Partnership Flips and California Property Taxes
California clarified that partnership flip transactions do not trigger property tax reassessments for solar projects.
The bill that did so still leaves some potential gaps that require attention to detail.
The California constitution limits property taxes on real property to 1% of the 1975 value or the value upon more recent new construction, plus an adjustment for inflation that is limited to 2% a year.
A change in ownership triggers a reassessment to the current value.
Section 73 of the California property tax statute effectively exempts active solar systems from assessment until there is a change in control after the initial construction.
Section 73 must be renewed from time to time. It applies currently to any active solar system put in service before 2025. Any such project remains exempted until a future change in control.
Avoiding a change in control is a significant issue in any M&A transaction where California solar projects are involved.
A change of control is considered to occur when more than 50% of both the profits and capital interests in a partnership are transferred. The state focuses on whether someone is gaining control in a transaction rather than on someone is losing it.
The most common way to finance solar projects is for the developer to own the project in a partnership with a tax equity investor. The investor is allocated 99% of profits, losses and tax credits until a flip date, after which its interest drops usually to 5% and the developer has an option buy the remaining post-flip interest of the investor. Cash is usually be shared in a different ratio.
Thus, the tax equity investor starts with more than a 50% profits interest. Whether it also starts with more than a 50% capital interest depends on the share of total capital put in by the tax equity investor.
Partnership flip transactions had the potential to trigger reassessments until California Governor Gavin Newsom signed SB 267 on September 30.
The new law clarifies that neither the initial investment by the tax equity investor nor the flip will trigger a reassessment, but the bill leaves some potential gaps.
Until now, if a tax equity investor started with more than a 50% profits and capital interest, then the flip would trigger a reassessment, assuming the investor did not retain more than a 50% capital interest after the flip. A partner’s “capital interest” is the share of asset value the partner would be distributed if the partnership liquidates.
If the tax equity investor still had more than a 50% capital interest after the flip, then control would transfer when the capital interest dropped below 50% after the flip or, at the latest, when the developer exercises its option to buy the investor interest.
If the investor does not get control at any point during the flip transaction, then the flip and exercise of the purchase option by the developer are irrelevant.
The new law says that neither the initial transfer of an interest to a tax equity investor nor the flip in a partnership flip transaction will trigger a reassessment. It does not address what happens when the purchase option is exercised, but in many deals the developer should already be considered to have control as a consequence of the flip so that exercise of the purchase option does not transfer control.
The bill exempts the solar equipment, but not the underlying site on which the solar project sits from reassessment if there is a change in control of the site.
The bill can be used to shield only one partnership flip transaction on any project from reassessment. This should not be an issue unless the “Build Back Better” bill giving solar projects the option to claim production tax credits on the electricity output for 10 years is enacted. New tax equity investors sometimes replace the original investors in partnership flip deals before the full 10 years of production tax credits have run. Care would have to be taken to ensure that the new investor merely steps into the shoes of the original investor rather than enters into a new flip transaction.
There is more than one way to put a partnership flip transaction in place. One approach is for the tax equity investor to buy an interest in the project company from the developer. The new law defines partnership flip transactions that will not trigger reassessment as transactions in which the tax equity investor makes a capital contribution to the partnership in exchange for an interest. The state will have to decide whether the relief applies to “purchase model” flips where the investor buys and interest from the developer.
The new law also defines a partnership flip transaction to which the relief applies as one in which the developer will obtain a majority profits and capital interest on the flip date. This may not always occur.