sharon canavan office of the comptroller of the currency stephen tracy novogradac & company llp...

Sharon CanavanOffice of the Comptroller of the Currency

Stephen TracyNovogradac & Company LLP

Darren Van’t HofU.S. Bancorp Community Development Corporation

Investment Restrictions

Bank holding company investment in ITC transactionso Restrictions under 23 A and B on types of

transactions in which holding company can partner with subsidiary or affiliate

General authority – Banks are lenders first Under special circumstances, bank may

directly or indirectly invest in real estate

Proposed Volker Rule

The Volcker Rule generally prohibits a “banking entity” from: (i) sponsoring, or acquiring or retaining an ownership interest in, a “covered fund” (unless otherwise permitted under the rule)

Covered fund is broadly defined to include most

privately offered funds, not solely private equity and hedge funds (Section 3(c)(1) or 3(c)(7) ICA)

Proposed Volker Rule

Public welfare investments are specifically permitted in statute (as were SBICs, or qualified rehabilitation expenditures related to IRC section 47 historic tax credit programs.)

Banks may acquire an ownership interest in or sponsor a covered fund that qualifies as a public welfare investment

Public Welfare Authority

Increased interest in renewable energy investments at bank level

Public welfare investment authority allows bank to take equity or ownership interest in real property or commercial assets

In 2011, banks invested $66 million in solar facilities using PWI authority

Meeting the Public Welfare Test

Source: Bank of America

• Must primarily benefit:• LMI individuals or areas

• Geocoding map at www.ffiec.gov• Areas targeted by a government entity for redevelopment• In assessment areas where a bank would receive consideration

of “qualified investments” under the Community Reinvestment Act.

• Provides LMI jobs • Affordable housing

Public Welfare Authority

Cannot expose bank to unlimited liability Investment limits

– 5% of capital and surplus– May increase to 15% with prior OCC approval

After-the fact notice can be filed by “well-capitalized bank”

Prior approval required if—– Don’t meet criteria for “well-capitalized bank”– Aggregate public welfare investments exceed 5% of

capital and surplus

Community Reinvestment Act

“Green” activities do not of themselves qualify for CRA consideration.

CRA consideration—Primary purpose must meet definition of

community development


Construction or substantial rehabilitation has a primary purpose of community development depending on its use—o Affordable housing for LMI individualso Community facilities that are located in LMI income

areas or serve primarily LMI individuals Health care facilities Charter schools

Demonstrate rehabilitation cost savings directly benefit LMI tenants or reduce operating expenses to maintain affordability for LMI tenants


“Twinning” Investment Tax Credit and New Markets Tax Credit—

CRA consideration for both

ITC and NMTC equity infusions into CDE

Interagency Q&As

(§ll.12(g)(3)—1)

ITC NMTC

CDE

QALICB installs solar

Bank


Loan or investment that supports permanent job creation or retention— For LMI persons In LMI area

• Revitalizes or stabilizes area targeted for redevelopment by local, state, Federal, or tribal government (formal or informal plan) Interagency Q&A §ll.12(g)(4)(i)—1

Source: Sunwheell Energy Partners

More Information from OCC

www.occ.gov OCC’s Community Affairs pageE-zine on “Investing in Solar Energy Using

the Public Welfare Investment Authority”Energy Investment Tax Credit Fact SheetPublic welfare investment Web Resource

DirectoryGeomapping information at www.ffiec.gov

13

INVESTMENT TAX CREDIT BASICS

– 30% Investment Tax Credit

– In place until 12/31/16

– After 2016 reverts back to 10% credit

– Tax credits generated 100% on the PIS

date

– Allocated to partners based on profit

percentage

– Carry back 1 year – Carry forward 20

years

Solar Tax Credits – Basic Rules

14

Facility Cost

What is the amount of the tax credit or grant?

30%Tax Credit

15

Credit is non-refundable

Tax Liability Tax Credits

No cash back

1 year 20 years

16

– ITC Reported on Form 3468 and Form 3800

– Schedule K-1 reflects your share of energy

credit basis

– ITC can reduce AMT - Since 2009

– 5-year recapture period (vests 20% per year)

– $2,000 credit cap lifted for residential installations - Section 25D

– Public Utilities may now use the tax benefits


17

– Treasury Grant program (Cash in lieu of ITC)• ARRA Section 1603; Extension not likely

– Subsidized Energy Financing taint removed• No longer causes a reduction in energy tax credit

basis

– Bonus Depreciation to be extended for 2012? We’ll see

– Loan Guarantee Program – DOE• Most would say it’s been a bust

• Solyndra fallout


18

Basis Investment Tax Credit

30%

“subsidized energy financing” or

private activity bonds

%

%

Prior to ARRA

19

Basis Investment Tax Credit

30%

“subsidized energy financing” or

private activity bonds

After ARRA(property PIS after 12/31/2008)

20

• Sale of electricity to a third party not

required

– Owner of the system can be the user• Combination of Investment (Solar) Tax

Credit (Treasury Grant) and accelerated depreciation may reduce capital cost by up to 56%• Rebates (if available) help further


21

• Equipment that uses solar energy to

generate electricity

– Constructed by the taxpayer

– Acquired by taxpayer and first used by taxpayer

• Exception for sale-leaseback transactions

• 90 day rule (Old IRC Section 48(b)(2))

Solar Tax Credits – Eligible Property

Defined

22

• What costs are eligible for the credit?

