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Sharon Canavan Office of the Comptroller of the Currency Stephen Tracy

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1 Sharon Canavan Office of the Comptroller of the Currency Stephen Tracy Novogradac & Company LLP Darren Van’t Hof U.S. Bancorp Community Development Corporation

2 Investment Restrictions
Bank holding company investment in ITC transactions 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 Much of bank’s investment activity in solar tax credit transactions has occurred through their holding companies, which have much broader asset powers than banks do. However, national banks must be aware that in making these investments holding companies may be subject to certain restrictions on the kinds of transactions in which they can partner with a subsidiary bank under Rule 23 A and B. The general statutory authority governing banks is that they are lenders first, with limited authority to make investments. In particular, banks can in real estate only under certain special circumstances. For example, a bank can own or lease the building in which it does business, purchase the home of a transferring employee, or hold property after a foreclosure until it can be sold.

3 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)

4 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

5 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 In addition to these very limited exceptions, Congress also provided authority for banks to make direct or indirect investments that “primarily benefit the public welfare” Federal savings associations are also permitted to make public welfare investments—although there are differences between their authority and that of banks. OCC is currently in the process of integrating the handling of thrifts’ public welfare investments with OCC regulations. In the meantime, thrifts should follow OTS processes. Over the past several years we have seen increasing interest by banks to use the public welfare authority to make solar facilities investments at the bank level. Last year, national banks invested nearly $66 million in solar energy using the public welfare investment authority. However, not all solar investments can be made by banks using this authority.

6 Meeting the Public Welfare Test
Provides LMI jobs Affordable housing Source: Bank of America Must primarily benefit: LMI individuals or areas Geocoding map at 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. To qualify as a public welfare investment, the solar facility would have to meet one of the requirements of the act, which are listed on the slide. Must primarily benefit: LMI individuals or areas 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. Investing in an affordable housing community that includes a solar facility would be a straightforward way to meet the public welfare test. Another way to meet the public welfare requirements would be to document the jobs generated through the installation and maintenance of a solar facility installation. In order to make this case, a bank would need to document the range of job skills—such as basic laborers, project managers or workers with specialized skills, as well as whether the jobs are temporary or permanent. Also, the location of the solar facility may be considered as a factor in approving a solar investment under the public welfare authority. The geocoding mapping system, which contains geography income information and the annually updated HUD median family income statistics can be obtained from the Federal Financial Institution Examination Council’s Web site—www.ffiec.gov  

7 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 Additionally, the a bank’s public welfare investment must not expose the bank to unlimited liability. To meet this requirement banks usually invest in energy investment tax credit funds that are structured as limited liability companies or limited partnerships. Another requirement is that the bank’s aggregate investments under the public welfare investment authority cannot exceed 5 percent of capital and surplus. However, this limit may be increased up to 15 percent if the bank submits a prior approval request to the OCC. When a bank makes a public welfare investment, the bank must file a CD-1 notice with the OCC. This CD-1 notice may be filed after-the-fact if the bank is “well capitalized” and meets all of the following criteria— • It has a composite rating of 1 or 2 under the Uniform Financial Institutions Rating System. • It has a CRA rating of “Outstanding” or “Satisfactory.” • It is not subject to a cease-and-desist order, consent order, formal written agreement, or Prompt Corrective Action directive. A prior approval request must be submitted to the OCC before making an investment, if a bank does not meet all of these criteria. Also, if a bank’s aggregate public welfare investments exceed 5 percent of capital and surplus, then the bank must submit prior approval requests for any investments above that limit. Even if the bank meets the “after the fact” notification requirements, the bank may want to consult with the OCC Community Affairs department. In a number of instances we have worked closely with banks to advise them on whether or not a proposed solar facilities investment qualifies under the public welfare requirements

8 Community Reinvestment Act
“Green” activities do not of themselves qualify for CRA consideration. CRA consideration— Primary purpose must meet definition of community development Another factor that banks may want to evaluate is whether a solar investment could qualify for consideration under the Community Reinvestment Act--CRA. Loans and investments in “green” buildings or energy-efficiency improvements, such as solar panels do not in and of themselves qualify for positive consideration under the CRA. The primary purpose of an activity remains the key factor for determining whether an activity meets the requirements of the CRA regulation and whether it receives consideration.

