Below are soundbites from Novogradac’s 2019 Financing Renewable Energy Tax Credits Spring Conference in San Francisco on May 23. The soundbites are from remarks made by panelists. The quotations are edited for clarity and organized by topic, rather than chronologically. This was prepared without the benefit of a transcript or a recording.

Topics covered include “start of construction” for tax credit qualification purposes, tax risk insurance, Qualified Opportunity Zones, storage, and community solar.

Future Demand for Tax Equity

“There is going to be three gigawatts of solar development in Texas alone in the next couple of years. That coupled with offshore wind needing the investment tax credit (ITC) means there may be a shortfall in ITC capacity.”
— Vice President, National Bank

“Tax equity is sticky: once you do one transaction with an investor, they are likely to come back for a deal next year.”   
— Vice President, National Bank

“We’re focused on utility scale solar.” 
— Vice President, Multinational Financial Services Company

“For a tax equity deal, I like to start at $25 million of investment, but I have done lower. Below $10 million of investment, we’re not going to like each other at the end of the deal due to the transaction costs.” 
— Senior Vice President, Bank Holding Company

“Start of Construction” to Qualify for Full Tax Credits

A wind project must have “started construction” in 2016 to qualify for a full 2.4 cent per kWh production tax credit or a 30 percent ITC, while a solar project must start construction in 2019 in order to qualify for a full 30 percent ITC. If construction starts of solar starts in 2020, the ITC is 26 percent; if construction starts in 2021, the ITC is 22 percent; if construction starts after 2022, the ITC is 10 percent. There are two ways to start construction: (1) in the applicable year incur five percent of the total cost of the project (the Five Percent Safe Harbor) or (2) meet the significant physical work test (PWT), which can be done with onsite work or offsite work. The guidance expressly provides that work performed on a custom step-up transformer by a manufacturer under a binding contract with a project owner qualifies under the PWT.

 “We’ve seen from ‘will’ opinions to ‘we just disagree’ on the same start of construction fact patterns.” 
— Senior Managing Director, Specialty Insurance Broker

 “Tax insurance markets won’t insure cost overruns with respect to the Five Percent Safe Harbor.”
— Managing Director, Specialty Insurance Broker

 “Is a four percent lower ITC worth safe harboring years in advance?  The year it is going to matter, is when it goes from 22 percent to ten percent, but there is a presidential election between here and there.” 
— Vice President, Tax Equity Syndicator

What this quotation seems to miss is that executing under the Five Percent Safe Harbor in 2019 means that in 2022 or 2023 that a solar project can qualify for a 30 percent ITC versus a ten percent ITC.  So unless one is confident in the outcome of the 2020 election and Washington’s appetite for tax credit policy after 2020, it seems prudent for solar developers that want to be competitive from 2021 through 2023 to execute a Five Percent Safe Harbor strategy in 2019.

 “Both the Five Percent Safe Harbor and the PWT are valid, but the Five Percent Safe Harbor is more straightforward. You need to evaluate significant physical work carefully.”   
— Vice President, Multinational Financial Services Company

 “Our preference in order is Five Percent Safe Harbor, on-site physical work and off-site physical work.”  
— Vice President, National Bank

“We are getting almost daily request for module supply loans for purposes of the Five Percent Safe Harbor. We see different types of security packages: some corporate guarantees, some pledges of rights to projects in advanced stages of development.” 
— Managing Director, Boutique Investment Bank

This quotation demonstrates the difficulty of raising financing to acquire equipment to meet the Five Percent Safe Harbor for projects that will not be complete until 2021 or later, if the sponsor does not have a creditworthy parent that is prepared to guarantee the loan. Another option is vendor financing, but then the equipment must be delivered in 2019 to qualify the project, it is later installed in, for the 30 percent ITC (i.e., the exception for delivery within 3.5 months of payment cannot be combined with vendor financing).

“The most common strategy for the PWT is manufacturing a main power transformer; if you don’t finish it in the same year that you start, we recommend that you combine it with some on-site work.”     
— Vice President, Multinational Financial Services Company

The IRS’s guidance does not contain a requirement that a step-up transformer (also known as a main power transformer) be completed in the same year it is started; nonetheless, more physical work is preferable to less.

 “For rooftop solar, the PWT will only work for near term deals, 2020 placed in service projects.”  — Managing Director, Solar Module Manufacturer

 Tax Risk Insurance

“After Alta Wind, some insurers have pulled out [of the market for providing ITC insurance], but other insurers still provide and at the same rates as before Alta.”  
— Senior Managing Director, Specialty Insurance Broker

Commentary: Alta Wind is a Federal Circuit case in which the court concluded it is possible for a power purchase agreement (PPA) or other project contract to have value as an intangible that is not eligible for the ITC or accelerated depreciation.

“Given where power purchase agreement (PPA) prices are, it is really hard to make the argument that a PPA is above market and has an intangible value.” 
— Managing Director, Solar Developer

“We’ve seen appraisals where the appraisers are conservative and takes the low value number [out of the income, cost and comparable sales valuation methods]. We have also seen appraisals in which the appraiser uses an average or even the highest. If the insurer thinks the appraiser is being aggressive, the insurer may require a deductible” (i.e., effectively insure based on a lower fair market value).   
—  Senior Managing Director, Specialty Insurance Broker

“Ten to 20 percent developer profit is a sweet spot for insurers, but we’ve been able to get to 30 or 40 percent developer profit insured but with a little higher premium.” 
— Managing Director, Specialty Insurance Broker

In this context, the “developer profit” is the difference between the developer’s costs and either (a) the amount the project is sold to a tax equity vehicle or investor for, (b) the fee the developer charges the project for its services in a developer services agreement structure or (c) in an inverted lease (or pass-through lease) structure the difference between the cost of the project to the lessor and the fair market value of the project.