– Solar panels, mounting, racking systems,

electrical wiring, inverters etc.

– Direct and indirect costs of installation

• Systems integration / system design / pre-operational

testing / independent engineer reports…..

• Permits, city fees etc.

• Interest expense prior to PIS – Subject to Section 266

Election

• Developer fee, other soft costs

Eligible Energy Tax Credit Basis

23

Solar Tax Credits – Eligible Hard Costs

Eligible

Ineligible

Eligible

Eligible

Reasonable Allocation

24

Courtesy of Borrego Solar

• Practical Issue is extent to which a support system qualifies for the credit – roof repairs generally do not qualify;

• Base for ground-mounted units generally ok

• Parking garage structures which support panels but provide shade?

– Portion of roofing repair? Reasonable allocation

– Parking garage / carport cost? What portion? Reasonable allocation. With and without test


25

• What costs are NOT eligible?

– Organization costs, permanent loan fees,

syndication costs, etc.

– Transmission costs/ Interconnection fees

– Security fencing, prepaid O&M

– Intangibles? PPA? Ground Lease

– Roofing costs allocated to the building

– Parking garage / carport installations – cost allocation

question


26

• Energy property depreciated using 5 year MACRS

• Bonus depreciation rules– 2011 last year for 100% bonus – Property PIS in 2012 eligible for 50% bonus

• Basis Reduction– Equal to 50% of investment tax credits claimed– 85% of energy property basis depreciable over

5 years

Depreciation

27

What is the amount of depreciation on the solar property?

Basis Tax Credit

50% basis reduction

30%

5 year MACRS

28

Basis Tax Credit

50% basis reduction

30k

5 year MACRS

100k

85k

15k

What is the amount of depreciation on the solar property?

29

• When is a facility placed in service?– “Ready and available for its intended use” –

IRC definition– Utility signoff – Permission to Operate

(PTO)Letter– Facility completed, licenses obtained, pre-

operational testing complete• Commercial Operation Date

– When customer is contractually obligated to buy power

Placed in Service

30

When is eligible property considered “placed in service”?

“Ready and available for its intended use”

Public Utilities

Approval Letter

GRIDLICENSE

31

• Generally, owner on placed-in-service date is entitled to ITC

• 90 day window for sale/leaseback transactions– Lessee can place in service and lessor can take the

credit if a sale leaseback transaction is consummated within 90 days of placed-in- service. (No such partnership rule)

• Lessor can pass credit through to lessee – Inverted Lease Structure – More on that later

• Used property has already been placed in service, so need new property. Can have 20% used parts. 80/20 test

Placed in Service

32

When can the credits be claimed ?

When are the credits in danger of recapture?

Placed-in-service date

100% of credits100% of credits

5-year recapture period

80 60 40 20

33

• Investment tax credit vests over five years• Results, if during the 5 year vesting period,

there is :– Change in ownership – Property ceases to be qualifying energy property

» Sale

» Foreclosure

» Force de majeure event (no rebuild)

• Recapture diminishes 20% per year• Recapture reported on IRS Form 4255

ITC Recapture Rules

34

• Partner is deemed to dispose of a portion of the underlying property if its interest in partnership profits goes below 66 2/3%

• Once the rule applies, it re-applies if the interest of a partner is reduced below 33 1/3% of their interest in the year in which the property was placed-in-service

• Forbearance Agreements

• Lender agrees not foreclose on the property

ITC Recapture Rules

35

Treasury Grant Program

Section 1603 – ARRA

36

• ARRA signed by President Obama on February 17,

2009• Cash grant from the Treasury in lieu of the ITC

• Temporary measure due to seized up capital

markets• Known as the “Section 1603 Treasury Grant”

• Generally receivable within 60 days of filing

application with Treasury• Treasury Grant program expired 12/31/11• Extension not likely

Treasury Grant Program

37

IRC Section 48 Credits

IRC Section 45 CreditsGrant

(30% of basis)

Grant(30%/10% of basis)

Treasury

Treasury Grant Election

38

30%

Grant = 30% or 10% of basis of facility

10%

(Subject to recapture similar to ITC)


39

• Property must be PIS during 2009, 2010 or 2011or after 2011 and before the investment tax credit termination date of January 1, 2017, but only if the construction of such property began during 2009, 2010 or 2011

• The Secretary has 60 days from the later of the application for such grant or PIS date to fund the grant

• All applications must be received before October 1, 2012.


