Posted on February 9, by Josh Lutton and Shirley You. This post was updated on February 9, The original version was published in March The three main pillars of competitiveness in the solar industry are the ability to acquire customers at low cost, install inexpensively, and achieve low cost of capital. This paper summarizes the main financial arrangements used for such financing: The examples in the paper are from solar, but many of the same principles apply to the wind industry as well.

These benefits have value because they reduce the amount of taxes a business would otherwise pay. Of course, in order to take direct advantage of these incentives a business must have a tax liability to begin with. Many solar dealers and developers do not have sufficient such liabilities; to use the incentives they partner with tax equity investors as described below. Under current law, bonus depreciation will phase out as follows: The ITC will also decrease over time: Treasury in lieu of the ITC.

They expired at the end of One critical consideration in determining the value of the ITC and depreciation benefits is how much one can claim as the basis against which one is claiming the benefits—the larger the basis, the larger the tax benefit.

The government will accept FMV calculated in any of three approaches: It may also include overhead related to the above. It may also include a reasonable profit, which Treasury defines as percent, and a developer fee of percent.

The developer fee should not be considered as covering developer costs that are not eligible to be included in basis, such as marketing or the cost of arranging financing, but rather as compensation for the capital put at risk before it knew there was going to be a sale.

The market approach is based on the sale of comparable properties. In other words, the price that similar systems in similar locations have sold for between unrelated parties. Finally, the income approach uses the discounted value of future cash flows of the project.

Treasury is least comfortable with this approach because it relies on assumptions that are difficult to verify or that require a lot of judgment. Although Treasury is uncomfortable with the income method, we understand the IRS uses this approach internally. FMV is a critical issue because presumably everyone wants to comply with the law but everyone also has an incentive to claim the highest FMV possible.

This is not to be taken lightly: However, companies that are conservative will receive fewer tax benefits than those that are more aggressive but still follow the law. Unfortunately, many businesses that invest in solar systems do not have significant tax liability. While an individual company that buys its own solar system might be able to use tax incentives efficiently, no business we know of that specializes in the installation or financing of solar systems for others has enough tax liability to be able to use all the federal tax benefits itself.

As a result, these businesses often seek tax equity investors—investors who can use the tax benefits—as partners. The arrangements used are complex and the number of parties that have been willing to invest in tax equity has been limited. As a result, both the administrative costs in terms of legal and accounting fees and financing cost in terms of rate of return required by tax equity investors are high.

As of this writing, tax equity investors require 7. This is the after-tax return to the tax equity investor, net of its tax benefits. The cash return to the tax investor and cost of capital seen by the developer are lower. The market uses three main structures used for tax equity investments: The partnerships are organized as limited liability companies so there are no income taxes at the partnership level; taxes are paid by the investors on their own corporate tax returns.

The flip is designed to happen as early as the end of year five or as late as year nine, and is supposed to coincide with a time when Tax Equity will have received a certain target rate of return, net of all tax benefits and cash it is distributed.

The flip cannot happen before the end of year five or the government will recapture a portion of the ITC. One important concept to understand when dealing with partnership flips is that the cash generated by the partnership can be distributed to the partners in a completely different ratio than the tax profit or loss.

Most of the cash goes to the sponsor. The buyout price is usually the greater of fair market value at the time of the buyout or the amount that would give the tax equity investor its required rate of return. In any event, because after the flip Tax Equity only gets a small minority of cash distributions, the buyout price is quite reasonable compared with the price in a sale-leaseback.

There are two major sub-types of the partnership flip. The so-called yield-based flip is the most popular. Tax Equity gets the vast majority of the tax benefits plus enough cash to get its required after-tax IRR at an expected target flip date.

If the assets underperform, the flip is delayed until Tax Equity gets its agreed return.

Some banks, including especially U. Bank, do flips in a slightly different way. The flip happens at the end of year 5 or 6 irrespective of whether Tax Equity received its target return. Fixed flips make sense if tax rates are stable; we expect they will become less popular going forward, given all the talk in Washington about possible changes to tax rates.

It is possible for ProjectCo to use debt. This is not shown in the Figure 2 for simplicity.

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Using debt at the project level is rare. For more information on partnership flips, see our more detailed article on their mechanics and accounting, Tax Equity There are two types of inverted leases: A simple inverted lease involves Tax Equity leasing solar systems from the developer.

A partnership inverted lease structure involves two partnership entities. Some developers prefer this structure because it allows them to keep half the depreciation tax benefits. Understanding and modeling tax equity investment funds is difficult.

If you choose to build your own financial model of a tax equity investment, here are the main elements your model should include:. Woodlawn has developed Microsoft Excel models for each structure; they are available at our web store. Woodlawn would also be happy to answer any questions you might have about tax equity structuring and investments. Please feel free to contact us.

Download a pdf version of this post. September 12, at 9: October 3, at December 9, at 4: Thank you Josh, as a solar installer looking to become a developer, this was the initial primer that I was looking for.

