Presentation on theme: "Sharon Canavan Office of the Comptroller of the Currency Stephen Tracy"— Presentation transcript:
1 Sharon CanavanOffice of the Comptroller of the CurrencyStephen TracyNovogradac & Company LLPDarren Van’t HofU.S. Bancorp Community Development Corporation
2 Investment Restrictions Bank holding company investment in ITC transactionsRestrictions under 23 A and B on types of transactions in which holding company can partner with subsidiary or affiliateGeneral authority – Banks are lenders firstUnder special circumstances, bank may directly or indirectly invest in real estateMuch 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 RuleThe 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 RulePublic 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 levelPublic welfare investment authority allows bank to take equity or ownership interest in real property or commercial assetsIn 2011, banks invested $66 million in solar facilities using PWI authorityIn 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 jobsAffordable housingSource: Bank of AmericaMust primarily benefit:LMI individuals or areasGeocoding map atAreas targeted by a government entity for redevelopmentIn 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 areasAreas targeted by a government entity for redevelopmentIn 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 liabilityInvestment limits5% of capital and surplusMay increase to 15% with prior OCC approvalAfter-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 surplusAdditionally, 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 developmentAnother 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 individualsCommunity facilities that are located in LMI income areas or serve primarily LMI individualsHealth care facilitiesCharter schoolsDemonstrate rehabilitation cost savings directly benefit LMI tenants or reduce operating expenses to maintain affordability for LMI tenantsIf 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 componentLoans 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 bothITC and NMTC equity infusions into CDEInteragency Q&As(§ll.12(g)(3)—1)BankITCNMTCA 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)CDEQALICB installs solar
11 Community Reinvestment Act Loan or investment that supports permanent job creation or retention—For LMI personsIn LMI areaSource: Sunwheell Energy PartnersRevitalizes 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)—1Another 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 pageE-zine on “Investing in Solar Energy Using the Public Welfare Investment Authority”Energy Investment Tax Credit Fact SheetPublic welfare investment Web Resource DirectoryGeomapping information atAs 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.
14 Solar Tax Credits – Basic Rules 30% Investment Tax CreditIn place until 12/31/16After 2016 reverts back to 10% creditTax credits generated 100% on the PIS dateAllocated to partners based on profit percentageCarry back 1 year – Carry forward 20 years14
15 What is the amount of the tax credit or grant? 30%Tax CreditFacility Cost
16 Credit is non-refundable No cash backTax CreditsTax Liability1 year20 years
17 Solar Tax Credits – Basic Rules ITC Reported on Form 3468 and Form 3800Schedule K-1 reflects your share of energy credit basisITC can reduce AMT - Since 20095-year recapture period (vests 20% per year)$2,000 credit cap lifted for residential installations - Section 25DPublic Utilities may now use the tax benefits17
18 Solar Tax Credits – Basic Rules Treasury Grant program (Cash in lieu of ITC)ARRA Section 1603; Extension not likelySubsidized Energy Financing taint removedNo longer causes a reduction in energy tax credit basisBonus Depreciation to be extended for 2012? We’ll seeLoan Guarantee Program – DOEMost would say it’s been a bustSolyndra fallout1818
19 private activity bonds Prior to ARRA“subsidized energy financing” orprivate activity bonds%30%%BasisInvestment Tax Credit
20 (property PIS after 12/31/2008) private activity bonds After ARRA(property PIS after 12/31/2008)“subsidized energy financing” orprivate activity bonds30%BasisInvestment Tax Credit
21 Solar Tax Credits – Basic Rules Sale of electricity to a third party not requiredOwner of the system can be the userCombination of Investment (Solar) Tax Credit (Treasury Grant) and accelerated depreciation may reduce capital cost by up to 56%Rebates (if available) help further2121
22 Solar Tax Credits – Eligible Property Defined Equipment that uses solar energy to generate electricityConstructed by the taxpayerAcquired by taxpayer and first used by taxpayerException for sale-leaseback transactions90 day rule (Old IRC Section 48(b)(2))2222
