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Sharon Canavan Office of the Comptroller of the Currency Stephen Tracy Novogradac & Company LLP Darren Vant Hof U.S. Bancorp Community Development Corporation.

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Presentation on theme: "Sharon Canavan Office of the Comptroller of the Currency Stephen Tracy Novogradac & Company LLP Darren Vant Hof U.S. Bancorp Community Development Corporation."— Presentation transcript:

1 Sharon Canavan Office of the Comptroller of the Currency Stephen Tracy Novogradac & Company LLP Darren Vant Hof U.S. Bancorp Community Development Corporation

2 Investment Restrictions Bank holding company investment in ITC transactions o 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

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

6 Meeting the Public Welfare Test 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. Provides LMI jobs Affordable housing

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 – Dont meet criteria for well-capitalized bank – Aggregate public welfare investments exceed 5% of capital and surplus

8 Community Reinvestment Act Green activities do not of themselves qualify for CRA consideration. CRA consideration Primary purpose must meet definition of community development

9 Community Reinvestment Act Construction or substantial rehabilitation has a primary purpose of community development depending on its use o Affordable housing for LMI individuals o 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

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) ITC NMTC CDE QALICB installs solar Bank

11 Community Reinvestment Act 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

12 More Information from OCC OCCs 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

13 13 INVESTMENT TAX CREDIT BASICS

14 – 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

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

16 Credit is non-refundable Tax Liability Tax Credits No cash back 1 year20 years 16

17 – 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 Solar Tax Credits – Basic Rules 17

18 – 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? Well see – Loan Guarantee Program – DOE Most would say its been a bust Solyndra fallout Solar Tax Credits – Basic Rules 18

19 BasisInvestment Tax Credit 30% subsidized energy financing or private activity bonds % % Prior to ARRA 19

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

21 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 Solar Tax Credits – Basic Rules 21

22 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

23 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

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

25 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 Eligible Energy Tax Credit Basis 25

26 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 Eligible Energy Tax Credit Basis 26

27 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

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

29 BasisTax Credit 50% basis reduction 30k 5 year MACRS 100k 85k 15k What is the amount of depreciation on the solar property? 29

30 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

31 When is eligible property considered placed in service ? Ready and available for its intended use Public Utilities Approval Letter GRID LICENSE 31

32 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

33 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

34 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

35 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

36 Treasury Grant Program Section 1603 – ARRA 36

37 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

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

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

40 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, Treasury Grant Election 40

41 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 Treasury Grant Election 41

42 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) Treasury Grant Election 42

43 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 Recapture Rules - Treasury Grant 43

44 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

45 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

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

47 For energy property NOT PIS in 2009, 2010, or 2011, construction must begin before January 1, 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

48 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

49 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

50 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

51 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 accountants certification if grant payment exceeds $1 million 5% Cost Safe Harbor Test

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

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

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

55 – 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

56 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

57 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

58 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

59 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

60 Sale Leaseback Structure 60

61 Solar Developer, LLC Lessee System Integrator/ Installer Solar Installation Host #1 PPA/Lease Agreements Sale Leaseback Structure Solar Installation Host #2 Solar Installation Host #3 Solar 1, LLC Solar 2, LLC Solar 3, LLC Corporate Investor Lessor 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 Payments SolarDeveloper Purchase Agreement 61

62 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. Sale Leaseback Structure 62

63 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 Sale Leaseback Structure 63

64 More effectively frontloads economics to developer – Allows developer to grow business with current cash flow – More effective use of developers 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

65 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

66 Lease Pass-Through Structure (Inverted Lease) 66

67 Capital Contribution State Incentive Programs Lease Pass-Through Sale of PV Panels Loan Proceeds Basis Reduction Income No basis reduction to depreciable basis Manufacturer LESSOR SOLAR LP PV System Owner General Partner 51%-99% partnership interest $ $ $ Capital Contribution Credits Cash – Preferred Return Call Option – Cash, Capital Loss Lease 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 Lease Lease Payments 1%-49% LP interest in losses Capital Contribution Pass-through Election P/L $ $ 67

68 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) Lease Pass-Through Attributes 68

69 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

70 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

71 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 Lease Pass-Through 71

72 Once you have gotten the investors IN, you need a way to get them OUT – Flip – reduces the investors 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 Exit Strategies 72

73 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 Strategies Partnership and Lease Pass-Through Structures 73

74 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

75 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

76 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

77 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

78 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

79 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

80 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

81 Twinning LIHTC with ITC

82 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

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

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

85 Systems Integrator/ Installer LIHTC Operating Partnership (with Solar Installation) Engineering Construction and Procurement Contract (EPC) Developer 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 Losses 99% - ITC and LIHTC - Tax Losses (depreciation) - Cash flow

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)

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!

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 entitys highest share of partnership items of income or gain –i.e. profit/loss/ residual % etc. (IRC Sec. 168(h)(6))

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

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 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

94 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

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

96 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 Total costs eligible for 30% solar ITC$ 620,000 Investment tax credit % 30% Solar ITCs$ 186,000 Total costs eligible for 30% solar ITC$ 620,000 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.

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 DDA9% 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 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$

99 Total solar installation costs eligible for LIHTC $ 538,250$ 50% basis reduction per Section 50(c) (93,000)(4) (93,000) Eligible basis from solar installation for LIHTC 445,250 Additional developer fee relating to LIHTC (15%) 66,787(5) 66,787 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 512, ,648 LIHTC applicable % 9.00% LIHTCs - annual 46,083 59, year credit period 10 Total LIHTCs 460, ,080 LIHTC credit price 0.72 Tax credit investor equity proceeds from LIHTC $ 331,798$ 431,338 (4)50% of solar ITC (5)Subject to state LIHTC allocating agencys QAP limit for developer fees Equity proceeds from LIHTCs 9% not in DDA9% in DDA

100 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) (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 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. 9% not in DDA9% in DDA

101 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) (46,000) Potential rebate income tax liability 16,100(7)16,100 Estimated net cost of solar installation $ 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. 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. 9% not in DDA9% in DDA

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

103 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 Total costs eligible for 30% solar ITC$ 620,000 Investment tax credit % 30% Solar ITCs$ 186,000 Total costs eligible for 30% solar ITC$ 620,000 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.

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 DDA4% 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 Total solar installation costs eligible for LIHTC $ 538,250$ 50% basis reduction per Section 50(c) (93,000)(4) (93,000) Eligible basis from solar installation for LIHTC 445,250 Additional developer fee relating to LIHTC (15%) 66,787(5) 66,787 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 512, ,648 LIHTC applicable % 3.28% LIHTCs - annual 16,795 21, year credit period 10 Total LIHTCs 167, ,330 LIHTC credit price 0.72 Tax credit investor equity proceeds from LIHTC $ 120,924$ 157,198 (4)50% of solar ITC (5)Subject to state LIHTC allocating agencys QAP limit for developer fees Equity proceeds from LIHTCs 4% not in DDA4% in DDA

107 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) (0) Potential rebate income tax liability (0)(7)(0) Estimated net cost of solar installation $ 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. 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. 4% not in DDA4% in DDA

108 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) (46,000) Potential rebate income tax liability 16,100(7)16,100 Estimated net cost of solar installation $ 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. 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. 4% not in DDA4% in DDA

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

110 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 incentive - Institutions? - Individuals? - Developer? Power Purchase/Lease Agreements Engineering Procurement and Construction Contract (EPC)

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

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?

113 QUESTIONS 113


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