The renewable energy market relies heavily on tax incentives to help generate competitive returns. Depending on the particulars of the project, the current value of tax credits and depreciation benefits can be as much as 60 percent of project cost.  

Because the financial crisis has reduced the number of potential investors having tax appetite—i.e., investors anticipating sufficient taxable income to benefit from existing incentives—the pool of potential investors has diminished, and those who remain in the market require higher yields. Consequently, investment has slowed.  

On February 17, 2009, the American Recovery and Reinvestment Act of 2009 (the “Recovery Act”) was enacted into law. The Act is intended to spur economic activity in general, with a special emphasis on the renewable sector. The Act includes an estimated $787 billion in tax incentives and new spending, approximately $43 billion of which is devoted to renewable energy. The following is a summary of the major tax provisions affecting businesses engaged in the renewable energy market; it does not cover all energy related tax provisions contained in the legislation.  

Extension of PTC; ITC Election

The primary tax credits available for investors in renewable energy projects are production tax credits (“PTCs”) and investment tax credits (“ITCs”).  

PTC is available for wind, biomass, geothermal, small irrigation, municipal solid waste, qualified hydropower, and marine and hydrokinetic renewables. PTC is claimed over a 10-year period and is based on the number of qualified kilowatt hours of electricity produced and sold during the tax year. The amount of the credit increases each year for inflation and currently equals 2.1 cents per kilowatt hour (1 cent per kilowatt hour for most biomass, small irrigation, landfill gas, trash, hydropower, and marine and hydrokinetic renewable energy facilities).  

ITC is based on the cost of qualified energy property placed in service during the year. A 30 percent credit is available for solar energy property, fuel cell property, and small wind energy property. A 10 percent credit is available for geothermal power production property, geothermal heat pump property, combined heat and power system property, and microturbine property.  

Prior to the Recovery Act, PTCs were available for wind farms only if they were placed in service before 2010. Biomass, geothermal and municipal solid waste facilities had to be placed in service before 2011, hydropower facilities had to add improvements before 2011, and marine and hydrokinetic facilities had to be placed in service before 2012. The Recovery Act extends the placedin- service date through 2012 for wind, and through 2013 for biomass, geothermal, municipal solid waste, qualified hydropower, and marine and hydrokinetic renewables. ITC is available for qualifying energy property placed in service before 2017.  

The Recovery Act also includes provisions permitting taxpayers to elect to receive ITC in lieu of PTC on projects placed in service before 2014. Wind facilities have to be placed in service before 2013 to be eligible for the election.  

Cash Grant Election

The Recovery Act allows taxpayers to elect to receive cash grants in lieu of ITC or PTC on specified energy property placed in service during 2009 or 2010 or, if construction begins during 2009 or 2010, before the credit termination date for the property. The cash grant equals 30 percent of cost in the case of solar energy property, wind, biomass, qualified fuel cells, municipal waste, geothermal property eligible for ITC, qualified hydropower, and hydrokinetic property, and 10 percent for geothermal property not eligible for ITC, microturbines, combined heat and power system property, and geothermal heat pump property.

Existing dollar limitations that apply to ITC apply to cash grants as well. Thus, the maximum cash grant for qualified fuel cell property is $1,500 for each 0.5 kilowatt of property capacity, and the maximum cash grant for qualified microturbine property is $200 for each kilowatt of property capacity. The maximum cash grant for combined heat and power property is reduced if the property has an electrical or mechanical capacity in excess of specified limits.  

Cash grants do not have to be reported in taxable income, but the depreciable basis of the energy property must be reduced by 50 percent of the grant. Grants are subject to recapture if the property is disposed of within five years, as well as a variety of other limitations that currently apply to ITC. Grants are not available to federal, state or local governments (or to instrumentalities thereof), taxexempt organizations, or to qualified issuers of clean renewable energy bonds.  

Subsidized Energy Financing

Under pre-Recovery Act law, both ITC and PTC were reduced for business energy property financed through certain government grant programs or with proceeds from private activity bonds. The Recovery Act eliminates the rule in respect of ITC. The reduction in respect of PTC remains unchanged.  

ITC For Small Wind Property

Under pre-Recovery Act law, thirty percent ITC was available for electricity-generating wind turbines with a nameplate capacity of not more than 100 kilowatts. The credit was limited to $4,000 per year. The Recovery Act eliminates the cap.  

Bonus Depreciation

Fifty percent bonus depreciation is extended to most types of property placed in service during 2009 (bonus depreciation is also available for certain property placed in service during 2010). In cases where the taxpayer receives a 30 percent cash grant or claims ITC, bonus depreciation equals 42.5 percent of equipment cost (50 percent of 85 percent), since taxpayers claiming a cash grant or ITC are required to reduce the tax basis of the relevant property by 15 percent (one-half of the grant or credit).  

NOL Carrybacks

The Recovery Act increases the carryback period for small businesses having net operating losses that arise during 2008 from two years to five years, with the taxpayer electing the specific number of years for the carryback. For purposes of the rule, a small business is a trade or business with average annual gross receipts of $15 million or less over a three-year period.  