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 installationSystems integration / system design / pre-operational testing / independent engineer reports…..Permits, city fees etc.Interest expense prior to PIS – Subject to Section 266 ElectionDeveloper fee, other soft costs2323
24 Solar Tax Credits – Eligible Hard Costs Reasonable AllocationEligibleEligibleEligibleIneligibleCourtesy 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 okParking garage structures which support panels but provide shade?Portion of roofing repair? Reasonable allocationParking garage / carport cost? What portion? Reasonable allocation. With and without test25
26 Eligible Energy Tax Credit Basis What costs are NOT eligible?Organization costs, permanent loan fees, syndication costs, etc.Transmission costs/ Interconnection feesSecurity fencing, prepaid O&MIntangibles? PPA? Ground LeaseRoofing costs allocated to the buildingParking garage / carport installations – cost allocation question2626
27 Depreciation Energy property depreciated using 5 year MACRS Bonus depreciation rules2011 last year for 100% bonusProperty PIS in 2012 eligible for 50% bonusBasis ReductionEqual to 50% of investment tax credits claimed85% of energy property basis depreciable over 5 years2727
28 What is the amount of depreciation on the solar property? 5 year MACRS30%basis reduction50%BasisTax Credit
29 What is the amount of depreciation on the solar property? 100k85k5 year MACRS30k85,00017,00027,20016,3209,7924,896basis reduction15k50%BasisTax Credit
30 Placed in Service When is a facility placed in service? “Ready and available for its intended use” – IRC definitionUtility signoff – Permission to Operate (PTO)LetterFacility completed, licenses obtained, pre-operational testing completeCommercial Operation DateWhen customer is contractually obligated to buy power3030
31 “Ready and available for its intended use” When is eligible property considered “placed in service”?“Ready and available for its intended use”Public UtilitiesApproval LetterWhen is a facility placed in service?“Ready and available for its intended use”Public utility approvalApproval/signoff letter – Akin to certificate of occupancyGrid connectedFacility completed, licenses obtained, pre-operational testingLICENSEGRID
32 Placed in ServiceGenerally, owner on placed-in-service date is entitled to ITC90 day window for sale/leaseback transactionsLessee 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 laterUsed property has already been placed in service, so need new property. Can have 20% used parts. 80/20 test32
33 5-year recapture period When can the credits be claimed ?When are the credits in danger of recapture?Placed-in-service date100% of credits5-year recapture period80604020Allocated 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 ownershipProperty ceases to be qualifying energy propertySaleForeclosureForce de majeure event (no rebuild)Recapture diminishes 20% per yearRecapture reported on IRS Form 42553434
35 ITC Recapture RulesPartner 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-serviceForbearance AgreementsLender agrees not foreclose on the property35
37 Treasury Grant Program ARRA signed by President Obama on February 17, 2009Cash grant from the Treasury in lieu of the ITCTemporary measure due to seized up capital marketsKnown as the “Section 1603 Treasury Grant”Generally receivable within 60 days of filing application with TreasuryTreasury Grant program expired 12/31/11Extension not likely3737
38 Treasury Grant Election (30%/10% of basis)Grant(30% of basis)IRC Section 45 CreditsIRC Section 48 Credits38
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 2011The Secretary has 60 days from the later of the application for such grant or PIS date to fund the grantAll applications must be received before October 1, 2012.40
41 Treasury Grant Election Treasury Grant cannot be made toGovernmental bodies, political subdivisions, agencies or instrumentalities thereofTo any organization described in Section 501(c) of the Code and exempt from tax under Section 501(a) of the CodeA clean renewable energy bond lenderA cooperative electric companyA pass-thru entity that has one of the aforementioned named as a partner41
42 Treasury Grant Election Grants are not includable in the federal gross income of the taxpayerTax-Exempt IncomeState considerations – Non-taxable in CAGives a partner tax basis in partnership interestTiming considerations of investor entryGrants shall be taken into account in determining the depreciable basis of the propertyBasis 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 recaptureGovernmental bodies, political subdivisions, agencies or instrumentalities thereof , non-profitsOther dispositions ok as long as property stays in serviceCCA 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”4343
