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Q&A: ITC Investments – Comparing Solar ITCs to Historic ITCs

Published by Tony Grappone, Novogradac & Company LLP RETC Working Group on Tuesday, May 1, 2012

Journal cover May 2012   Download PDF

Question: How do investment tax credits (ITCs) generated by solar projects compare to those generated by historic rehabilitation building projects?

Answer: As with any tax equity investment there are many aspects to consider and probably none more so than how to structure an investment.

Renewable energy participants are scrambling to find equity sources that can help replace the financing gap created by the now expired Section 1603 cash grant program. There are many tax credit industry participants comparing the energy investment tax credit to the historic investment tax credit. On the surface the credits for both programs seem practically identical. However, as with many things in life, the devil is in the details.  

First let’s quickly review typical historic tax credit investment structures. Generally, historic tax credit projects are owned either by a single-entity limited partnership or a dual-entity structure commonly referred to as a lease pass-through (LPT), or inverted lease structure.  

In a single-entity structure there is typically one partnership that owns and operates the project (similar to a partnership flip but without the flip) in which there is a 1 percent general partner and a 99 percent investor limited partner (ILP) that is allocated most of the tax credits, depreciation plus some cash in the form of a priority return. This structure works well when there is an ILP that values both tax credits and depreciation.
In an LPT structure there are two separate partnerships; one partnership that owns the project (owner or landlord) and a second partnership that operates the project (tenant or lessee). One of the primary goals with the LPT is to try to separate the depreciation benefits (generated by the landlord) from the ITC benefits (generated by the tenant).  

So how do these structures generate different results for solar projects vs. historic projects? From a tax point of view, Internal Revenue Code (IRC) Section 50(c) requires owners of property that generate ITCs to reduce their investment by a portion of the ITC. Owners of historic tax credit projects must reduce their investment by 100 percent of the amount of the ITC. However, owners of energy property are only required to reduce their investment by 50 percent of the ITCs. For single-entity structures (i.e. the partnership flip) this is an easy benefit to understand and is illustrated below.  

You can see below that although each investment offers $4.5 million of ITCs, the solar investment would actually yield the investor close to $800,000 of additional benefits assuming all other things being equal, and the investor is redeemed after the tax credit recapture period (60 months for both programs). Using a single entity structure summarizes these additional benefits in a relatively straightforward manner.

Understanding these differences with an LPT structure compared to a partnership flip structure is a bit of a different analysis. Although IRC Section 50(c) requires owners of property that generate ITCs to reduce their investment by a portion of the ITC, that requirement is not applicable to the LPT structure in which the tenant entity claims the ITC. That being said, the IRC does require the tenant partners to more or less cure this disparity by requiring them to take into taxable income the basis adjustment avoided by using the LPT. This basis adjustment income is generally recognized over the depreciable life of the assets that gave rise to the credits (typically five years for solar and 39 years for commercial use historic buildings). Under this scenario, although the solar investment basis reduction income is, in total, only half of what it is with historic projects, that income will be allocated to the ILP during the five-year recapture period instead of over 39 years with historic investments. (See overview of the basis adjustment income recognized using the LPT structure.)

As a result of the additional income recognition for solar project ILPs in the LPT scenario, one would expect to see tenant entities making a greater investment in the landlord in order to obtain sufficient tax depreciation to shelter the additional basis adjustment income. The question is: will project developers be able to raise additional tax equity in exchange for giving up more of the depreciation than would otherwise be done in a historic tax credit transaction?  

Hopefully this discussion helps shed some additional light on structuring renewable energy tax credit investments. As you evaluate what is best for you please know that Novogradac & Company is here to help you structure your tax credit transactions. 

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