 “Below a five million dollar insurance limit, the premiums and transaction costs are not efficient.”    
— Senior Managing Director, Specialty Insurance Broker

Battery Storage

Under current law, stand-alone storage does not qualify for ITC.  However, if the storage is charged at least 75 percent by solar (or another type of ITC eligible project), and has the same owner and is adjacent to the solar project, then the storage does qualify for ITC as a deemed component of the solar project.

“We have funded our first solar plus storage deal.”  
— Vice President, Multinational Financial Services Company

“We haven’t financed any solar plus storage projects. We are working on our first transaction.”    
— Vice President, National Bank

“The software is critical to a battery, so the quality of the software provider is critical” to financiers of the battery.  
— Vice President, National Bank

 “The solar plus battery deal we did was not behind the meter, but we had the software set-up to not allow charging from the grid. But you need to be confident the software will work.”    
— Vice President, Multinational Financial Services Company

Solar Projects as Qualified Opportunity Zone Investments

"Qualified Opportunity Zones” are low income census tracts as determined under the 2010 census that were nominated by the governor of the state the tract is in and approved by the Treasury. 

An investor that invests the proceeds of a capital gain in a Qualified Opportunity Zone Fund (QOF) is able to defer the tax owed on the capital gain, after five years of being invested in the QOF ten percent of the tax is forgiven, after seven years five percent more of the tax is forgiven, and after ten years the investment in the QOF can be sold without federal income tax.  However, the balance of the capital gains tax (i.e., the original capital gains amount less whatever has been forgiven in light of the holding period at that point) is due on December 31, 2026.

There are many technical requirements that must be satisfied to capture these tax benefits. The most significant of which is that a QOF must hold 90 percent of its assets in “qualified opportunity zone property,” which can be one of three items: (1) newly issued stock of a corporation, (2) newly issued partnership interests and (3) tangible business property in a qualified opportunity zone. For stock or a partnership interest to constitute qualified opportunity zone business property for purposes of the 90 percent test, the corporation or partnership must conduct a “qualified opportunity business.” If the QOF invests in a partnership or corporation to meet the qualified opportunity business requirement, only 70 percent of the tangible property of the subsidiary corporation or partnership must be held for use in qualified opportunity zone business property.

There is no prohibition on a solar project being “qualified opportunity zone business property.”  However, due to the passive activity loss rules and to some extent the at-risk rules that each apply to individuals and closely held businesses, tax equity investors are typically banks, insurance companies and other publicly traded corporations that are not subject to those rules, while typically it is individual investors that recognize capital gains. Hence, it is likely that a solar qualified opportunity zone deal would need to accommodate both (i) a tax equity investor monetizing the ITC and depreciation and (ii) an individual seeking to avoid tax on capital gains.  That combination is something of a challenging prospect to structure and document.

“We’re working on three deals with opportunity zone investors on the sponsor side; it is a piece of money staying in the project for ten years and getting paid out of cash flow.” 
— Vice President, Tax Equity Syndicator

“Nobody has brought us an opportunity zone project.”
— Vice President, National Bank

“Absent a main sponsor asking us to focus on opportunity zones, we are not going to spend time on it.” 
— Vice President, Multinational Financial Services Company

“For a solar project that penciled as it was, the upfront investment [in professional fees and time] for the opportunity zone architecture was not worth the uplift to the deal.”
— Senior Director, Solar Finance and Development Company

“A lot of structural things make it unlikely that opportunity zone investors are going to be a big player in renewables.” 
— Tax Professional

 “2026 is [in the statute] because [the authors of the statute] thought it would be passed in 2016.”   
— Vice President, Tax Equity Syndicator

This quotation is a reference to the fact that the tax on the deferred capital gain must be paid in 2026, which for any investment made after 2019, will be before the vesting of the forgiveness of five percent of the capital gains that requires a seven-year holding period.

Community Solar

Community solar has become a fourth segment of the solar market: there are now utility scale, C&I, residential and community solar market segments. Community solar is something of a hybrid segment of the market as it is typically a utility scale size project but either purely residential subscribers or a mix of residential and C&I subscribers, and some are contracted with only C&I subscribers

“We underwrite community solar subscribers, but we need to get away from that. These aren’t long term contracts because the customers can terminate for little or no cost.”   
— Vice President, National Bank

“In community solar, the subscription manager is really critical.” 
— Vice President, Tax Equity Syndicator

“We are looking at community solar [in utility districts] that have caps [on how much community solar there can be], so [someone else’s] later project does not have lower pricing and take customers from our earlier projects.” 
— Vice President, Tax Equity Syndicator

“Community solar projects are subsidized by other ratepayers, and there is only so much the public utility commissions will allow that.” 
— Managing Director, Solar Module Manufacturer

The Future of Utilities

 “Utilities are going to be a clearinghouse between suppliers and users [of electricity.]” 
— Managing Director, Solar Module Manufacturer