40

• Treasury Grant cannot be made to– Governmental bodies, political subdivisions, agencies

or instrumentalities thereof – To any organization described in Section 501(c) of the

Code and exempt from tax under Section 501(a) of the Code

– A clean renewable energy bond lender – A cooperative electric company – A pass-thru entity that has one of the aforementioned

named as a partner


41

• Grants are not includable in the federal gross income of the taxpayer– Tax-Exempt Income

– State considerations – Non-taxable in CA

– Gives a partner tax basis in partnership interest

– Timing considerations of investor entry

• Grants shall be taken into account in determining the depreciable basis of the property

• Basis of property reduced by 50% of the grant amount (similar to ITC)


42

• Generally same rules as ITC except…• Dispositions to ineligible participants will trigger

recapture

– Governmental bodies, political subdivisions, agencies or instrumentalities thereof , non-profits

• Other dispositions ok as long as property stays in service

• CCA 200943029 Issued 10-23-09 – “Recapture will not be handled through the income tax system; it will be handled as a debt owed to the government and Justice will have to sue to recover if the payments are not voluntarily paid to Treasury”

Recapture Rules - Treasury Grant

43

• Above the line versus below the line accounting treatment

- Tax equity investors prefer the accounting treatment of the Treasury Grant over the ITC

• Preservation of investor tax appetite- Allows tax equity investors to preserve their tax appetite

for other investments

-Investors may not have current tax appetite

• Recapture rules more relaxed than ITC• Cash is king

- Improves Liquidity

Popularity of the 1603 Treasury Grant

Program

44

Tax Credit Comparison

45

PTC

• Electricity must be sold to a third party

• Credit computed based on kWh output

• Credits earned over ten years

• AMT is offset for first four years only

• No risk of recapture

• No depreciable basis reduction

ITC/ Grant

• Does not have to be sold to a third party

• Credit computed as a % of the cost of the facility

• Full AMT offset allowed

• Subject to recapture for five years

• 50% ITC/Grant basis reduction

The Sunset Clause Under

Section 1603

Beginning of Construction Safe Harbor

For energy property NOT PIS in 2009, 2010, or

2011, construction must begin before January 1,

2012.

Two ways to satisfy this requirement:

1. Sufficient physical work – physical work of a

significant nature test

2. 5% cost safe harbor – safe harbor test

The Sunset Clause

Sufficient physical work – includes:

• Both on-site and off-site construction activities

• Work on foundation

• Pouring concrete pads

• Building certain roads

• Assembly of machinery

Work of a Significant Physical Nature

Sufficient physical work – does not include:

• Preliminary Activities

• Planning/Designing

• Researching

• Securing Financing

• Removing an existing facility

• Clearing land/Test drilling

• Obtaining permits

Work of a Significant Physical Nature

5% cost safe harbor – safe harbor test

• An applicant must have paid or incurred more than 5% of

the total cost of the property on or before 12/31/2011

• An accrual basis applicant incurs cost and a cash basis

applicant pays cost

• For property produced for the applicant under a binding,

written contract with a third party, costs are treated as

paid or incurred when the property or title is delivered

• Property that is delivered to the applicant within 3 ½

months of the date of payment will be deemed delivered

on the date of payment

5% Cost Safe Harbor Test

5% cost safe harbor – safe harbor test

• Both self-constructed property and property constructed

under a written binding contract are combined

• Only costs included in eligible basis are considered

• No continuous program of construction issue

• Failure to meet safe harbor may arise if actual final

costs are greater than initially projected to the extent

the 5% threshold is not met upon the placed in service

date

• Will require accountant’s certification if grant payment

exceeds $1 million


5% cost safe harbor – includes:

• Direct construction costs

• Facility property (solar panels,

inverters etc.)

• Engineering/Designing

• Benefits and burdens of ownership

• Spend money!


How are renewable energy transactions structured?

1-Partnership Flip

2-Sale-Leaseback

3-Lease Pass-through

4-Outright purchase

53

InvestorDeveloper/Sponsor

HostCustomer

System Integrator

Private Equity

Lender

Key Players

Panel Manufacturer

54

– Three common arrangements have developed:• “Partnership with a Flip” Structure

– Originated in wind energy transactions and adapted for solar

• Lease (Sale/Leaseback) Structure– Sale/leaseback cannot be used in wind transactions

because Production Tax Credits (PTCs) are not available to a non-operator owner

• Lease Pass-Through (Inverted Lease Structure)– Originated in historic tax credit transactions and

adapted for solar– “Sandwich lease” structure for HTC

System Ownership and Investment Funding

55

Tax Credit

Equity Investor

99%

Fund

General Partner

1%

Investment Fund

Tax Credits

Depreciation Deductions

Cash Flow

System Integrator/

Installer

$

1%

Solar

Installation

Host #1

PPA/Lease Agreements

Developer

Fee

Partnership Flip

Solar

Installation

Host #2

Solar

Installation

Host #3

Solar

Installation

Host #4

Solar 1, LLC

Solar 2, LLC

Solar 3, LLC

Solar 4, LLC

100%

Developer

99%

Lender

Debt Service Payments

Loan Proceeds

56

• Typically preferred by developers desiring long term and residual ownership interest benefits

• Appeals to investors who are mostly interested in short term ownership benefits

• 6-7 year investment – can be longer

• Put/Call buy out structures prevalent

• Vehicle for larger investment funds

– Additional deals (tranches) easily added

Partnership with a Flip

57

• During the period when tax benefits are available or until such later time as the Investor achieves a specified rate of return on its investment (typically 6-7 years), a large majority (typically, 95% or more) of taxable income, loss and tax credits are allocated to the Investor.