Advanced Energy Manufacturing Project Credit

A new 30 percent investment tax credit is created for investments in qualified property used in a qualified advanced energy manufacturing project. The project has to reequip, expand, or establish a manufacturing facility for the production of specified clean and renewable energy property. Credits are available only for projects certified by the Secretary of Treasury, in consultation with the Secretary of Energy.  

Qualified Conservation Bonds; Clean Renewable Energy Bonds

The legislation authorizes an additional $1.6 billion of clean renewable energy bonds (“CREBs”) to finance facilities that generate electricity from renewable resources. CREBs were first authorized by the Energy Policy Act of 2005 and are essentially zero interest bonds issued by electric cooperatives and specified governmental entities to finance renewable energy projects (wind, biomass, geothermal, solar, municipal solid waste, small irrigation and hydropower). The bondholder receives a tax credit in lieu of interest.  

The legislation also authorizes an additional of $3.2 billion of qualified energy conservation bonds (“QCEBs”) to finance state, municipal, and tribal government programs and initiatives designed to reduce greenhouse gas emissions. QCEBs were initially authorized as part of the Economic Stabilization Act of 2008 and are similar to CREBs—bondholders receive a federal tax credit and the issuer gets interest-free financing.

Effect on Transaction Structures

Most renewable energy projects intended to make use of ITCs (and not self-financed) are structured as partnership flip or sale-leaseback transactions. Renewable energy projects intended to benefit from PTCs (and not self-financed) are generally structured as partnership flip transactions. A saleleaseback structure is not available in a PTC transaction (except for biomass) because Section 45 requires that the qualifying project be both owned and operated by the taxpayer; in a lease transaction the lessor owns the project and the lessee operates the project.

Although the precise form of the transaction varies depending on the amount and placement of debt, and the amount of the developer’s contribution, a basic partnership flip transaction involves a partnership between a tax investor and a developer that allocates the vast majority of income, loss and tax credits to the tax investor until it receives a bargained-for return (this generally occurs after tax benefits are realized and any ITC credit recapture period has expired), and then flips, allocating the vast majority of income and loss to the developer. The developer generally receives an option to acquire 100 percent ownership after the flip.

Click here to view Partnership Flip Transaction.

A basic sale-leaseback transaction involves a sale of the project to a tax investor followed by a lease back to the developer. As the owner of the property, the tax investor is entitled to depreciation and ITC. The developer generally has a purchase option at the end of the lease term.

Click here to view Sale-Leaseback Transaction.

The Recovery Act permits use of a lease structure for projects such as wind and geothermal, which previously could not utilize such a structure because of the PTC limitations discussed above. In certain circumstances, the Recovery Act may favor a lease structure over a partnership flip since a lease structure permits taxpayers to separate the credit from the depreciation allowance.  

Specifically, in a partnership flip transaction, the credit can be allocated to the tax investor only if the tax investor is allocated depreciation deductions as well. This was generally not problematic under pre-Recovery Act law since investors that can benefit from tax credits can benefit from depreciation as well; in both cases, the investor has to have sufficient tax appetite.  

By permitting an election to receive cash in lieu of credits, the Recovery Act permits an investor to benefit from the credit even if the investor does not have taxable income. Thus, it may be beneficial to separate the depreciation from the credit, allocating the depreciation to a party that has tax appetite, and the credit to a party that does not have tax appetite. This is possible in a lease structure, which permits the parties to pass the cash grant (or ITC) to the lessee.  

Thus, a renewable energy project can be sold to a party that has the ability to utilize depreciation, either as a result of having current income or the ability to use carry backs. The lessor could then either retain the ITC/cash grants for its own benefit, or lease the project to another entity and elect to pass the ITC/cash grant on to the lessee.  

For example, a developer could sell a renewable energy project to a tax equity investor and lease it back, retaining the cash grant. This would reduce the developer’s financing costs since 30 percent of the purchase price would be captured in the form of the cash grant. The developer could be granted a purchase option so that it could reacquire the property at the end of the lease.

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Alternatively, a developer could retain ownership of the project and lease it to an investor, passing on the ITC/cash grant but retaining depreciation to offset rental income. This structure permits the developer to retain ownership of the project at the end of the lease term without need of exercising a purchase option.

Finally, developers could continue to transfer both the depreciation and ITC/cash grants to investors, either through use of a partnership flip transaction or through use of a sale-leaseback.

Developers will need to determine which alternative yields the package of benefits that is best from an overall financing standpoint.

Effect on Renewable Energy Financing Market

The Recovery Act will likely improve the financing market somewhat because it permits investors to monetize credits through the cash grant program, even if those investors do not have sufficient taxable income. Monetization of depreciation benefits is more difficult.

The legislation does not open the market to non-corporate investors since such investors are limited in their ability to utilize losses and credits from renewable energy projects under the passive loss rules. In general, these rules prevent non-corporate taxpayers from utilizing credits and losses attributable to so-called passive activities (in general, business activities in which the taxpayer does not materially participate) to offset active business or portfolio income. Providing an exemption from the passive rules for losses and credits from renewable energy projects would potentially increase the investor pool.