9 Community Reinvestment Act
Construction or substantial rehabilitation has a primary purpose of community development depending on its use— Affordable housing for LMI individuals 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 If a project itself meets the primary purpose of community development, the inclusion of energy efficiency components, does not affect CRA consideration. Examiners would not give additional consideration for or discount a loan or investment because it included an energy efficient component Loans and investments used to construct or rehabilitate affordable housing for low- or moderate-income individuals meet this primary purpose test. So, for example, the entire amount of a loan or investment to construct an affordable housing development that includes as a component solar energy generating panels would be eligible for CRA consideration. Other types of facilities may also meet the necessary community development purpose for CRA consideration. For example, charter schools or health care facilities, may meet the definition of community development if they primarily serve LMI individuals. Determining whether rehabilitation expenses qualify for CRA consideration will depend on the facts and circumstances. A determination regarding primary purpose is the key factor. Examiners may consider whether the rehabilitation improves or retains the affordability of a housing development in determining whether the investment receives consideration. For example, if the bank is able to demonstrate that cost savings from installing solar on affordable housing or community facilities will directly benefit LMI tenants or that the savings will reduce operating expenses and will be used to maintain affordability for LMI tenants the investment may receive CRA consideration. For example, a power purchase agreement that directs utility savings to tenants or to common areas in an affordable housing development could be used to demonstrate cost savings.

10 Community Reinvestment Act
“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) Bank ITC NMTC A transaction involving solar facilities can be structured to take advantage of both the Investment Tax Credit and the New Markets Tax Credit. In these “twinned” transactions, the bank makes two separate equity investments into a Community Development Entity that, in turn, invests those funds in a Qualified Active Low Income Community Business. The entire amount of the combined investments is eligible for CRA consideration. The Interagency Q&As indicate that the agencies will presume that any loan to or investment in a New Markets Tax Credit-eligible Community Development Entity promotes economic development .  The fact that an investment into a New Markets Tax credit eligible entity is structured so that a bank receives the benefit of two separate types of tax credits does not preclude the combined investment from CRA consideration. (§ll.12(g)(3)—1) CDE QALICB installs solar

11 Community Reinvestment Act
Loan or investment that supports permanent job creation or retention— For LMI persons In LMI area Source: Sunwheell Energy Partners 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 Another way to receive CRA consideration is to demonstrate that a loan or investment supports permanent job creation, retention, or improvement for LMI persons or in an LMI geography. Also CRA consideration is available for activities that help to attract new or retain existing businesses in an area targeted for redevelopment. The bank should be able to demonstrate that a local, state, Federal, or tribal government entity has a plan in place to revitalize or stabilize the area. A plan may not involve formal area designations, but still may be made in an area targeted for redevelopment by a governmental entity. For example, a local government agency may partner with a national bank, chamber of commerce, and community leaders to develop and operate an industrial park to help attract new small businesses and expand employment opportunities. The local government may provide, for example, infrastructure improvements to the industrial park and offer tax abatements to the businesses that locate there. So, examples where a bank could receive CRA consideration would include a bank making a loan to a solar installation company that hires LMI individuals for its permanent work force, or where the bank makes an equity investment in a fund that will capitalize a company that plans to locate its new solar installation business in a revitalization area.

12 More Information from OCC
OCC’s Community Affairs page E-zine on “Investing in Solar Energy Using the Public Welfare Investment Authority” Energy Investment Tax Credit Fact Sheet Public welfare investment Web Resource Directory Geomapping information at As you can see, for both public welfare investment and CRA consideration, it is not always crystal clear whether a loan or investment in solar qualifies. We encourage banks that are considering a solar transaction to consult with us prior to making that decision. Also, for more information on these programs, I encourage you to visit the OCC’s Community Affairs page on where you will find additional resources that fully explain how to comply with the public welfare investment requirements. I’ve also brought copies of a recent newsletter the OCC published, which describes solar investments by banks and the applicable regulatory requirements.

13 INVESTMENT TAX CREDIT BASICS

14 Solar Tax Credits – Basic Rules
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 14

15 What is the amount of the tax credit or grant?
30% Tax Credit Facility Cost

16 Credit is non-refundable
No cash back Tax Credits Tax Liability 1 year 20 years

17 Solar Tax Credits – Basic Rules
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

18 Solar Tax Credits – Basic Rules
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 18

19 private activity bonds
Prior to ARRA “subsidized energy financing” or private activity bonds % 30% % Basis Investment Tax Credit

20 (property PIS after 12/31/2008) private activity bonds
After ARRA (property PIS after 12/31/2008) “subsidized energy financing” or private activity bonds 30% Basis Investment Tax Credit

21 Solar Tax Credits – Basic Rules
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 21

22 Solar Tax Credits – Eligible Property Defined
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)) 22 22

23 Eligible Energy Tax Credit Basis
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 23 23

24 Solar Tax Credits – Eligible Hard Costs
Reasonable Allocation Eligible Eligible Eligible Ineligible Courtesy of Borrego Solar

