The Basics of Solar Tax Credits Forrest Milder 617-345-1055 fmilder@nixonpeabody.com Herb Stevens 202-585-8811 hstevens@nixonpeabody.com © 2008

1 – Solar Tax Credits Solar credit is an investment tax credit (or ITC) Based on cost of facility Usually taken all in one year Generally only available for new property (there’s an 80% test) Mostly: depreciation over 5 years

2 – Overview of ETCs Energy Tax Credits are generally 30% of “facility” cost (e.g., transmission lines and substations are not eligible for the ITC) Includes Photovoltaic (PV) Concentrated Solar Power (CSP) & fuel cells Must generate electricity, heating, cooling, hot water, or fiber-optic lighting. Sale of elec. is not required

2 – Overview of ETCs (cont’d) Usually taken in the year the facility is “placed in service”, but can sometimes use “progress expenditures” over more than one year Possible recapture for 5 years (100% in first year, 80% in second year, etc.) Called “Energy Tax Credits” in Section 48 of Tax Code Applies to property placed in service before December 31, 2016

3 – Need for an Owner No “sales” of credits. They are generally claimed by the owner of the facility which makes an “investment” in a partnership or LLC, or, if the developer wants “out”, the facility could be sold No government ownership Sometimes, a lease is used, and the tenant claims the credits (note: “anti-depreciation” for tenant). A lot like HTC.

3 – Need for an Owner (cont’d) Lengthy documents detail the relationship – addresses investment timing, allocating credits, distributing cash, and withdrawal of the investor Usually: 5+ year relationship with investor

4 – Allocations Developer Investor IRS has elaborate rules for allocating the credits among the parties ITCs follow the “profits” of the owner This is NOT the same as LIHTC (they follow depreciation) Wide range of ratios possible, not just 99-1 1% 99% Partnership Solar Facility

5 – Sharing Cash and Credits They don’t have to be shared in the same way IRS might treat cash distributions as a share of profits or gross sales and re-allocate the credits Must track capital accounts Might be able to use debt, management or development fees to get cash to developer

6 – Need for a Forecast Shows how credits and cash go to the investor and the GP Must be done by someone who knows syndication (otherwise, there may be very unwieldy projections) Remember that Allocations are different from LIHTC Pricing is often based on IRR, not cents per dollar of credit

7 – Placed In Service (“PIS”) When to start claiming credits – it’s not based on when the investor comes in. If investor gets in late, ETC may be lost (possible 3-month lease exception) ETC may be able to use “progress expenditures” to get credits earlier, and higher rate

7– More on Placed in Service (cont’d) When is a facility placed in service? Usually when completed, with licenses and after pre-operational testing “Daily operation” can matter Acquired property must be delivered and ready to use; mere purchase is not enough

8 – Other Subsidies Bonds and “subsidized energy financing” generally reduce federal credits on a pro rata basis State programs usually don’t reduce solar credit, but may be taxable, e.g., state grants IRS keeps attacking state tax credits

9 -Technical Rules Almost all investors are corporations because of “At Risk” and “Passive Loss” Rules Basis reduction of 50% of ITC, meaning less depreciation Profit motive – But compare Rev. Proc. 2007-65 (for wind) with Reg. 1.42-4 (for LIHTC) AMT is eliminated, effective for years beginning after October 3, 2008.

10 – Flips, Puts, and Calls Once you’ve gotten the investor IN, you need a way to get it OUT. Flip – reduce the investor’s percentage to make it cheaper to buy him out Put – The investor can get out for a small amount. Less used in energy deals Call – The developer can buy out the investor for fair market value

11 -Puerto Rico Solar Tax Credit Puerto Rico enacted legislation in August 2008 to provide a corporate or individual taxpayer with a credit for acquiring and installing "solar electric equipment." The credit is allowed against the taxpayer's Puerto Rico income tax. Through fiscal years 2008-09, the credit amount is 75% of the cost of the equipment and installation. During fiscal years 2009-10 and 2010-11, the credit is 50% of the cost of the equipment and installation. During fiscal year 2011-12 and beyond, the tax credit is limited to 25% of the cost of equipment and installation.

