Solar Tax Equity Investment Allows Corporations to Do Well by Doing Good

 

Tax-Efficient Structure Provides Low-Risk Above-Market Return

While Creating Environmental and Social Benefits

By Jess Brooks, Chief Development Officer

IMG_0925.JPG

In recent years, U.S. companies have made record investments in solar energy. Apple, Amazon, Walmart, Target, Google and Facebook have all announced multimillion-dollar investments in solar energy projects. These companies recognize what large solar investors like Citigroup, JP Morgan, Bank of America and Wells Fargo have long demonstrated: investing in solar is not only good for the environment; it’s good for their bottom lines.

Tax equity provides investors with a low-risk way to achieve stable above-market, risk-adjusted after-tax returns in a growing and increasingly vital market.

In addition to taking advantage of solar installations on corporate headquarters and other facilities, companies can receive valuable tax benefits by investing in offsite solar installations. Solar tax equity investment allows corporate investors to benefit from the federal solar Investment Tax Credit (ITC) and tax deductions, as well as preferred
returns on power generated by these solar projects. With the majority
of this return from these investments coming from federal tax benefits
in Year 1 of investment, tax equity provides investors with a low-risk way
to achieve above-market risk-adjusted after-tax returns in a stable,
growing and increasingly vital market.

Key Reasons to Invest in Solar Tax Equity

  • An established investment class providing stable, above-market, risk-adjusted return

  • Higher IRR and shorter duration than other tax credit investments

  • Cash flow generated by long-term, fixed contracts offer returns uncorrelated with market cycles

  • Tax incentives are built into the federal tax code with bipartisan support

  • Provides a triple bottom-line of environmental, social and financial returns

Solar Investment Tax Credit (ITC) Quick Facts

Enacted in 2006 to support the expansion of the renewable energy industry, the solar Investment Tax Credit (ITC) is a federal tax credit that provides a dollar-for-dollar reduction in income taxes that a corporation or individual would otherwise pay the federal government.  Described in Section 48 of the Internal Revenue Code (IRC), the tax credit can be claimed for the tax year in which the solar project is completed and placed in service. If a taxpayer does not have enough tax liability to use the full credit in the year the investment is made, the tax credit can also be carried back one year or rolled forward for up to twenty years. 

For projects started in 2020, the ITC provides a tax credit equal to 26% of the basis invested in commercial and residential solar projects. The ITC then steps down as follows:

  • 22% for projects started in 2021

  • After 2021, the commercial credit remains at a permanent 10%

In many cases, a solar project qualifies for tax credits but the project host is unable to use them (e.g., because the project host site is a nonprofit organization or a municipality without federal tax liability). Here, the project developer can agree to own and operate the project at the project host’s location, and to sell power to the host through a power purchase agreement (PPA) or energy service agreement.  A solar tax equity structure allows the developer to pair these projects with eligible investors who have tax appetite and who want to invest in solar.

How Solar Tax Equity Works

Solar tax equity allows a third-party investor to provide an equity investment into a solar project in exchange for a majority of the tax benefits and preferred returns on the cash flows generated by the project.  The tax equity investment typically represents only a portion of the capital stack, but receives 99% of the tax benefit, allowing the tax equity investor to recoup upwards of 75% of an investment through tax incentives in Year 1. 

Benefits of tax equity investment for corporate investors include:

  • Rapid return of capital via dollar-for-dollar reduction in federal taxes through the ITC and accelerated depreciation deductions for the majority of the cost of the solar assets, allowing investors to “keep” funds that would otherwise be paid to the IRS

  • Double-digit after-tax returns from tax savings and cash yield

  • Low-risk, predictable returns based on tax benefits and stable, fixed-rate cash flows from long-term contracts with credit-worthy offtakers

  • Scalable structure, providing effective tax planning opportunities to banks and corporations with regular taxable income  

Solar tax benefits are typically allocated to investors in a solar tax equity transaction through a partnership flip structure. In this structure, the project developer, or sponsor, and the tax equity investor form a partnership through a limited liability company, and the allocation of profits, tax benefits and cash “flips” between the partners over the life of the partnership agreement.  Typically, the tax equity investor receives 99% of tax credits, profits and losses for the first five full years of the contract (the length of the IRS ITC compliance period; after that time, the share flips to a lower percentage.

After the flip, the sponsor has the opportunity to buy out the tax equity investor at the fair market value of the agreement, or the price that would give the investor the target rate of return.

Solar investments are typically considered passive activities, which means individuals and trusts can only use the credits and losses to offset passive income. Corporate investors are not subject to passive income requirements and can use the tax credits to offset any federal income tax liability.

Solar Tax Equity Example

Here is a recent example illustrating how corporate tax equity investment works for a portfolio of solar projects that cost $1 million dollars to develop and that are placed in service in 2020. These projects are entitled to federal investment tax credits worth 26% of the total eligible costs of the projects, or approximately $260,000.  If the solar tax equity investor provides 50% of the capital stack, and receives 99% of the tax benefit, the investor contributes $500,000, and receives approximately $257,000 in federal ITCs in Year 1. At a corporate tax rate of 21%, the investor also receives $174,000 in tax benefits from depreciation, for a total Year 1 tax benefit of $431,000, or 86% of their original benefit.

The remainder of the return on investment comes over the remaining life of the investment in the form of preferred returns on project cash flows and the buyout after the conclusion of Year 5.

Conclusion

Solar tax equity provides corporations and banks with a powerful tax planning tool providing stable, low-risk returns secured by the federal tax code and fixed-rate cash flows from long-term contracts. To learn more about Sunwealth’s corporate tax equity offerings, contact us.


 
 
jess-circle-alt.png

Jess Brooks is Chief Development Officer at Sunwealth where she helps investors put their money to work building a better clean energy future. When she isn't connecting with investors, she's proud Mom-in-Chief to two boys; she also volunteers with The Carrot Project, Generation Citizen and First Teacher.

 
Jon Abe