Tax Credits The Lynchpin for Federal Renewable Energy Financing Policy. Kathy Parker

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1 Tax Credits The Lynchpin for Federal Renewable Energy Financing Policy Kathy Parker Partner Rodman and Rodman CPA Environmental Business Council of New England Energy Environment Economy

2 GREEN ENERGY TAX SERVICES Federal Incentives & Tax Implications Presented by Kathy Parker, CPA, MST

4 Business Energy Investment Tax Credit Section 48 Did the taxpayer invest in alternative energy property to generate power for its own use? Y E S NO No additional benefit available N O Is the property: 1. Qualified biomass? 2. Qualified small wind turbines? 3. Solar used to generate electricity for heating or cooling or to provide solar process heat? 4. Other Property listed on next slide? NO NO Is the property: 1. Equipment for producing or distributing geothermal energy? 2. Equipment that uses the ground or ground water to heat or cool a structure? 3. Qualified micro-turbines (small combustion)? 4. Combined heat and power systems? Y E S Y E S Y E S Y E S Y E S Was the property placed in service on or before December 31, 2016? 10% credit 30% credit (10% for solar after 2016) Note that the credit for geothermal property, with the exception of geothermal heat pumps, has no stated expiration date.

5 Investment Tax Credit Issues Summary Solar, Landfill Gas, Wind, Biomass, Hydroelectric, Geothermal Electric, Fuel Cells, Geothermal Heat Pumps, Municipal Solid Waste, CHP/Cogeneration, Hydrokinetic Power (i.e., Flowing Water), Anaerobic Digestion, Small Hydroelectric, Tidal Energy, Wave Energy, Ocean Thermal, Fuel Cells using Renewable Fuels, Microturbines, No requirement for third-party sales No reduction of credit for subsidized or tax-exempt financing No ownership requirement Structuring available to monetize the credit 50% basis reduction in the property Accelerated five-year life Credit is 100% offset to AMT

6 Depreciation Bonus Depreciation expired end of 2013 Solar depreciated over 5 year life under accelerated depreciation Accelerated Depreciation

7 Payments for Specified Energy Property in Lieu of Tax Credits - Section 1603 Did the taxpayer own a specified energy property? Was the property placed in service between 1/1/2009 and 12/31/2011? Y E S Y E S Grant amount equal to 10% or 30% of the tax basis of the eligible property, depending on the type of property NO NO YES No additional benefit available N O If construction of the property began* between 1/1/2009 and 12/31/2011, was the property placed in service after 2011 and before the credit termination date? *Safe harbor provisions set the beginning of construction at the point where the applicant has incurred or paid at least 5% of the total cost of the property, excluding land and certain preliminary planning activities. **If the total cost ends up being more than originally estimated when determining the 5%, the safe harbor can be blown. 1. Specified energy properties are depreciable properties that are, among others, part of an electricity production facility using wind, biomass, geothermal or solar energy, or certain power plants using fuel cells or micro-turbines. a. Qualified property includes expansions of an existing property that is qualified property under 45 or 48 of the IRC. 2. For property placed in service in OR for properties that were not placed in service in but for which construction began in , applications must be submitted after the property has been placed in service and before October 1, Eligible persons must be the owner or lessee of the property and must have originally placed the property in service. 4. See Pages/1603.aspx for more information regarding credit termination dates and applicable payment percentages. 5. Independent account attestation for project costs between $500k and $1mm is required in the form of agreed upon procedures; >$1mm require an audit report.

8 1603 Frequently Asked Questions from US Treasury Website Question: Are manufacturers of specified energy property eligible applicants? Payments are only available to entities that place specified property into service. Manufacturers that produce specified property but do not place into service do not qualify for the 1603 Payment. Question: Can a lessee of eligible property receive payment? Yes, if the lessor/owner of the property waives their right to payment and elects to pass it on to the lessee and the property in question is eligible. Question: Is a partnership that has a foreign entity as a partner eligible? Yes, as long as the foreign entity is not tax-exempt. Question: If a business receives a section 1603 payment for energy property used at a residential rental property, and subsequently sells the residential property to the tenant within five years, will the business be required to return all or part of the 1603 payment? Yes. The property ceases to be specified energy property when sold to a person who cannot depreciate because of personal use of the property.

10 Passive vs. Active Passive issues Must materially participate to be active Treasury has rules/test 500 hours of day to day management Limits losses and credits through Passive Activity Loss (PAL) PAL can be offset against other Passive Income Losses can be carried forward Credits can be carried forward (carried back 1 year, carried forward 20 years) Must carryback.