12 - Combining LIHTC and Solar Project can qualify for both 2008 Act requires States to take account of energy efficiency in the QAP Remember that bonds can be a problem Remember that LIHTC and Solar are allocated among partners differently (so watch out for contingent fees)

Combining LIHTC and Solar (cont.) Solar credits reduce LIHTC basis (illustration follows) Solar also offers rapid depreciation to investor -- 5-yr MACRS (Only 5-yr S/L if bond-financed). Also, unlike the real estate, solar is eligible for 50% “bonus” depreciation in 1st year (must be PIS in 2008). Crucial to track capital accounts and “minimum gain” – the accelerated depreciation may drive investors negative very early; debt structure will be important

Example: Solar and Housing Credits Amount of Credits Available 9% Housing Credit 4% Housing Credit Solar Panel Cost $1,000,000 Solar Credit at 30% $300,000* $150,000** assumes 50% tax-exempt debt Housing Credit Basis (reduced by ½ solar credit) $850,000 $925,000 Credit Percentage (assumed) 9% x 10 = 90% 3.5% x 10 = 35% Housing Credit $765,000 $324,000 Total Credits $1,065,000 $474,000 *Plus 5-year MACRS (and **Plus S/L depreciation 50% bonus depreciation if PIS in 2008)

13 - Pricing Solar Credits Solar is often priced based on IRR, not cents per credit dollar, because (i) all credits in one year, plus (ii) rapid depreciation mean (iii) a different pricing model than applies to LIHTC. The Most likely purchaser is the owner of the LIHTC project, so there may not be competitive bidding for the credits

14 - Technical Rules Bonds reduce the ETC. So, pay attention to LIHTC projects that are 51%+ bond-financed (May be able to “trace” the bond proceeds and allocate them away from the solar, so as to maximize the ETC. See PLR 200820011) Placed-in-service date can be different for panels than for housing units. You can’t “warehouse” the ETC, so it’s important to have the investor ready (or already in) If solar qualifies for LIHTC, it can qualify for the 130% boost too (if project is in DDA or QCT)

More Technical Rules Tax Exempt Use Rules – If there’s a tax-exempt partner, make sure that its share of the deal is a “qualified allocation” or use a Section 168(h)(6) electing entity. Profit motive should not be necessary because of Section 1.42-4 of the regulations that applies to LIHTC deals (But consider “lease pass-through” structures in which the panels are leased to a different investor which only takes the credits)

15 - Things to Remember -- Solar and LIHTC ETC Issues LIHTC and Solar are allocated among partners differently (so watch out for contingent fees and other proxies for profits that can screw up the ETC) May be able to delay incentive fees to year 6 to avoid risk that fees will be treated as profits during recapture period

Things to Remember – Solar and LIHTC (cont) LIHTC Issues If residents are charged, then solar is “commercial” and not eligible for the LIHTC Utility Allowance rules (1.42-10) hadn’t required that cost savings from solar-provided electricity be taken into account. So: permitted tenant rents are lower than they “should” be. (Illustration follows). But: recent changes allow a building owner to hire a qualified professional to calculate utility allowances taking into account “systems” and “appliances”.

16 - Utility Allowance Illustration Assume total permitted rent is $1000, and utility allowance is $75. So, tenants can only be charged $925 by the landlord Suppose solar panels would reduce utility cost by $25. So, instead of $75, we expect the actual utility cost to be $50/mo. Using $1000 permitted rent, landlord should be able to charge $950 (because utility allowance should be reduced from $75 to $50), but 1.42-10 doesn’t require the utility allowance to take renewables into account. Instead, it may be “stuck” at $75 So landlord doesn’t get the benefit of the $25 savings; instead, he still charges $925, the tenants only pay $50 for utilities, and their total expenses go down from $1000 to $975

17 - Solar for Housing without the LIHTC Solar panels can be added later by an LIHTC partnership (without getting low income credits for the solar), or The panels could be owned by an unaffiliated owner and either: (i) this owner could lease the panels to the LIHTC partnership, or (ii) this owner could sell power to the partnership or its tenants But consider the loss of the LIHTC (generally 80+% of costs). It is much larger than the ETC (30% of costs) Having a separate owner typically avoids bond tracing rules (if applicable) and may avoid contingent fee issues

NMTC/Solar Investment Structure Leverage Fund NMTC Equity Leverage Loan NMTC Investor Leverage Lender NMTC Equity 99.99% NMTC CDE Solar Tax Credit Investor Solar Equity Solar Credits Loan Solar Equity Solar Project Owner Master Tenant 49% Interest Solar Credit Pass-through to Master Tenant

Thanks Forrest Milder and Herb Stevens