I look forward to learning more, hopefully from you. Your clear and concise style is much appreciated. January 13, at 8: Hey, for someone who is unfamiliar with financing, this article is describing common ways that consumers get their purchases of systems financed? Or is this only applicable to situations where developers are installing a system at a consumers property and the consumer does not technically own the system, but instead are only leasing the right to use it? January 14, at 7: Steve, the article is not for consumers.

It describes how businesses that own systems and lease them to consumers can take advantage of federal tax benefits. April 19, at 3: Josh — nice piece. Your statement that the MACRS benefits flow through binary search tree insertion and deletion c program to the Developer and the Tax Investor contradicts a Chadbourne presentation John Marciano.

Is there an error in your work? April 22, at 9: In his piece John is referring to the Master Tenant, which cannot take depreciation. June 18, at the stock market concord I have been approached by a catholic property which recently paid for solar on ground next to its buildings went into service last week.

Is it possible for them to sell the PV to a tax appetite investor who can use the ITC since the project was just completed? June 19, at John, theoretically they could sell the system and lease it back sale-leaseback if they do it within 90 days of start of operation.

The other two structures require the ownership be in place when the system starts operation. August 31, at 9: The church missed the boat. August 1, at 9: Presumably the structures vary based on type of tax investor s in each fund. Separately, I assume that additional projects can be tagged on as those are developed under all of these structures or am I off?

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August 7, at 2: Senake, I believe SolarCity has used all three of the structures I describe in the post. I imagine they are doing few, if any, sale-leasebacks at this point because they want to own the residual value. The funds are set up so projects can be added after the fund is set up. In fact, for flips and inverted leases the funds have to be in place before the projects are placed in service. August 9, at 8: August 11, at 6: Mike, check out http: April 7, at 9: The cost approach may include the cost of equipment, engineering, permitting, and installation.

May 18, at 7: May 17, at 7: We are partnered with a Solar LLC and allow our tax clients to join the LLC and receive pass through energy credits to use to offset their own tax. The LLC typically gets 90 cents on the dollar for this transfer using A K1 and forms and Have you heard of this?

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It sounds like you may want to contact a tax attorney. May 18, at 3: Thank you for the excellent article and insights into how tax equity structures work. But once you levered equity is a put option wexford global strategies trading limited everything structured correctly, how do you find these tax equity investors?

Can I as a smaller developer goto the ones you mentioned the more established players work with? You probably should not be selling or structuring deals without knowing who your tax equity investors will be.

In my experience the ones I list in my article are only interested in working when they can put tens of millions to work in one transaction. Smaller fred tam daily stock market outlook have a few options.

Third, Work with a bank or other investor who will buy the whole project. June 19, at 6: Thanks for the article, Josh.

This is really helpful. In modeling out the cash flows, how much of the tax benefit actually accrues to the developer?

Does the tax equity investor provide the developer with some small and discounted amount upon project completion and then realize all of the tax benefits ITC and MACRS over the subsequent 5-year period? Also how would participation by a YieldCo change the cash flows? June 22, at How much of the tax benefit accrues to the developer depends on the structure. For example, in the sale-leaseback it is zero, but in the flip and inverted lease some of the benefit does get allocated to the sponsor, but the specific amount depends on both the structure and what the parties negotiate.

Many sponsors developers have no tax liability, so they try to minimize the amount of the tax benefit they receive. A YieldCo does not change the fundamentals of these structures, but one has to make sure that the ownership of the assets does not change in a way making money on paypal currency exchange would trigger the IRS canton trade days vendors information recapture the tax benefits.

July 8, at 4: I am looking to add a PPA option for our clients. We would not be looking to do tons of them a year maybehowever would like to keep it separate from the existing company for payments and such. Looks like the Sale-leaseback set up would work the best for this? Instead of leasing back to the installation company could the payments go directly to the PPA for simplicity?

July 10, at Your development company would sell the solar system to someone perhaps levered equity is a put option bank. July 25, at 1: Under the Flip scenario, is the buy-back price pre-determined? Are there any tax requirements that the buy-back has to be FMV. If not, what is the typical price range? Is it based on the original transfer price, or is it a multiple of PPA annual payments? July 28, at 9: The buyout option price can be predetermined, but it has stock index futures and options ppt be a reasonable estimate, at the time of closing, of the FMV at the time the option is to be exercised.

August 17, at 7: Thanks for your article. For the sale-leaseback option: For instance, I heard that the lessor needs a special lending license and only banks can really do this.

Tax equity investors generally tend to be widely held C corporations not individuals or small partnershipshowever, because the ITC can only be used to offset passive income which most individuals do not have unless the investor is actively involved in the operation of the solar system.

May 9, at 9: Are banks able to raise tax equity funds? May 10, at 4: Regulated banks probably could not raise tax equity funds, although a bank holding company may be able to.

May 4, at 1: The benefits of ITC and bonus depreciation in the first year will cause a negative account balance. Do tax equity partners tend to shy away from bonus depreciation deals as a result? May 4, at 2: Fran, Yes, you are right about the negative capital accounts problem.

