Affordable Housing Finance

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Using Energy Credits

AFFORDABLE HOUSING FINANCE • March 2009

How to combine solar and housing tax credits for valuable benefits

BY THOMAS A. GIBLIN AND FORREST D. MILDER

Incorporating solar panels at housing tax credit properties offers many valuable benefits. In addition to reducing energy costs and possibly increasing cash flow, solar energy may provide a competitive edge when applying for a housing credit award or positioning your property for a reduction in the applicable utility allowance.

Utilizing solar energy is likely to increase a property’s marketability and value. The cost of the solar property should also generate additional tax credit equity. This article highlights some of the issues to consider when jointly structuring transactions to qualify for solar energy tax credits (energy credits) and lowincome housing tax credits (LIHTCs).

Energy tax credit basics

The energy credit is equal to 30 percent of the cost of the “energy property” (typically the solar panels, inverter, and much of the related equipment). Eligible energy property does not include ancillary items such as transmission lines and substations, but may include a reasonable development fee. The amount of energy credit does not depend on the amount of energy produced, and it is not necessary to sell the electricity. In fact, not selling the electricity may be key to preserving the LIHTC on the cost of the solar panels.

Similar to the federal historic tax credit, the entire energy credit is claimed in full on the day that the solar equipment is placed in service. The energy credit is subject to recapture for five years (the amount of recapture declines by 20 percent each year). Energy credits are not awarded on a competitive basis, and the property owner does not have to receive an allocation or separate award from a state or federal agency to claim the credits.

Solar equipment should be eligible for additional LIHTCs (subject to a basis reduction equal to half of the energy credit). Developers should consult with their state allocating agencies to determine if (and to what extent) they allow the solar property to generate additional LIHTCs.

Both newly constructed and existing properties can benefit from adding solar panels. Some developers structure their transactions so the housing partnership owns both the building and the panels (receiving both the energy credit and the LIHTC), while other developers separate the ownership of the buildings from the solar panels.

Getting started

Combining energy credits and LIHTCs requires careful structuring. Look for the following key issues before you get started:

1. Not all properties are good candidates for solar energy. The property’s physical location and the building’s design often determine if solar energy makes sense. If the solar property doesn’t qualify for LIHTCs, then the availability of state incentive/subsidy programs to “buy down” the cost of solar property may be necessary to make solar financially feasible.

2. Charging tenants for the use of electricity will cause the solar equipment to be reclassified as “commercial property” and prevent the solar property from qualifying for LIHTCs. Accordingly, developers often limit solar energy to common areas to avoid losing LIHTCs on the solar property. We note, however, that charging for solar energy will not affect the remainder of the property, which can still qualify for LIHTCs.

3. Energy credits are allocated in accordance with an owner’s profits (unlike LIHTCs, which follow depreciation). This calls for careful tax planning to assure that fees and cash flow aren’t re-characterized as profits that cause the energy credit to be allocated to the developer (as opposed to the investor). As a result, developers should expect to receive fewer economic benefits (cash flow, sale proceeds, etc.), at least during the fiveyear energy credit recapture period.

4. The placed-in-service dates for solar property and the building may be different. The ultimate investor needs to be admitted to the partnership that owns the solar property when the solar property is placed-in-service or the energy credits will be allocated to someone else.

5. Energy credits interact negatively with other financing sources. For example, the energy credit is reduced proportionately if the property is financed with tax-exempt bonds or subsidized energy financing. However, the Internal Revenue Service has issued a Private Letter Ruling indicating that tax-exempt bonds may not cause a reduction in the energy credit in certain circumstances.

Securing the best investor for your development

Not all LIHTC investors will buy energy credits (and those who do may not fully value the additional tax benefi ts). However, since the energy credit typically generates a small portion of a property’s total equity, having separate investors may not be the most efficient execution. Furthermore, only the owner of the housing will qualify for LIHTCs, so having separate ownership can cost the project the LIHTC that would otherwise be available for the solar equipment.

In order to maximize economic results, developers should decide whether or not to include solar panels during the early planning stages of a property and solicit investors who value both credits whenever possible.

Several issues with the energy credit vary from investor to investor, including the methodology used to calculate the equity, the timing of the equity payments, and the due diligence requirements. Be sure to address these issues before selecting your investor in order to avoid any surprises.

Solar is hot, but don’t get burned

Installing solar panels on your property offers many benefits and opportunities for developers, but it can also present some challenges and possible complications. Early planning and careful structuring are key to increasing the odds that your energy credit/LIHTC transaction will succeed.

Thomas A. Giblin and Forrest D. Milder are partners in the tax credit syndication practice at the law firm of Nixon Peabody, LLP, and are based in its Boston office.