally, developers must often give up more tax benefits under the sale-leaseback structure than they would under a direct investment structure due to related party restrictions associated with equipment lease rules. 

Lease-Pass Through Structures 

A pass-through lease structure, sometimes referred to as an inverted lease structure, allows a taxpayer to bifurcate the investment credit from the other benefits of ownership. Typically, separate partnerships are formed: one to hold the legal title of the solar equipment and the other to lease it. The lessor/owner benefits from the depreciation, while the lessee/investor receives the benefit of the solar energy credits. 

Like a sale-leaseback structure, the pass-through lease requires more documentation than a direct investment. The investor recognizes 50(d) income instead of the 50% depreciable basis reduction that customarily occurs when a taxpayer claims solar credits in a direct investment structure. 

Streamlining Solar Credit Transfers Transferability 

The IRA includes a new provision that has made it easier to monetize solar credits. For tax years beginning after December 31, 2022, §6418 allows any taxpayer not eligible to make the §6417 direct pay election (discussed below) to elect to transfer all or a portion of their credits to an unrelated taxpayer. The election must be made by the due date of the return for the tax year so the credit can be claimed. The consideration paid for the transfer must also be cash. If a partnership or S-corporation owns the solar property, the entity makes the election. The credits must be transferred for the year accrued, so transferors cannot transfer carry-forward credits. 

Solar credits can only be transferred once, and, once the election is made, it is irrevocable. The transferor does not recognize taxable income or a deduction on the transfer of the credit. Instead, the proceeds are treated as tax-exempt income. 

Direct Pay Options for Solar Credit Monetization 

The IRA also created a way for tax-exempt organizations to monetize solar credits by allowing the tax-exempt entity to request a refund of the full value of the credits, enabling nonprofits, state and local governments, and tribal nations to participate. 

To qualify for direct pay, the tax-exempt entity must own the solar property outright; a partnership cannot be the owner. Additionally, a refund is received after the building is placed in service and credit is earned. This could make direct pay less attractive than other methods of monetizing solar credits, as the tax-exempt entity must advance the solar equipment costs, wait until its tax return, and refund request are processed. 

The IRA created new mechanisms for monetizing energy credits, but it requires planning and thorough knowledge of the tax code to avoid hidden traps. 

Do you need help assessing how to monetize solar credits in your organization? EisnerAmper has a depth of resources to help our clients. Contact us today to discuss how we can support you.