Prior to the IRA, the primary federal tax incentives for solar projects were the Production Tax Credit, the Investment Tax Credit and accelerated depreciation deductions.5 The Inflation Reduction Act increased or extended those existing tax credits and also added several new tax credits (energy community, domestic content, and LMI credit).6 Many states also provide additional tax incentives. In California, Net Energy Metering (NEM),7 and property tax and sales tax exemptions,8 provide additional benefits which accelerate the benefits to be captured from qualifying projects. Colorado’s various tax credits, property tax exemptions and rebates for certain solar projects also support increased returns.9 The impact of the IRA is clear. Expected solar deployment has increased by over 40% compared to pre-IRA projections, even with persisting supply chain issues in the near term.10 At the same time, solar adoption by the largest U.S. companies has also rapidly increased, with more than half of all solar capacity installed with commercial and corporate offtakers having been installed since 2020.11 77% of such new installation capacity since 2020 was in large off-site systems used to power these companies’ operations.12 Lenders looking to take advantage of the substantial opportunities in the commercial solar space should be familiar with the complexities of solar project financing. On top of the dramatic growth to date, the solar energy industry has an untapped capacity for continued and even increased growth. Even with the progress to date, solar still only accounted for roughly 2.8% of U.S. energy generation in 2021, with that number rising to 3.4% in 2022, according to the U.S. Energy Information Agency.13 Additionally, based on their current energy expenditures, approximately 70% of commercial buildings in the U.S. could benefit financially from investing in solar systems, but only about 3.5% of commercial buildings in the U.S. had solar as of 2020.14 Solar financing deals are a mix of potential real estate, personal property, equipment leasing, energy and regulatory issues, so lenders should seek counsel with a team that has expertise in all of these areas. The Role of Tax Equity Structures Lenders should first understand how solar projects are structured and the role that tax equity investors play. As a result of federal and state tax incentives, there can be significant value in solar projects for sponsors, but in order to ensure profitability, deals have to be structured in a manner that maximizes this value, which often includes the involvement of a tax equity investor as a key source of funding.15 The main tax incentives for solar projects are the availability of tax credits. However, tax credits can only be used to offset against profits, and sponsors generally do not generate enough profit to take advantage of these credits. For this reason, sponsors often turn to tax equity investors. Tax equity investors are typically institutional investors who invest in solar projects in order to take advantage of the tax benefits16 and do generate sufficient profits to take advantage of the credits. The three primary tax equity structures are sale-leasebacks, partnership flips and inverted leases. There are many variations of these structures, but lenders should understand the key features of the typical structures.17 In a sale-leaseback, the project company, which is typically a special purpose entity owned by the sponsor, develops and constructs a project and then sells the project to a special purpose entity owned by a tax equity investor. The investor then leases the project back to the project company, and the project company uses the sale proceeds to repay project debt and make lease payments. This structure allows the tax equity investor, as the owner of the project, to claim the Investment Tax Credit and depreciation deductions.18 In a partnership flip, the project company is owned by a holding company, the membership interests of which are owned by the sponsor and the tax equity investor. The holding company is treated as a partnership for federal income tax purposes, while the project company is treated as a disregarded entity. Thus, the holding company and project company are treated as a single partnership, and as the owner of the project, the partnership is entitled to claim the Investment Tax Credit and the depreciation deductions. The tax credit and deductions, in turn, pass through to the sponsor and the investor, as the partners in the partnership, since the partnership is a flowthrough entity.19 In an inverted lease, an LLC owned by the sponsor develops and constructs the project and then leases it to an LLC that is owned by the tax equity investor. Since both LLCs are treated as disregarded entities for federal income tax purposes, the sponsor is considered the lessor and the investor is considered the lessee. The sponsor makes a pass-through election to allow the investor to claim the Investment Tax Credit, but the sponsor claims the depreciation deductions since there is no similar election for depreciation.20 Dealing With the Recapture Risk of Lender Financing Since lender underwriting is more concerned with a project’s overall creditworthiness than with specific tax structuring matters, tax equity structures and lender financing are typically compatible from a lender’s perspective.21 However, from a tax equity investor’s perspective, lender financing raises what is known as “recapture risk.” Recapture risk refers to the possibility of the IRS claiming that a transaction’s structure is invalid or even an abuse of the tax code, resulting in the IRS recapturing Investment Tax Credits and depreciation deductions, and thus taking away a tax equity investor’s main sources of return on their investment in the project.22 This is particularly significant in lender financing transactions because a key cause of a recapture event is when a party with an interest 23 Colorado Banker
RkJQdWJsaXNoZXIy MTg3NDExNQ==