• After the later of the expiration of the tax credit recapture period or the achievement of the investor's specified hurdle rate of return, the ownership of the LLC (partnership) interests flips, to, for example, 90% or 95% to the Developer and the rest to the Investor.

• After target IRR is reached, Developer frequently has an option to buy out the Investor's interest for fair market value determined when the option is exercised. Option should not be continuous, but may be exercisable at predetermined times.

Partnership with a Flip

58

• Fund is the owner of the solar installations (via

lower tier LLCs disregarded for tax purposes)

• Tax Benefits

– Depreciation deductions

– 30% ITC flows through to the tax credit equity investor

– State incentives – Rebates, Renewable Energy

Certificates (RECs) and state tax credits

– Cash flow from PPA / Lease revenue

Investment Fund in a Partnership Flip

59

Sale Leaseback Structure

60

Solar Developer, LLCLessee

System Integrator/

Installer

Solar

Installation

Host #1

PPA/Lease

Agreements


Solar

Installation

Host #2

Solar

Installation

Host #3

Solar 1, LLC

Solar 2, LLC

Solar 3, LLC

Corporate InvestorLessor

Energy Procurement

Contract (“EPC”)

Lessor is owner of SEF, Investment Tax Credits,

Tax Losses (Depreciation Deductions), Rebates,

RECs, Recipient of lease payments, Potential

residual buyout

Solar Developer may provide certain

guarantees to Corporate Investor and

funds would be held in escrow

accordingly. Yield guarantees, O&M,

Insurance etc. Funds released to Solar

Developer as guarantees burn off.

Lease Agreement

Sales Proceeds

Sale of SEFs and Lease

PaymentsSolar

Developer

Purchase Agreement

61

• Tax-advantaged investor purchases the qualifying solar system from Developer and immediately leases the system back to Developer (or an SPE established by Developer).– Thus, Investor is the lessor, Developer is the lessee

• Lease is typically a net, "hell-or-high water" lease.• Developer/lessee is obligated to pay fixed rent (or

specified termination value in the event of a loss of the assets) to Investor/lessor for the term of the lease irrespective of the actual performance of the system, existence of force majeure events, etc.


62

• Developer lessee bears all operating costs, costs of insurance, etc.

• At the end of the lease term, the system is retained by the Investor/lessor (who is its owner all along)

• Developer/lessee typically has an option to purchase the system at the end of the lease term (and sometimes at one or more specified times before the end of the term)

– Purchase option at fair market


63

• More effectively frontloads economics to developer

– Allows developer to grow business with current cash flow

– More effective use of developer’s capital?

• Developer establishes track record

– Generally sacrifices residual interest for current cash flow

– Prepaid lease payment to investor equals deferred fees

• Investor has flexibility to get into the deal within 90 days of PIS mitigating/eliminating construction risk

Sale Leaseback Attributes

64

• System is owned 100% by investor

-No leakage of tax benefits (e.g. 1% to G.P.)

-Efficient monetization of tax benefits

• Simplicity of structure, Cost effective -Investor utilization of lease optimization model

• Sales taxes paid over life of the lease agreement

Sale Leaseback Attributes

65

Lease Pass-Through Structure

(Inverted Lease)

66

Capital Contribution

State Incentive Programs

Lease Pass-ThroughSale of PV Panels

Loan Proceeds

Basis Reduction Income

No basis reduction to depreciable basis

Manufacturer

LESSOR SOLAR LPPV System Owner

General Partner

51%-99%

partnership interest

$$

$

Capital Contribution

CreditsCash – Preferred Return

Call Option – Cash, Capital LossLe

ase

Developer/ Installer

Lender

Host

1% General Partner(Developer)

99% Limited Partner(Corporate Investor)

P/L and Credits

Power

Install/Maintenance Debt Service Payments

SOLAR MASTER TENANT LP

Leas

e

Lease Payments

1%-49% LP interest in losses

Capital ContributionPass-throughElection

P/L

$

$

67

• Election to treat Lessee (Master Tenant) as owner of solar system for ITC purposes ONLY– IRC Section 48(d)(1) / Treasury Regulation 1.48-4(f)

• Ownership of system, and thus, depreciation deductions remain solely with Lessor (Owner)– Flexible Ownership of Owner by Master Tenant