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 ITCPreservation of investor tax appetite- Allows tax equity investors to preserve their tax appetite for other investments-Investors may not have current tax appetiteRecapture rules more relaxed than ITCCash is king- Improves Liquidity
45 Tax Credit Comparison PTC ITC/ Grant Electricity must be sold to a third partyCredit computed based on kWh outputCredits earned over ten yearsAMT is offset for first four years onlyNo risk of recaptureNo depreciable basis reductionDoes not have to be sold to a third partyCredit computed as a % of the cost of the facilityFull AMT offset allowedSubject to recapture for five years50% ITC/Grant basis reduction
46 The Sunset Clause Under Beginning of Construction Safe Harbor Section 1603Beginning 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 test5% cost safe harbor – safe harbor test4747
48 Work of a Significant Physical Nature Sufficient physical work – includes:Both on-site and off-site construction activitiesWork on foundationPouring concrete padsBuilding certain roadsAssembly of machinery4848
49 Work of a Significant Physical Nature Sufficient physical work – does not include:Preliminary ActivitiesPlanning/DesigningResearchingSecuring FinancingRemoving an existing facilityClearing land/Test drillingObtaining permits4949
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 12/31/2011An accrual basis applicant incurs cost and a cash basis applicant pays costFor 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 deliveredProperty that is delivered to the applicant within 3 ½ months of the date of payment will be deemed delivered on the date of payment5050
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 combinedOnly costs included in eligible basis are consideredNo continuous program of construction issueFailure 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 dateWill require accountant’s certification if grant payment exceeds $1 million5151
52 5% Cost Safe Harbor Test 5% cost safe harbor – includes: Direct construction costsFacility property (solar panels, inverters etc.)Engineering/DesigningBenefits and burdens of ownershipSpend money!5252
53 How are renewable energy transactions structured? 1-Partnership Flip2-Sale-Leaseback3-Lease Pass-through4-Outright purchase53
55 System Ownership and Investment Funding Three common arrangements have developed:“Partnership with a Flip” StructureOriginated in wind energy transactions and adapted for solarLease (Sale/Leaseback) StructureSale/leaseback cannot be used in wind transactions because Production Tax Credits (PTCs) are not available to a non-operator ownerLease Pass-Through (Inverted Lease Structure)Originated in historic tax credit transactions and adapted for solar“Sandwich lease” structure for HTC55
57 Partnership with a Flip Typically preferred by developers desiring long term and residual ownership interest benefitsAppeals to investors who are mostly interested in short term ownership benefits6-7 year investment – can be longerPut/Call buy out structures prevalentVehicle for larger investment fundsAdditional deals (tranches) easily added5757
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 BenefitsDepreciation deductions30% ITC flows through to the tax credit equity investorState incentives – Rebates, Renewable Energy Certificates (RECs) and state tax creditsCash flow from PPA / Lease revenue59
61 Sale Leaseback Structure Purchase AgreementSolar 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, LLCLesseeCorporate InvestorLessorLease AgreementSales ProceedsSale of SEFs and Lease PaymentsSolarDeveloperLessor is owner of SEF, Investment Tax Credits, Tax Losses (Depreciation Deductions), Rebates, RECs, Recipient of lease payments, Potential residual buyoutPPA/Lease AgreementsSolar 1, LLCSolar 2, LLCSolar 3, LLCEnergy Procurement Contract (“EPC”)System Integrator/InstallerSolarInstallationHost #1SolarInstallationHost #2SolarInstallationHost #36161
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 lesseeLease 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 market63
64 Sale Leaseback Attributes More effectively frontloads economics to developerAllows developer to grow business with current cash flowMore effective use of developer’s capital?Developer establishes track recordGenerally sacrifices residual interest for current cash flowPrepaid lease payment to investor equals deferred feesInvestor has flexibility to get into the deal within 90 days of PIS mitigating/eliminating construction risk6464