11 TAX EQUITY Limitation on credit for those who have losses Hard to find Some deals are too small Passive issues At Risk Rules Recourse debt (at least 80%) Tax Structure Partnership flip Sale lease back Inverted lease Consider bundling projects

12 Equity Flip Partnership (PTC & ITC) Developer Tax Equity Investor Interest & Principal Returns Back Leverage Funding Equity Investment Tax Benefit/Grant State/Local Incentives Project Debt Interest & Principal Project Nontax Government Subsidy mwh $/mwh Utility This structure provides the tax investor with special allocations of the credits and depreciation in order to provide a return on their investment, although they will bear some amount of operations risk during the early years, while the developer is able to monetize the tax benefits that could not be utilized and bears the operating risk throughout the investment. Note: Federal income tax rules must be followed for the structure and allocations to be respected; this structure may not work for tax-exempt investors.

13 Equity Flip Partnership (Cont.) FORMATION: The Tax Equity Investor s contribution is derived based on anticipated return: Cash Tax Credits SALT Incentives Depreciation Deductions YEAR 1: Tax Equity Investor receives a substantial percentage of: Cash Tax Credits SALT Incentives Depreciation Deductions Developer Lower % Developer PS HP Tax Equity Investor PS HP Higher % Tax Equity Investor

14 Equity Flip Partnership (Cont.) AFTER RATE OF RETURN IS ACHIEVED: The partnership allocations flip to previously agreed upon percentages Developer has option to purchase Equity Investor s interest in the Flip increases % partnership PS HP Flip decreases % Developer Tax Equity Investor Partnership potentially terminates upon exercise of option.

15 Sale Leaseback (ITC Only) Developer (Seller, Lessee) Sale Proceeds Lease Payments Tax Equity Investor (Owner) $/mwh mwh Real Returns Tax Benefit/Grant State/Local Incentives Utility Nontax Government Subsidy Project In this structure, the tax investor is the owner/lessor and, as such, is entitled to the credits and depreciation. The tax investor further benefits by being able to mitigate operations risk through locking in purchase price and stream of rental payments. The developer is able to receive up-front proceeds from the sale of property, while transferring full ownership of the property. This transaction must occur within 90 days of the original placed-in-service date. Note: A PPA should be examined for sale of electricity to a third party to mitigate potential price shifts. *Recapture potential of credit if developer buys back the property in a certain time period.

16 Sale Leaseback (Cont.) The developer sells eligible equipment to Tax Equity Investor at retail. Tax Equity Investor subsequently leases back to developer Tax Equity Investor benefits by reaping tax credits, SALT incentives, depreciation deductions, and payments Tax Equity Investor: 1.Responsible for all capital infusion 2.Calculates lease payments to achieve return Developer: responsible for maintenance on equipment Developer sells energy to utility Payments are mandatory regardless of profitability or revenue streams Buy out option usually exists at conclusion of lease Equipment Sale Equipment Lease Developer Equipment Tax Equity Investor Equipment Developer $$$ for Purchase $$$ Lease Payments

17 Summary of Two Investment Options Choice of transaction depends on Investor s capital, liquidity, need for return: 1. The flip affords investor more flexibility 2. Leaseback does not require substantial initial capital infusion Leaseback: If the equipment operates effectively early, flip occurs earlier. If equipment performance is lacking, flip is delayed. Flip : If the equipment operates effectively early, more revenue is generated. If it under performs, less revenue materializes. Either way the lease payments are constant and for a defined term.

18 Inverted Lease Structure Off-taker receives the energy from a system via a PPA and in turns pay Investor for the energy produced Developer may operate the system on behalf of investor The Developer (as owner) claims tax depreciation and can elect to take ITC The investor (as lessee) claims tax deduction for lease payments. At end of lease term, the system automatically reverts back to Developer. Pros: Cons: Popularity and understanding of lease structures Developer retains the residual interest Easy exit for the Investor Developer may capture some upside during lease term under an O&M Agreement Achieves separation of ITC Grant and depreciation Investor recognizes income equal to 50% of ITC Grant over initial five years of lease term Tax-exempt or government entities can t be Developer or Investor Lease must qualify for credit pass-through election Lease must qualify as a true lease for U.S. federal tax purposes Copyright Rodman & Rodman, P.C. All Rights Reserved. 18

20 THANK YOU Kathy Parker, CPA, MST Rodman & Rodman, PC 3 Newton Executive Park Newton, MA kathy@rodmancpa.com