• No basis reduction to depreciable basis for Owner, but…

• Master Tenant required to recognize income equal to 50% of ITC claimed over 5 years– IRC Section 48(d)(5)

Lease Pass-Through Attributes

68

• Tailored to gives investors what they want?– Annual preferred return on capital – 2-5%

– Flexible Profit/Loss Ownership – Investor does not have to absorb 99% of losses

– Write off of capital account (capital loss) upon disposition of ownership interest in Master Tenant

– Ownership interest may flip down to approximately 5% after 5-year recapture period

– Put/call – cash payment equal to the greater of FMV of ownership interest (after flip) or amount of cash required to achieve desired IRR. Some attorneys do not respect the PUT option

– Economic Substance Doctrine

Lease Pass-Through Attributes

69

• Issues for partners of the Lessor (Ownership Entity)– Can the partners use the (remaining) tax losses?

• Owner(s) of Lessor must have tax appetite

– Loss Investor (e.g. a Leasing Company) available to be a partner in Lessor?

• Sponsor equity required in addition to loss investor equity?

– Potential IRC 704(b) issues for the Developer as partner of Lessor

– Potential IRC 704(d) issues for the Developer as partner of Lessor

– Economic substance doctrine issues

– Risk that ownership structure gets collapsed into a single entity partnership structure?

Lease Pass-Through

70

• Issues if Master Tenant is not a partner of Lessor– Master Tenant stands alone

– Master Tenant (Lessee) typically makes a lease pre-payment to Owner (Lessor) equal to Investor capital contribution

• IRC Section 467 loan created • Residential solar – Below Section 467 $250,000 thresold

– Must structure and size investor preferred return and lease payment

– Lease term – Treasury Regulation Section 1.48-4 (short-term lease rules)

– Economic substance doctrine issues

Lease Pass-Through

71

• Once you have gotten the investors IN, you need a way to get them OUT– Flip – reduces the investor’s ownership percentage to

make it cheaper to buy it out

– Put – investor can exercise option requiring developer to make a small payment to buyout investor; not as common in energy deals as in other transactions because of Rev. Proc. 2007-65

– Call – developer can exercise option to buy out the investor for fair market value of partnership interest

– Purchase option or early buy out option

Exit Strategies

72

• Investors generally want out of the transactions at the end of year 6 – Put/Call option

• Most common exit is through a flip:– Investor ownership interest flips from 99% to 5%

– Developer/GP exercises call option to buy out investor for greater of FMV of ownership interest or amount required to achieve agreed-upon IRR

Exit StrategiesPartnership and Lease Pass-Through Structures

73

• Sale/leaseback transaction can be closed up to 90 days after PIS

• Partnership transaction must be closed before the facility is PIS

• Less pressure for Developer to delay placing the facility in service if the investor is not yet in the deal.

• 100% financing available at full value. Investor buys the facility

– Generally no investment is necessary from developer– In a partnership structure, the Developer may have to leave

money in the deal (deferred developer fee) or contribute sponsor equity

Advantages of a Lease Structure

74

• Fixed rent and ability to stretch out the term of the

lease result in the lessee being immediately able to

keep the upside if the project generates greater

returns than is anticipated.

• In a partnership structure, the principal effect of

greater returns is to accelerate the date of the "flip”

• Lessor gets a predictable rent stream.

Advantages of a Lease Structure

75

• Lessee's purchase option is more expensive than in a partnership structure. In a lease, the investor owns all of the residual value of the asset (must be estimated to be at least 20% of initial cost).

• Developer is required to make scheduled rent payments and comply with extensive covenants. Accordingly, there is a risk of default and thereby a loss of the Developer's entire investment.

• Developer may not have visibility (transparency) with respect to the tax investor's return. Especially in the absence of financial expertise in "reverse engineering" leasing models, Developer may be at a negotiating disadvantage vis-à-vis the lessor investor. In a partnership structure, the investor's yield is known upfront.

Disadvantages of a Lease Structure

76

• Leasing deals have traditionally been document- and time-intensive. Lease documents contain extensive representations, warranties, covenants and indemnities; there is typically a complex tax indemnity agreement. Partnership structure deals have generally stayed away from such level of detail and complexity (although this can vary depending on who the investor is).

• An appraisal is almost always required for each project. In a partnership structure an appraisal is optional.

Disadvantages of a Lease Structure

77

• Investor does not need a 20% residual value as in a lease. A 5% residual is sufficient.

• Cheaper purchase option at the time it is to be exercised. Since a lessor in a lease owns the entire residual value, buying it out is more expensive than buying out the remaining portion of an investor's interest (typically 5%) after the flip point was reached.

• Less default risk than in a lease - there is no fixed rent schedule or covenant package that Developer must comply with. Failure to generate expected cash flows can punish the Developer by delaying the flip, but Developer is not at a risk of losing its interest entirely and has time to work out problems. (In a lease, fixed rent and covenants could result in defaults and exercise of remedies by lessor.)

