Solar and Public Utility Property
“Public utility property” questions continue to take up IRS time.
The issue is whether an investment tax credit and accelerated depreciation can be claimed on solar and solar-plus-storage projects in which regulated utilities have a direct or indirect ownership interest.
The IRS said in a private letter ruling made public in late November that a particular utility-scale solar project will not be “public utility property” despite being owned by a partnership in which a regulated electric and gas utility is a partner.
The utility signed a build-transfer agreement with an independent developer to buy the special-purpose project company that owns the project once the project reaches mechanical completion near the end of construction.
The utility plans to resell the project company immediately to a partnership in which it is a partner.
The partnership will sell the electricity generated to the utility under a power purchase agreement. The utility will then resell the electricity into the local grid and buy back from the grid what it needs to supply its ratepayers.
The utility plans to put the circled cash that it contributes to the partnership so that the partnership can buy the project company, and that the utility then receives back as purchase price for the project company, into its rate base, allowing it to earn a return on the amount. It may have been able to put the full purchase price under the build-transfer agreement into rate base had it retained the project directly.
A solar project is “public utility property” if the rates at which electricity is sold are established or approved by a regulatory body on a rate-of-return or cost-of-service basis.
If a project is public utility property, then an investment tax credit and accelerated depreciation become harder in theory to claim. Such tax benefits cannot be claimed on any project where a public utility commission requires the benefits to be passed through to ratepayers more quickly than under a “normalization” method of accounting.
The IRS said the project in the ruling is not public utility property because the electricity will be sold by the partnership to the utility at a negotiated rate rather than a price set by a public utility commission based on a permitted rate of return or cost of service for the utility.
The IRS has confirmed in multiple private letter rulings to utilities over the last three years that projects owned indirectly by regulated utilities through partnerships are not public utility property if the electricity is sold for a negotiated rate. (For more details, see “Utility Tax Equity Partnerships” in the August 2021 NewsWire, “Public Utility Property: More IRS Rulings” in the December 2020 NewsWire, “Solar Projects and ‘Public Utility Property’,” in the October 2020 NewsWire, and “Utility Tax Equity Structures” in the December 2019 NewsWire.)
The latest ruling is Private Letter Ruling 202140014.
It is unclear why the IRS has not issued a general revenue ruling by now to the same effect on which all utilities can rely as a labor-saving measure.
None of the rulings addresses another key issue.
Partnerships that own solar projects normally run a net loss for tax purposes for the first three years due to accelerated depreciation on such projects. A partnership that sells electricity to a partner may not be able to claim any net loss for tax purposes. Section 707(b) of the US tax code bars partnerships from claiming losses on sales of property to affiliates. Electricity is considered property for this purpose.
The IRS is studying section 707(b).
It put the issue on a priority guidance plan in October listing areas in which it hopes to issue guidance by next June 30. It is not unusual to see items on the priority guidance plan carried over from year to year until the IRS can get to them or even dropped without guidance having been issued in cases where the urgency wanes in relation to other subjects requiring guidance.
Many partnerships avoid the issue by structuring the contract with the affiliate as a swap or hedge or an agency arrangement where the affiliate places the power in the market for the partnership.