As a result, the investment agreements almost always stipulate that the sponsor not claim bonus depreciation. July 29, at 1: As I understand these structures apply primarily to residential and commercial financing. Do these same structures apply to utility scale development and project finance? From my understanding those transactions are primarily financed with debt.

Is the debt raised from partners similar to tax equity investors or in completely different capital markets as they are project based? Thanks for the article, its incredibly helpful! July 29, at 2: Sale-leasebacks are almost exclusively used in the commercial rooftop market.

Partnership flips are used in the utility market. Many projects or groups of project also have debt, but a project financed without tax equity would be at a significant cost disadvantage unless the project sponsor itself can use all the tax benefits.

January 6, at 9: He will own the system and lease back to the organization.

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If structured properly, can he claim the ITC and the MARCS depreciation? January 9, at Your investor will probably lose the ability to take the take benefits if he leases the system to a non-profit. He should be sure to structure his agreement as a service contract PPA. January 23, at 2: Josh, I very much appreciate your articles. My state only allows PPAs with commercial businesses if they are an affiliate of the IPP.

Have you heard of any structures involving tax equity that would accommodate this restriction for commercial projects? There is some precedent in CA that says the flip does not represent a change in ownership for property tax purposes. I hope someone has already solved this problem. February 10, at I can imagine a case where the commercial business offtaker and tax equity form an SPV call it an IPP that sells energy to the offtaker under a PPA.

I am not sure if that is exactly what you were envisioning. It sounds like you might need to talk with an attorney about the precise definition of affiliate and whether the structure you imagine would qualify. Your email address will not be published. Trump Infrastructure Intro ES Structures Tax Equity Woodlawn Associates Management Consulting. Strategy Finance Energy Tech Other Industries Team Blog Store Contact.

Federal Incentives for Solar There are three federal incentives for businesses that invest in solar systems: Accelerated MACRS Depreciation — Businesses can depreciate solar systems using a 5-year schedule even though the useful life of a solar system is years. Future Changes Under current law, bonus depreciation will phase out as follows: Cost Basis and Fair Market Value One critical consideration in determining the value of the ITC and depreciation benefits is how much one can claim as the basis against which one is claiming the benefits—the larger the basis, the larger the tax benefit.

Tax Equity Unfortunately, many businesses that invest in solar systems do not have significant tax liability. Three Tax Equity Structures The market uses three main structures used for tax equity investments: Sale-Leaseback The sale-leaseback is the most straightforward of the structures see Figure 1: Developer finds customer, signs contract for PPA or lease, and builds system Tax Equity buys system and associated contract from Developer.

Cost of capital from tax equity investors may be higher than from other sources. Very well understood structure used for years in wind energy deals Most common structure used in solar Sponsor can buy out the tax equity investor after flip at reasonable cost Often no fixed payment, so if projects underperform worst case for Sponsor is usually a delay in the flip Disadvantages: If Sponsor cannot use some ITC or depreciation, this may be inefficient Partnership must be in place and funded prior to assets being placed in service High legal and accounting costs.

Tax Equity leases systems from Developer. Tax Equity makes lease payments per agreement with Developer Customer pays Tax Equity monthly Customer pays Developer after end of lease term. Lease term is typically 12 years. Master Tenant sub-leases to Customer. Allows Developer to keep some depreciation benefits may not be ideal for all developers Lessee Tax Equity or Master Tenant can claim FMV based on appraised value for purposes of ITC; it has no insight into cost since it is merely a lessee Disadvantages: Tax Equity receives fewer tax benefits than in other structures No tax laws directly govern inverted leases, so highest tax structuring risk Relatively small number of tax equity investors will do inverted leases for tax equity they were more common for financing of grants.

Comments John Joshi says September 12, at 9: Excellent explanation and diagrams showing development of finance methods! Either way thanks for the informative article. Do you have a catalogue of all your work pertaining to Solar PV? Hi Josh, Thank you for the excellent article and insights into how tax equity structures work. AJ, You probably should not be selling or structuring deals without knowing who your tax equity investors will be.

Paul, How much of the tax benefit accrues to the developer depends on the structure. Josh, I am looking to add a PPA option for our clients. Ryan, That seems right. Sal, The buyout option price can be predetermined, but it has to be a reasonable estimate, at the time of closing, of the FMV at the time the option is to be exercised. Hi Josh, As I understand these structures apply primarily to residential and commercial financing.

Katherine, Sale-leasebacks are almost exclusively used in the commercial rooftop market. Leave a Reply Cancel reply Your email address will not be published.

Read our blog See our thinking about strategy, management, energy, and tech. Subscribe to blog by email. Featured posts Trump Infrastructure Intro ES Very well understood structure used for years in wind energy deals Most common structure used in solar Sponsor can buy out the tax equity investor after flip at reasonable cost Often no fixed payment, so if projects underperform worst case for Sponsor is usually a delay in the flip.

Allows Developer to keep some depreciation benefits may not be ideal for all developers Lessee Tax Equity or Master Tenant can claim FMV based on appraised value for purposes of ITC; it has no insight into cost since it is merely a lessee.