25 Eligible Energy Tax Credit Basis
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

26 Eligible Energy Tax Credit Basis
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 26

27 Depreciation 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 27 27

28 What is the amount of depreciation on the solar property?
5 year MACRS 30% basis reduction 50% Basis Tax Credit

29 What is the amount of depreciation on the solar property?
100k 85k 5 year MACRS 30k 85,000 17,000 27,200 16,320 9,792 4,896 basis reduction 15k 50% Basis Tax Credit

30 Placed in Service 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 30 30

31 “Ready and available for its intended use”
When is eligible property considered “placed in service”? “Ready and available for its intended use” Public Utilities Approval Letter When is a facility placed in service? “Ready and available for its intended use” Public utility approval Approval/signoff letter – Akin to certificate of occupancy Grid connected Facility completed, licenses obtained, pre-operational testing LICENSE GRID

32 Placed in Service 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 32

33 5-year recapture period
When can the credits be claimed ? When are the credits in danger of recapture? Placed-in-service date 100% of credits 5-year recapture period 80 60 40 20 Allocated to partners according to profit percentage

34 ITC Recapture Rules 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 34 34

35 ITC Recapture Rules 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 35

36 Treasury Grant Program
Section 1603 – ARRA 36

37 Treasury Grant Program
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 37 37

38 Treasury Grant Election
(30%/10% of basis) Grant (30% of basis) IRC Section 45 Credits IRC Section 48 Credits 38

39 Treasury Grant Election
Grant = 30% or 10% of basis of facility (Subject to recapture similar to ITC) 30% 10% 39

40 Treasury Grant Election
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

41 Treasury Grant Election
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

42 Treasury Grant Election
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

43 Recapture Rules - Treasury Grant
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 Issued – “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” 43 43

44 Popularity of the 1603 Treasury Grant Program
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

45 Tax Credit Comparison PTC ITC/ Grant
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 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

46 The Sunset Clause Under Beginning of Construction Safe Harbor
Section 1603 Beginning of Construction Safe Harbor

47 The Sunset Clause Two ways to satisfy this requirement:
For energy property NOT PIS in 2009, 2010, or 2011, construction must begin before January 1, 2012. Two ways to satisfy this requirement: Sufficient physical work – physical work of a significant nature test 5% cost safe harbor – safe harbor test 47 47

48 Work of a Significant Physical Nature
Sufficient physical work – includes: Both on-site and off-site construction activities Work on foundation Pouring concrete pads Building certain roads Assembly of machinery 48 48

49 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 49 49

50 5% Cost Safe Harbor Test 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 50 50

51 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 51 51

52 5% Cost Safe Harbor Test 5% cost safe harbor – includes:
Direct construction costs Facility property (solar panels, inverters etc.) Engineering/Designing Benefits and burdens of ownership Spend money! 52 52

53 How are renewable energy transactions structured?
1-Partnership Flip 2-Sale-Leaseback 3-Lease Pass-through 4-Outright purchase 53

54 MILK Key Players Developer/Sponsor Investor Host Customer Lender
System Integrator Host Customer Lender Panel Manufacturer Private Equity

55 System Ownership and Investment Funding
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 55

56 Depreciation Deductions
Partnership Flip Loan Proceeds Lender Fund General Partner 1% Investment Fund Tax Credits Depreciation Deductions Cash Flow 1% Debt Service Payments 99% Tax Credit Equity Investor 99% Developer $ Developer Fee 100% Solar 1, LLC Solar 2, LLC Solar 3, LLC Solar 4, LLC System Integrator/ Installer PPA/Lease Agreements Solar Installation Host #1 Solar Installation Host #2 Solar Installation Host #3 Solar Installation Host #4 56 56

57 Partnership with a Flip
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 57 57

58 Partnership with a Flip
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. 58

59 Investment Fund in a Partnership Flip
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 59

60 Sale Leaseback Structure
60 60

61 Sale Leaseback Structure
Purchase Agreement 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. Solar Developer, LLC Lessee Corporate Investor Lessor Lease Agreement Sales Proceeds Sale of SEFs and Lease Payments Solar Developer Lessor is owner of SEF, Investment Tax Credits, Tax Losses (Depreciation Deductions), Rebates, RECs, Recipient of lease payments, Potential residual buyout PPA/Lease Agreements Solar 1, LLC Solar 2, LLC Solar 3, LLC Energy Procurement Contract (“EPC”) System Integrator/ Installer Solar Installation Host #1 Solar Installation Host #2 Solar Installation Host #3 61 61