Advantages of a Partnership Structure

78

• Deal must be closed and investor must have funded before the facility is placed in service.

• Developer has to fund its portion of the partnership/LLC interests. However, Developer may be permitted to receive a return of its capital from the project up to the value of its investment.

• Management rights and powers (issues related to who has the power to manage the company and run the projects and what level of consents is needed for what actions) can be difficult to negotiate. (In contrast to leases, which have been used for a long time and with respect to which an accepted practice exists.) However, Developer may be able to negotiate for greater flexibility in a partnership structure than would be afforded through a lease covenant package.

Disadvantages of a Partnership Structure

79

• Developer does not have the immediate ability to keep for itself all of the upside generated by the project as would be the case in a lease, where rent payments are fixed upfront.

• No clear advantage to one or other structure and both leases and partnerships are common.

• There may be advantages and disadvantages from accounting perspective.

Disadvantages of a Partnership Structure

80

Twinning LIHTC with ITC

Structure Options

1-LIHTC Partnership - PPA w/ 3rd

Party Solar Developer

2-Traditional LIHTC Partnership

-Owns solar system

3-Captive Energy Company

-PPA w/ LIHTC GP

PPA w/ Solar Developer

-Easiest

-3rd Party Solar developer provides financing

-Passes on benefit of tax attributes/subsidies

Traditional LIHTC Partnership

with Solar - New Construction

Combine Solar and LIHTC

Systems Integrator/

Installer

LIHTC

Operating

Partnership

(with Solar

Installation)

Engineering

Construction and

Procurement Contract

(EPC)

DeveloperDeveloper

Fee

General Partner

1%

Tax Credit

Equity Investor

Fund

General Partner 1%

99%

Investment Fund

Tax Credits (ITC and LIHTC)

Depreciation Deductions

Cash Flow

Tax Credit

Equity

Tax Credit

Equity

ITC & LIHTC Credits/

Tax Losses99%

- ITC and LIHTC

- Tax Losses (depreciation)

- Cash flow

Traditional LIHTC Partnership• Owner of real estate and solar installation

• Earns BOTH 30% solar energy credits and LIHTCs

• Solar credits generated 100% in year 1 – IRR additive

• 5 year MACRS depreciation deductions for energy

property

• State subsidies (www.dsireusa.org for state by state

database)

– NSHP/MASH Program (CA)

– Renewable Energy Certificates (SRECs)

Benefits of Including PV in Your Project

• Use tax credits and state rebates to buy down costs• Lower operating costs and energy hedge for 25 years• Advantage in competition for LIHTC?• Environmental Benefits• Utility allowance issues-IRS Notice 2009-44

Solar Tax Credits combined with LIHTC – Issues

– How will the electricity generated by the solar panels be used by the Project?

– Electricity sold to tenants or the grid • Commercial property taint • Sale of electricity to tenants creates commercial

property

Commercial property is not eligible for LIHTCs!

Methods to avoid commercial taint for LIHTC

• Electricity used for heating/cooling systems only– Common areas (cost of solar panels not eligible for

ITC if electricity generated by solar panels is used to heat a swimming pool)

– Electricity cannot be sold to tenants

• Utility allowance effect– Project requests lower tenant utility allowance– Results in increased Section 42 rents– Electricity effectively given to tenants– Risk that tenants abuse the privilege

• Master Meter structure– One inverter versus one for each unit– Electronically monitored sub-metering

Solar Tax Credits with LIHTC – Issues

– Beware of tax-exempt entity participation (i.e. non-profit general partners)

• Tax-exempt use property not eligible for solar tax credits

• Should structure around tax-exempt use property rules to avoid losing solar tax credits

– Similar to LIHTC depreciation issue

• Tax-exempt use % ownership based on entity’s highest share of partnership items of income or gain

– i.e. profit/loss/ residual % etc. (IRC Sec. 168(h)(6))

Solar Tax Credits combined with LIHTC – Issues

– 1603 Treasury Grant is a federal grant

– Federal grants reduce LIHTC eligible basis by the amount of the grant• IRC Section 42(d)(5)

– Developers looking to combine solar credits with LIHTC will likely not pursue the Treasury Grant

How Investors Evaluate Hybrid LIHTC/ Solar Deals

• Primary motive is the LIHTC investment; Solar system is a minor addition

• Worth about 25 basis points in IRR (give or take)

• Energy credit delivery is fast (adds small first-year boost)

• No opposition from the OCC, OTS, FDIC, Federal Reserve - as long as the underlying project follows all federal and state affordability regulations

• Support exists for solar as environmental enhancement and source of operating savings

• Gross income shall not include the value of any subsidy provided (directly or indirectly) by a public utility to a customer for the purchase or installation of any energy conservation measure. (IRC Section 136)

– The term “energy conservation measure” means any installation or modification primarily designed to reduce consumption of electricity or natural gas or to improve the management of energy demand with respect to a dwelling unit.