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 benefitsSimplicity of structure, Cost effective-Investor utilization of lease optimization modelSales taxes paid over life of the lease agreement6565
67 State Incentive Programs Lease Pass-ThroughLenderManufacturerSale of PV PanelsDeveloper/ InstallerLoan Proceeds$Debt Service PaymentsInstall/Maintenance$State Incentive Programs$LESSOR SOLAR LPPV System OwnerNo basis reduction to depreciable basisP/LGeneral Partner51%-99%partnership interestCapital Contribution$Pass-throughElection1%-49% LP interest in lossesCapital ContributionLeaseSOLAR MASTER TENANT LPBasis Reduction Income$Capital ContributionCreditsCash – Preferred ReturnCall Option – Cash, Capital LossP/L and CreditsLeaseLease Payments1% General Partner(Developer)99% Limited Partner(Corporate Investor)PowerHost6767
68 Lease Pass-Through Attributes Election to treat Lessee (Master Tenant) as owner of solar system for ITC purposes ONLYIRC 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 TenantNo basis reduction to depreciable basis for Owner, but…Master Tenant required to recognize income equal to 50% of ITC claimed over 5 yearsIRC Section 48(d)(5)6868
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 lossesWrite off of capital account (capital loss) upon disposition of ownership interest in Master TenantOwnership interest may flip down to approximately 5% after 5-year recapture periodPut/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 optionEconomic Substance Doctrine6969
70 Lease Pass-ThroughIssues for partners of the Lessor (Ownership Entity)Can the partners use the (remaining) tax losses?Owner(s) of Lessor must have tax appetiteLoss 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 LessorPotential IRC 704(d) issues for the Developer as partner of LessorEconomic substance doctrine issuesRisk that ownership structure gets collapsed into a single entity partnership structure?7070
71 Lease Pass-Through Issues if Master Tenant is not a partner of Lessor Master Tenant stands aloneMaster Tenant (Lessee) typically makes a lease pre-payment to Owner (Lessor) equal to Investor capital contributionIRC Section 467 loan createdResidential solar – Below Section 467 $250,000 thresoldMust structure and size investor preferred return and lease paymentLease term – Treasury Regulation Section (short-term lease rules)Economic substance doctrine issues7171
72 Exit StrategiesOnce you have gotten the investors IN, you need a way to get them OUTFlip – reduces the investor’s ownership percentage to make it cheaper to buy it outPut – 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. ProcCall – developer can exercise option to buy out the investor for fair market value of partnership interestPurchase option or early buy out option72
73 Partnership and Lease Pass-Through Structures Exit StrategiesPartnership and Lease Pass-Through StructuresInvestors generally want out of the transactions at the end of year 6 – Put/Call optionMost 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 IRR7373
74 Advantages of a Lease Structure Sale/leaseback transaction can be closed up to 90 days after PISPartnership transaction must be closed before the facility is PISLess 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 facilityGenerally no investment is necessary from developerIn a partnership structure, the Developer may have to leave money in the deal (deferred developer fee) or contribute sponsor equity74
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
82 1-LIHTC Partnership - PPA w/ 3rd Party Solar Developer Structure Options1-LIHTC Partnership - PPA w/ 3rd Party Solar Developer2-Traditional LIHTC Partnership-Owns solar system3-Captive Energy Company-PPA w/ LIHTC GP82
83 PPA w/ Solar Developer -Easiest -3rd Party Solar developer provides financing-Passes on benefit of tax attributes/subsidies83
84 Traditional LIHTC Partnership with Solar - New Construction Combine Solar and LIHTC84
85 Investment Fund Fund General Partner 1% Tax Credit Equity Investor 99% Tax Credits (ITC and LIHTC)Depreciation DeductionsCash Flow1%- ITC and LIHTC- Tax Losses (depreciation)- Cash flowTax CreditEquityTax CreditEquity InvestorGeneral Partner99%ITC & LIHTC Credits/Tax Losses99%1%Tax CreditEquityLIHTCOperatingPartnership(with SolarInstallation)Systems Integrator/InstallerDeveloperEngineering Construction and Procurement Contract (EPC)DeveloperFee85