62 Sale Leaseback Structure
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

63 Sale Leaseback Structure
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

64 Sale Leaseback Attributes
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 64 64

65 Sale Leaseback Attributes
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 65 65

66 Lease Pass-Through Structure
(Inverted Lease) 66 66

67 State Incentive Programs
Lease Pass-Through Lender Manufacturer Sale of PV Panels Developer/ Installer Loan Proceeds $ Debt Service Payments Install/Maintenance $ State Incentive Programs $ LESSOR SOLAR LP PV System Owner No basis reduction to depreciable basis P/L General Partner 51%-99% partnership interest Capital Contribution $ Pass-through Election 1%-49% LP interest in losses Capital Contribution Lease SOLAR MASTER TENANT LP Basis Reduction Income $ Capital Contribution Credits Cash – Preferred Return Call Option – Cash, Capital Loss P/L and Credits Lease Lease Payments 1% General Partner (Developer) 99% Limited Partner (Corporate Investor) Power Host 67 67

68 Lease Pass-Through Attributes
Election to treat Lessee (Master Tenant) as owner of solar system for ITC purposes ONLY IRC Section 48(d)(1) / Treasury Regulation (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) 68 68

69 Lease Pass-Through Attributes
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 69 69

70 Lease Pass-Through 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? 70 70

71 Lease Pass-Through 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 (short-term lease rules) Economic substance doctrine issues 71 71

72 Exit Strategies 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 Call – developer can exercise option to buy out the investor for fair market value of partnership interest Purchase option or early buy out option 72

73 Partnership and Lease Pass-Through Structures
Exit Strategies Partnership and Lease Pass-Through Structures 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 73 73

74 Advantages of a Lease Structure
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 74

75 Advantages of a Lease Structure
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. 75

76 Disadvantages of a Lease Structure
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. 76

77 Disadvantages of a Lease Structure
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. 77

78 Advantages of a Partnership Structure
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.) 78

79 Disadvantages of a Partnership Structure
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. 79

80 Disadvantages of a Partnership Structure
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. 80

81 Twinning LIHTC with ITC
81

82 1-LIHTC Partnership - PPA w/ 3rd Party Solar Developer
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 82

83 PPA w/ Solar Developer -Easiest
-3rd Party Solar developer provides financing -Passes on benefit of tax attributes/subsidies 83

84 Traditional LIHTC Partnership with Solar - New Construction
Combine Solar and LIHTC 84

85 Investment Fund Fund General Partner 1% Tax Credit Equity Investor 99%
Tax Credits (ITC and LIHTC) Depreciation Deductions Cash Flow 1% - ITC and LIHTC - Tax Losses (depreciation) - Cash flow Tax Credit Equity Tax Credit Equity Investor General Partner 99% ITC & LIHTC Credits/ Tax Losses 99% 1% Tax Credit Equity LIHTC Operating Partnership (with Solar Installation) Systems Integrator/ Installer Developer Engineering Construction and Procurement Contract (EPC) Developer Fee 85

86 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) 86

87 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

88 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! 88

89 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

90 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)) 90

91 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 91

92 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

93 Public Utility Subsidies – Section 136
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. 93 93

94 Public Utility Subsidies
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 94 94

95 Numerical – 9% Deals Example – no PBI or NSHP

96 Combining Section 42 (LIHTC) with Section 48 (Solar Energy Credits)
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 (1) Soft costs (2) 15% of cost (3) Org. costs, syndication, etc.

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

98 Combining Section 42 (LIHTC) with Section 48 (Solar Energy Credits)
Equity proceeds from the solar ITC 9% not in DDA 9% in DDA Total costs eligible for 30% solar ITC $ 620,000 % of costs financed with Tax-Exempt Bonds N/A Adjusted costs eligible for the 30% solar ITC ITC percentage 30% Energy tax credits 186,000 Energy tax credit price 0.75 Tax credit investor equity proceeds from 30% solar ITC 139,500

99 Equity proceeds from LIHTCs
9% not in DDA 9% in DDA Equity proceeds from LIHTCs Total solar installation costs eligible for LIHTC $ 538,250 50% basis reduction per Section 50(c) (93,000) (4) Eligible basis from solar installation for LIHTC 445,250 Additional developer fee relating to LIHTC (15%) 66,787 (5) Total eligible basis from solar installation for LIHTC 512,037 Not In DDA = 100%; In DDA = 130% 100% 130% Adj. eligible basis from solar installation for LIHTC 665,648 LIHTC applicable % 9.00% LIHTCs - annual 46,083 59,908 10 year credit period 10 Total LIHTCs 460,830 599,080 LIHTC credit price 0.72 Tax credit investor equity proceeds from LIHTC 331,798 431,338 50% of solar ITC Subject to state LIHTC allocating agency’s QAP limit for developer fees

100 Net cost of solar installation excluding PBI 9% not in DDA 9% in DDA
Total installation costs $ 626,750 Tax credit investor equity proceeds from 30% energy ITC (139,500) Tax credit investor equity proceeds from LIHTC (331,798) (431,338) California Solar Initiative rebate (0) (6) Potential rebate income tax liability (7) Estimated net cost of solar installation 155,452 55,912 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 system would 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.

