The Current: Ten Things to Know When Combining Renewable Energy and Low-Income Housing Tax Credits

Published by Forrest D. Milder on Tuesday, January 10, 2017
Journal thumb January 2017

Of course, the investment tax credit (ITC) for most renewable energy facilities, especially solar, is 30 percent of its cost (or the value, if the lease-pass-through or inverted lease method is used). So, for example, a $1 million facility generates a $300,000 renewable energy tax credit (RETC). 

Now, let’s consider how a project might simultaneously qualify for the far larger low-income housing tax credit (LIHTC). For example, our million-dollar facility may be able to generate another $765,000 of LIHTCs. That’s right–when the RETC is combined with the LIHTC, we may achieve more than $1 million of credits for a housing development that cost $1 million. 

Of course, nothing this good can be that easy. Here are 10 things you should know: 

  1. LIHTCs are generally competitively awarded. Each state has a limited amount of LIHTCs to allocate and a qualified allocation plan (QAP) providing its rules and scoring system for picking winners. Section 42 of the Internal Revenue Code, the longest single section in the Code, applicable Treasury regulations and other published guidance provide a broad number of rules about rents, tenant incomes and record keeping, credit computation, project disposition and recapture. Under these rules, QAPs must give better scores for housing developments that have renewables. While the same expenditure can qualify for both the LIHTC and the RETC (as in my example), the state agency may choose to award fewer LIHTCs than requested.
  2. Bond-financed housing. While most LIHTCs are competitively awarded, a second rule allows properties that benefit from tax-exempt housing bonds to qualify for the LIHTC (usually at a lower rate; see below) without the competitive process. The amount of credits is proportional to the percentage that is bond financed, but if a housing development is more than 50 percent bond financed, then 100 percent of the eligible costs qualify for the LIHTC. For example, a $10 million housing development financed in part by $4 million of bonds qualifies for 40 percent of the usual credits, but the same development with $5 million of bonds qualifies for 100 percent.
  3. The LIHTC must be monetized. Even though the state allocates LIHTCs, it doesn’t provide actual money. Like the RETC, LIHTCs must be monetized. Typically, there’s a partnership or limited liability company with a managing general partner and an investor limited partner that is allocated most of the credits and depreciation.
  4. The LIHTC is a 10-year credit. Unlike the RETC, which is all taken when the facility is placed in service, the LIHTC is taken over 10 years. Moreover, the LIHTC recapture period runs for 15 years. That means a far longer relationship between investor and developer than the minimum five-year period that we associate with most RETC transactions.
  5. Rates for LIHTCs. New construction and rehabilitation of existing buildings are eligible for a 9 percent per year (times 10 years) LIHTC, i.e., 90 percent in total. The LIHTC for tax exempt bond-financed housing developments and acquisition costs regardless of the source of the credits (not including land, which is not eligible) is announced monthly, and it is generally about 3.2 percent, with the exact rate fixed for the life of the development, typically when it is placed in service. In addition, a property’s credits must also be scaled back to reflect the percentage of low income tenants (if less than 100 percent). So, a $1 million,70 percent low-income housing development that qualifies for 9 percent credits yields an annual credit of $63,000, or $630,000 over 10 years. If this 70 percent development was at least 50 percent bond-financed, and the credit rate was 3.2 percent, then the credit amount would be $22,400 per year, or $224,000 in total.
  6. Basis (and the LIHTC) is reduced by half the RETC. Claiming both credits has a drawback. Assume a $1 million facility that qualifies for both the 30 percent RETC and a 9 percent LIHTC. That yields a $300,000 RETC and a $150,000 basis reduction. The LIHTC applies the 9 percent rate to this reduced amount, yielding a $765,000 LIHTC, i.e., $850,000 times 9 percent times 10 years. We could avoid this basis reduction with a lease-pass-through (or inverted lease), but this makes a complicated LIHTC transaction, and it is rarely done.
  7. The basis in the housing development is only computed once for the LIHTC. The LIHTC is computed at the end of the first year the LIHTC is claimed (usually when the property is placed in service, although the taxpayer can elect a one-year delay). So for a renewable facility to generate an LIHTC, the renewable piece must be part of the housing development’s basis at that time. Adding renewables in a later year will still qualify for the RETC, but the double bang of also getting the LIHTC will be lost. And despite the intuitive appeal of a one year RETC, many syndicators are loathe to call their LIHTC investors a few years later and ask for more capital contributions that weren’t previously budgeted.
  8. Allocating the credits. The allocation methods for tax credits are somewhat inscrutable. RETCs are allocated in accordance with the entity’s income, meaning that the RETC investor must be allocated 99 percent of the company’s income to get 99 percent of the RETCs. LIHTCs are different; they are allocated in accordance with depreciation deductions, which means that the LIHTC investor is generally allocated 99 percent (or more) of the partnership’s losses to get 99 percent (or more) of the LIHTCs. As discussed below, this can affect other deal terms, like incentive fees that are often paid to general partners of low-income housing deals. 
  9. Incentive management fees. Because the LIHTC is allocated in accordance with losses, investors don’t normally worry about how the income is allocated or whether cash-flow based “incentive” fees, like giving the general partner 90 percent of any leftover cash, might be characterized as a distribution of profits and affect the allocation of the LIHTC. RETC investors do worry about whether giving all of the available cash to a general partner with little or no capital account (as is often the case in housing) might be perceived as allocating 99 percent of the income of the partnership to the general partner, so that the general partner, and not the investor, would get the RETCs. As a result, if a LIHTC deal also has RETCs, tax advisers usually require the management fee to be a fixed amount or a percentage of gross revenue (and not available cash). In response, many developers must be persuaded that this will not cause them to leave any cash on the table in order to get the additional capital contribution associated with the RETC.
  10. A facility must benefit the residents to qualify for the LIHTC. Simply renting roof space to a solar developer will not qualify the solar installation for the LIHTC. 