86 Traditional LIHTC Partnership Owner of real estate and solar installationEarns BOTH 30% solar energy credits and LIHTCsSolar credits generated 100% in year 1 – IRR additive5 year MACRS depreciation deductions for energy propertyState 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 costsLower operating costs and energy hedge for 25 yearsAdvantage in competition for LIHTC?Environmental BenefitsUtility 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 gridCommercial property taintSale of electricity to tenants creates commercial propertyCommercial property is not eligible for LIHTCs!88
89 Methods to avoid commercial taint for LIHTC Electricity used for heating/cooling systems onlyCommon 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 tenantsUtility allowance effectProject requests lower tenant utility allowanceResults in increased Section 42 rentsElectricity effectively given to tenantsRisk that tenants abuse the privilegeMaster Meter structureOne inverter versus one for each unitElectronically 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 creditsShould structure around tax-exempt use property rules to avoid losing solar tax creditsSimilar to LIHTC depreciation issueTax-exempt use % ownership based on entity’s highest share of partnership items of income or gaini.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 grantFederal grants reduce LIHTC eligible basis by the amount of the grantIRC Section 42(d)(5)Developers looking to combine solar credits with LIHTC will likely not pursue the Treasury Grant91
92 How Investors Evaluate Hybrid LIHTC/ Solar Deals Primary motive is the LIHTC investment; Solar system is a minor additionWorth 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 regulationsSupport 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.9393
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 subsidiesDifferent answer for:ResidentialResidential rental9494
96 Combining Section 42 (LIHTC) with Section 48 (Solar Energy Credits) Investment Tax Credit Calculation - Solar Installation (Sec. 48)Solar installation price per watt$5.50Watts (95 kilowatts)95,000Solar installation costs522,500Additional installation costs22,500(1)Solar installation costs before developer fee - Solar Installation545,000Developer fee - Solar Installation81,750(2)Total installation costs including developer fee - Solar Installation626,750Less: costs ineligible for 30% solar ITC(6,750)(3)Total costs eligible for 30% solar ITC620,000Investment tax credit %30%Solar ITCs186,00050% basis reduction (50% of solar ITCs)(93,000)Depreciable basis - 5 year MACRS527,000(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$545,000Less: costs ineligible for tax credit basis(6,750)Total solar installation costs eligible for LIHTC538,250
98 Combining Section 42 (LIHTC) with Section 48 (Solar Energy Credits) Equity proceeds from the solar ITC9% not in DDA9% in DDATotal costs eligible for 30% solar ITC$620,000% of costs financed with Tax-Exempt BondsN/AAdjusted costs eligible for the 30% solar ITCITC percentage30%Energy tax credits186,000Energy tax credit price0.75Tax credit investor equity proceeds from 30% solar ITC139,500
99 Equity proceeds from LIHTCs 9% not in DDA9% in DDAEquity proceeds from LIHTCsTotal solar installation costs eligible for LIHTC$538,25050% basis reduction per Section 50(c)(93,000)(4)Eligible basis from solar installation for LIHTC445,250Additional developer fee relating to LIHTC (15%)66,787(5)Total eligible basis from solar installation for LIHTC512,037Not In DDA = 100%; In DDA = 130%100%130%Adj. eligible basis from solar installation for LIHTC665,648LIHTC applicable %9.00%LIHTCs - annual46,08359,90810 year credit period10Total LIHTCs460,830599,080LIHTC credit price0.72Tax credit investor equity proceeds from LIHTC331,798431,33850% of solar ITCSubject 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$626,750Tax 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 installation155,45255,912Assumes no California Solar Initiative incentive.(7) IRC Section 136 could apply to rebates and other subsidies received by the partnership.In that case income would not be recognized for the subsidy but the basis of the systemwould have to be reduced resulting in less tax credits and less equity from the sale of those tax credits.*Incentives vary from state to state. Please visit dsireusa.org for state specific information.
101 Net cost of solar installation including PBI 9% not in DDA 9% in DDA Total installation costs$626,750Tax 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 liability16,100(7)Estimated net cost of solar installation125,55226,012California 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 systemwould have to be reduced resulting in less tax credits and less equity from the sale of those tax credits.*Incentives vary from state to state. Please visit dsireusa.org for state specific information.