– The term “dwelling unit” includes a house, apartment, condominium, mobile home, boat, or similar property, and all structures or other property appurtenant to such dwelling unit.

Public Utility Subsidies – Section 136

• Subsidy funded by ratepayer or utility?– Section 136(b) generally reduces the adjusted basis of property by

the amount of direct or indirect public utility subsidies which are not

taken into income by the taxpayer.

• Most practitioners believe California Solar Initiative

(CSI) rebates are not considered public utility

subsidies

• Different answer for:

• Residential

• Residential rental

Public Utility Subsidies

Numerical – 9% Deals Example – no PBI or NSHP

Investment Tax Credit Calculation - Solar Installation (Sec. 48)

Solar installation price per watt $ 5.50

Watts (95 kilowatts)

95,000

Solar installation costs 522,500

Additional installation costs 22,500 (1)

Solar installation costs before developer fee - Solar Installation

545,000

Developer fee - Solar Installation 81,750 (2)

Total installation costs including developer fee - Solar Installation

626,750

Less: costs ineligible for 30% solar ITC (6,750) (3)

Total costs eligible for 30% solar ITC $ 620,000


Investment tax credit % 30%

Solar ITCs $ 186,000


50% basis reduction (50% of solar ITCs) (93,000)

Depreciable basis - 5 year MACRS $ 527,000

Combining Section 42 (LIHTC) with Section 48 (Solar Energy Credits)

(1) Soft costs (2) 15% of cost (3) Org. costs, syndication, etc.


Low-Income Housing Tax Credit Eligible Basis (Sec. 42)

Solar installation costs before developer fee - Solar Installation $

545,000

Less: costs ineligible for tax credit basis

(6,750)

Total solar installation costs eligible for LIHTC $ 538,250


Equity proceeds from the solar ITC 9% not in

DDA 9% in DDA


620,000

% of costs financed with Tax-Exempt Bonds N/A N/A

Adjusted costs eligible for the 30% solar ITC 620,000

620,000

ITC percentage 30% 30%

Energy tax credits 186,000

186,000

Energy tax credit price 0.75

0.75

Tax credit investor equity proceeds from 30% solar ITC $

139,500 $

139,500

Total solar installation costs eligible for LIHTC $ 538,250 $

538,250

50% basis reduction per Section 50(c)

(93,000) (4)

(93,000)

Eligible basis from solar installation for LIHTC 445,250

445,250

Additional developer fee relating to LIHTC (15%)

66,787 (5)

66,787

Total eligible basis from solar installation for LIHTC

512,037

512,037

Not In DDA = 100%; In DDA = 130% 100% 130%Adj. eligible basis from solar installation for LIHTC

512,037

665,648

LIHTC applicable % 9.00% 9.00%

LIHTCs - annual 46,083

59,908

10 year credit period 10

10

Total LIHTCs 460,830

599,080

LIHTC credit price 0.72

0.72

Tax credit investor equity proceeds from LIHTC $

331,798 $

431,338

(4) 50% of solar ITC (5) Subject to state LIHTC allocating agency’s QAP limit for developer fees

Equity proceeds from LIHTCs 9% not in DDA 9% in DDA

Total installation costs $

626,750 $

626,750

Tax credit investor equity proceeds from 30% energy ITC

(139,50

0)

(139,500

)

Tax credit investor equity proceeds from LIHTC

(331,79

8)

(431,338

)

California Solar Initiative rebate (0) (6) (0)

Potential rebate income tax liability (0) (7) (0)

Estimated net cost of solar installation $

155,452 $

55,912

Net cost of solar installation excluding PBI

(6) Assumes no California Solar Initiative incentive.(7) IRC Section 136 could apply to rebates and other subsidies received by the partnership.

In that case income would not be recognized for the subsidy but the basis of the systemwould have to be reduced resulting in less tax credits and less equity from the sale of those tax credits.

*Incentives vary from state to state. Please visit dsireusa.org for state specific information.

9% not in DDA 9% in DDA


626,750 $

626,750


(139,50

0)

(139,500

)


(331,79

8)

(431,338

)

California Solar Initiative rebate – PBI

(46,000

) (6)

(46,000)

Potential rebate income tax liability16,100

(7)16,100


125,552 $

26,012

Net cost of solar installation including PBI

(6) California Solar Initiative – PBI of $0.09 per kwh paid over 5 years.For installations greater than 30 kw. Discounted at a rate of 8%.Rates per kwh may vary among utility administrators.

(7) PBI rebate proceeds x 35% federal corporate income tax rate. Nontaxable for CA state tax purposes.(8) IRC Section 136 could apply to rebates and other subsidies received by the partnership.




