REITs remain hard to use for solar projects.

Final regulations the IRS issued in late August on what types of assets may be owned by real estate investment trusts were disappointing to solar advocates.

REITs are corporations or trusts that do not have to pay income taxes on their earnings to the extent the earnings are distributed each year to shareholders.

The renewable energy industry is interested in REITs potentially as a source of cheaper capital. Congress created REITs in 1960 as a way for small investors to invest in large-scale real estate projects. Small investors pool their investments in the REIT and are treated essentially as if they had invested in the real estate projects directly without a corporate-level tax being taken out along the way. The challenge for renewable energy is that a REIT must hold at least 75% real property or interests in real property. Examples of such assets are land, site leases, buildings and mortgages secured by real property.

Solar advocates hoped the IRS would treat solar panels as real property by viewing the panels as structural improvements to buildings, as inherently permanent structures on land or as real property for REIT purposes simply as policy move to encourage renewable energy. The IRS declined to go farther than it went in May 2014 in proposed regulations. (For earlier coverage, see the June 2014 NewsWire article, REITs.)

Machinery does not ordinarily qualify as real property. An example in the regulations makes clear that the IRS views solar panels as machinery.

Solar equipment can qualify as real property as a “structural component” of a building if it performs a utility-like function for the building, such as providing electricity. However, the IRS said the electricity must be part of what the building occupants get for their rent for the use of space, the REIT must own or have the same legal interest in both the solar equipment and the building, and the solar equipment must be expected to remain permanently in place.

The IRS and US Treasury are still thinking about whether it makes a difference if some of the electricity is supplied to the local utility, for example, through net metering. The IRS said in August that it will not object in the meantime as long as no more electricity is sent to the local utility in a tax year through net metering than is purchased from the utility that year for the building.

The regulations have two solar examples. One concludes that a solar system mounted on the ground next to a building whose electricity it supplies is a structural component of the building. The system is sized solely to serve the building and there is nothing to suggest the system will not remain in place indefinitely.

The other example concludes that the land, underground gathering lines, concrete base and metal racks that hold the solar panels in place at a utility-scale project qualify as real property, but the solar panels do not.

Some renewable energy companies have been worried that any expansion of what is considered real property for REIT purposes could undermine other positions the industry has taken. The industry treats solar projects as equipment in order to claim investment tax credits and five-year accelerated depreciation on the projects. These tax benefits can be claimed only on equipment and not also on real property. The US renewable energy sector has attracted a large amount of foreign investment, including by prominent European utilities. These investors are not subject to US capital gains taxes when they exit US projects unless the projects are considered real property.

The IRS said the regulations draw lines between real property and equipment solely for REIT purposes.