103 Combining Section 42 (LIHTC) with Section 48 (Solar Energy Credits) Investment Tax Credit Calculation - Solar Installation (Sec. 48)Solar installation price per watt$5.50Watts (95 kilowatts)95,000Solar installation costs522,500Additional installation costs22,500(1)Solar installation costs before developer fee - Solar Installation545,000Developer fee - Solar Installation81,750(2)Total installation costs including developer fee - Solar Installation626,750Less: costs ineligible for 30% solar ITC(6,750)(3)Total costs eligible for 30% solar ITC620,000Investment tax credit %30%Solar ITCs186,00050% basis reduction (50% of solar ITCs)(93,000)Depreciable basis - 5 year MACRS527,000(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$545,000Less: costs ineligible for tax credit basis(6,750)Total solar installation costs eligible for LIHTC538,250
105 Combining Section 42 (LIHTC) with Section 48 (Solar Energy Credits) Equity proceeds from the solar ITC4% not in DDA4% in DDAAdjusted costs eligible for the 30% solar ITC$620,000ITC percentage30%Energy tax credits186,000Energy tax credit price0.75Tax credit investor equity proceeds from 30% solar ITC139,500
106 Equity proceeds from LIHTCs 4% not in DDA4% in DDAEquity proceeds from LIHTCsTotal solar installation costs eligible for LIHTC$538,25050% basis reduction per Section 50(c)(93,000)(4)Eligible basis from solar installation for LIHTC445,250Additional developer fee relating to LIHTC (15%)66,787(5)Total eligible basis from solar installation for LIHTC512,037Not In DDA = 100%; In DDA = 130%100%130%Adj. eligible basis from solar installation for LIHTC665,648LIHTC applicable %3.28%LIHTCs - annual16,79521,83310 year credit period10Total LIHTCs167,950218,330LIHTC credit price0.72Tax credit investor equity proceeds from LIHTC120,924157,19850% of solar ITCSubject 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$626,750Tax 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 installation366,326330,052Assumes no California Solar Initiative incentive.(7) IRC Section 136 could apply to rebates and other subsidies received by the partnership.In that case income would not be recognized for the subsidy but the basis of the systemwould have to be reduced resulting in less tax credits and less equity from the sale of those tax credits.*Incentives vary from state to state. Please visit dsireusa.org for state specific information.
108 Net cost of solar installation including PBI 4% not in DDA 4% in DDA Total installation costs$626,750Tax 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 liability16,100(7)Estimated net cost of solar installation336,426300,152California Solar Initiative – PBI of $0.09 per kwh paid over 5 years.For installations greater than 30 kw. Discounted at a rate of 8%.Rates per kwh may vary among utility administrators.PBI rebate proceeds x 35% federal corporate income tax rate. Nontaxable for CA state tax purposes.IRC Section 136 could apply to rebates and other subsidies received by the partnership.In that case income would not be recognized for the subsidy but the basis of the systemwould have to be reduced resulting in less tax credits and less equity from the sale of those tax credits.*Incentives vary from state to state. Please visit dsireusa.org for state specific information.
109 The Captive Energy Company Existing Multi-Family and other AssetsA way to green your existing portfolio109
110 Engineering Procurement and Construction Contract (EPC) Developer(Managing Member)1%Captive EnergyCompany, LLCPublic UtilityDeveloperFee- MASH program- Production basedincentive- ITC (solar) / grant- Tax Losses (depreciation)- PPA Revenues (cash flow)- State subsidiesInvestor Member99%$- Institutions?- Individuals?- Developer?100%Multi-FamilySolar 1, LLC(disregarded)Multi-FamilySolar 2, LLC(disregarded)Multi-FamilySolar 3, LLC(disregarded)Multi-FamilySolar 4, LLC(disregarded)Power Purchase/LeaseAgreementsSystems Integrator/InstallerEngineering Procurement and Construction Contract (EPC)Multi-FamilyHousingProjectHost #1Multi-FamilyHousingProjectHost #2Multi-FamilyHousingProjectHost #3Multi-FamilyHousingProjectHost #4110110
111 Captive Energy Company Owns the solar installation30% ITC or Treasury GrantTax losses (depreciation)State subsidies (e.g. CSI/MASH)Earns a developer feeMonetizes the tax benefitsAdded benefit to tenants111
112 Issues Section 136 Issue (MASH Program) Use of Blocker Corps. For Treasury GrantHousing AuthoritiesWelfare Tax Exemption interplayTreasury Grant – LIHTC Section 42(d)(5) ProblemNet Metering/Utility AllowancesPassive Loss Reform?112
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