Numerical – 4% Deals Example – no PBI or NSHP

Investment Tax Credit Calculation - Solar Installation (Sec. 48)

Solar installation price per watt $ 5.50

Watts (95 kilowatts)

95,000

Solar installation costs 522,500

Additional installation costs 22,500 (1)

Solar installation costs before developer fee - Solar Installation

545,000

Developer fee - Solar Installation 81,750 (2)

Total installation costs including developer fee - Solar Installation

626,750

Less: costs ineligible for 30% solar ITC (6,750) (3)



Investment tax credit % 30%

Solar ITCs $ 186,000


50% basis reduction (50% of solar ITCs) (93,000)

Depreciable basis - 5 year MACRS $ 527,000


(1) Soft costs (2) 15% of cost (3) Org. costs, syndication, etc.


Low-Income Housing Tax Credit Eligible Basis (Sec. 42)

Solar installation costs before developer fee - Solar Installation $

545,000

Less: costs ineligible for tax credit basis

(6,750)

Total solar installation costs eligible for LIHTC $ 538,250


Equity proceeds from the solar ITC 4% not in

DDA 4% in DDA

Adjusted costs eligible for the 30% solar ITC $ 620,000 $

620,000

ITC percentage 30% 30%

Energy tax credits 186,000

186,000

Energy tax credit price 0.75

0.75

Tax credit investor equity proceeds from 30% solar ITC $

139,500 $

139,500

Total solar installation costs eligible for LIHTC $ 538,250 $

538,250

50% basis reduction per Section 50(c)

(93,000) (4)

(93,000)

Eligible basis from solar installation for LIHTC 445,250

445,250

Additional developer fee relating to LIHTC (15%)

66,787 (5)

66,787

Total eligible basis from solar installation for LIHTC

512,037

512,037

Not In DDA = 100%; In DDA = 130% 100% 130%Adj. eligible basis from solar installation for LIHTC

512,037

665,648

LIHTC applicable % 3.28% 3.28%

LIHTCs - annual 16,795

21,833

10 year credit period 10

10

Total LIHTCs 167,950

218,330

LIHTC credit price 0.72

0.72

Tax credit investor equity proceeds from LIHTC $

120,924 $

157,198

(4) 50% of solar ITC (5) Subject to state LIHTC allocating agency’s QAP limit for developer fees

Equity proceeds from LIHTCs 4% not in DDA 4% in DDA


626,750 $

626,750


(139,50

0)

(139,500

)


(120,92

4)

(157,198

)

California Solar Initiative rebate (0) (6) (0)

Potential rebate income tax liability (0) (7) (0)


366,326 $

330,052

Net cost of solar installation excluding PBI

(6) Assumes no California Solar Initiative incentive.(7) IRC Section 136 could apply to rebates and other subsidies received by the partnership.





626,750 $

626,750


(139,50

0)

(139,500

)


(120,92

4)

(157,198

)

California Solar Initiative rebate – PBI

(46,000

) (6)

(46,000)

Potential rebate income tax liability16,100

(7)16,100


336,426 $ 300,152

Net cost of solar installation including PBI

(6) California Solar Initiative – PBI of $0.09 per kwh paid over 5 years.For installations greater than 30 kw. Discounted at a rate of 8%.Rates per kwh may vary among utility administrators.

(7) PBI rebate proceeds x 35% federal corporate income tax rate. Nontaxable for CA state tax purposes.(8) IRC Section 136 could apply to rebates and other subsidies received by the partnership.




The Captive Energy Company

Existing Multi-Family and other Assets

A way to green your existing portfolio

Investor Member

99%

Developer

(Managing Member)

1%

Captive Energy

Company, LLC

Systems Integrator/

Installer

$

Multi-Family

Housing

Project

Host #1

Developer

Fee

Multi-Family

Solar 1, LLC

(disregarded)

Multi-Family

Solar 2, LLC

(disregarded)

Multi-Family

Solar 3, LLC

(disregarded)

100%

Multi-Family

Housing

Project

Host #2

Multi-Family

Housing

Project

Host #3

Multi-Family

Solar 4, LLC

(disregarded)

Multi-Family

Housing

Project

Host #4

- ITC (solar) / grant

- Tax Losses (depreciation)

- PPA Revenues (cash flow)

- State subsidies

Public Utility

- MASH program

- Production based

incentive

- Institutions?

- Individuals?

- Developer?

Power Purchase/Lease

AgreementsEngineering Procurement

and Construction Contract

(EPC)

Captive Energy Company– Owns the solar installation

– 30% ITC or Treasury Grant

– Tax losses (depreciation)

– State subsidies (e.g. CSI/MASH)

– Earns a developer fee

– Monetizes the tax benefits

– Added benefit to tenants

Issues

– Section 136 Issue (MASH Program)

– Use of Blocker Corps. For Treasury Grant

– Housing Authorities

– Welfare Tax Exemption interplay

– Treasury Grant – LIHTC Section 42(d)(5) Problem

– Net Metering/Utility Allowances

– Passive Loss Reform?

QUESTIONS

113

sharon canavan office of the comptroller of the currency stephen tracy novogradac & company llp...

Documents

credit tax credits

solar bank slide

basisinvestment tax

investment tax credit

surplus slide

tax liability tax credits

historic tax credit

investment restrictions