101 Net cost of solar installation including PBI 9% not in DDA 9% in DDA
Total installation costs $ 626,750 Tax credit investor equity proceeds from 30% energy ITC (139,500) Tax credit investor equity proceeds from LIHTC (331,798) (431,338) California Solar Initiative rebate – PBI (46,000) (6) Potential rebate income tax liability 16,100 (7) Estimated net cost of solar installation 125,552 26,012 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. PBI rebate proceeds x 35% federal corporate income tax rate. Nontaxable for CA state tax purposes. 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 system would 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.

102 Numerical – 4% Deals Example – no PBI or NSHP

103 Combining Section 42 (LIHTC) with Section 48 (Solar Energy Credits)
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 (1) Soft costs (2) 15% of cost (3) Org. costs, syndication, etc.

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

105 Combining Section 42 (LIHTC) with Section 48 (Solar Energy Credits)
Equity proceeds from the solar ITC 4% not in DDA 4% in DDA Adjusted costs eligible for the 30% solar ITC $ 620,000 ITC percentage 30% Energy tax credits 186,000 Energy tax credit price 0.75 Tax credit investor equity proceeds from 30% solar ITC 139,500

106 Equity proceeds from LIHTCs
4% not in DDA 4% in DDA Equity proceeds from LIHTCs Total solar installation costs eligible for LIHTC $ 538,250 50% basis reduction per Section 50(c) (93,000) (4) Eligible basis from solar installation for LIHTC 445,250 Additional developer fee relating to LIHTC (15%) 66,787 (5) Total eligible basis from solar installation for LIHTC 512,037 Not In DDA = 100%; In DDA = 130% 100% 130% Adj. eligible basis from solar installation for LIHTC 665,648 LIHTC applicable % 3.28% LIHTCs - annual 16,795 21,833 10 year credit period 10 Total LIHTCs 167,950 218,330 LIHTC credit price 0.72 Tax credit investor equity proceeds from LIHTC 120,924 157,198 50% of solar ITC Subject to state LIHTC allocating agency’s QAP limit for developer fees

107 Net cost of solar installation excluding PBI 4% not in DDA 4% in DDA
Total installation costs $ 626,750 Tax credit investor equity proceeds from 30% energy ITC (139,500) Tax credit investor equity proceeds from LIHTC (120,924) (157,198) California Solar Initiative rebate (0) (6) Potential rebate income tax liability (7) Estimated net cost of solar installation 366,326 330,052 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 system would 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.

108 Net cost of solar installation including PBI 4% not in DDA 4% in DDA
Total installation costs $ 626,750 Tax credit investor equity proceeds from 30% energy ITC (139,500) Tax credit investor equity proceeds from LIHTC (120,924) (157,198) California Solar Initiative rebate – PBI (46,000) (6) Potential rebate income tax liability 16,100 (7) Estimated net cost of solar installation 336,426 300,152 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. PBI rebate proceeds x 35% federal corporate income tax rate. Nontaxable for CA state tax purposes. 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 system would 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.

109 The Captive Energy Company
Existing Multi-Family and other Assets A way to green your existing portfolio 109

110 Engineering Procurement and Construction Contract (EPC)
Developer (Managing Member) 1% Captive Energy Company, LLC Public Utility Developer Fee - MASH program - Production based incentive - ITC (solar) / grant - Tax Losses (depreciation) - PPA Revenues (cash flow) - State subsidies Investor Member 99% $ - Institutions? - Individuals? - Developer? 100% Multi-Family Solar 1, LLC (disregarded) Multi-Family Solar 2, LLC (disregarded) Multi-Family Solar 3, LLC (disregarded) Multi-Family Solar 4, LLC (disregarded) Power Purchase/Lease Agreements Systems Integrator/ Installer Engineering Procurement and Construction Contract (EPC) Multi-Family Housing Project Host #1 Multi-Family Housing Project Host #2 Multi-Family Housing Project Host #3 Multi-Family Housing Project Host #4 110 110

111 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 111

112 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? 112

113 ? QUESTIONS 113


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