    Here are the basic transaction structures and the credits each would generate:

    (A) Renewable company (RC) leases roof space on a housing development and pays rent to housing partnership (HP). RC sells the power and keeps the proceeds. This is commercial use, and might make a small portion of the cost of the roof ineligible for the LIHTC. The cost of the solar facility, which would not be owned by HP, would not generate LIHTCs.
    (B) HP puts a solar facility on the roof of its housing development. HP owns the facility and it sells the resulting electricity to third parties. This is commercial use and might make a small portion of the cost of the roof ineligible for the LIHTC. The cost of the solar facility, which would be owned by HP, would generate RETCs (but not LIHTCs).
    (C) HP puts a solar facility on the roof of its housing development and it uses the electricity to power the property’s common areas. This is residential use and would make the cost of the solar facility eligible for both the RETC and the LIHTC. Remember that (i) the RETC calls for basis reduction of 50 percent of the credit, so the LIHTC will only be based on 85 percent of the cost of the solar, and (ii) while the RETC is 30 percent of the cost of the facility, the LIHTC requires EITHER an allocation of credits from the state or an appropriate amount of bond financing.
    (D) HP puts a solar facility on its roof, and it uses the electricity to reduce the tenants’ electric bills. This is residential use and would make the cost of the solar facility eligible for both the RETC and the LIHTC, subject to the limitations described above. Note that special rules apply if the tenants are charged for the electricity generated.

Of course, remember that this is a high-level summary–almost every rule has technical variations and exceptions that must be considered as well. You are well-advised to have an expert in tax equity assure that your two credits are “playing well together.”

Forrest David Milder is a partner with Nixon Peabody LLP. He has more than 30 years’ experience in tax-advantaged investments including the tax credits that apply to affordable housing, energy, new markets and historic rehabilitation, as well as the tax treatment of partnerships and LLCs, tax-exempt organizations, and structured financial products. He can be reached (617) 345-1055 or [email protected]