The Inflation Reduction Act’s vast array of tax and climate provisions offer opportunities for organizations across many industries to take advantage of renewable energy credits. For this month’s Affordable Housing News and Views , Affordable Housing industry leader Beth Mullen sat down with Lee Peterson, of CohnReznick’s Renewable Energy practice, to unpack top components that those in the industry need to know, such as:
- The latest on the Investment Tax Credit for renewable energy development
- “Adder credits” for affordable housing and other projects benefiting low-income communities
- Upcoming changes to the interaction of ITC and LIHTC basis
Watch their conversation below, or continue down the page to read it in transcript form.
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Did the Investment Tax Credit for solar, geothermal, and storage change for 2022?
Yes, Beth, it did. And it changed in some sort of interesting and still somewhat complicated ways. One of the things I wanted to help folks appreciate is the need to pay attention to some of the specific details in the transition rules. The first thing that happened was the Investment Tax Credit for solar or geothermal, etc., went up immediately to 30% as of the effective date of the Act. So for 2022 you now have the opportunity to claim a 30% Investment Tax Credit on property that previously would have only been 26% based on the prior phase-down. But in addition to that, some other things happened, and there was an addition of storage to the ITC on what’s called a stand-alone basis. In the past you had to mate storage with an existing solar or other facility in order to have the storage eligible for the ITC. But the new rule for stand-alone storage is, it’s really good in new development, but that does not take effect until next year, 2023, which means that even though the ITC for solar went up, and therefore, if you had an existing 2022 project that was already planning on using storage, and they were twinned together, you could get the 30% ITC on that project. But if you were planning on doing a stand-alone storage in 2022, you would not get the increase. So there’s some complexity there based on what you’re doing, how you’re doing it, and when the new rules kick in. And then an additional interesting note on the credit is how it increases. Because there is a shift for projects basically above a megawatt on the ITC side where they’re changing the regime for the credit so that you start with what’s called the base credit, which actually ends up being 6% in most cases, can be less than others, and then you get an additional 24% increase on top of that for meeting prevailing wage and apprenticeship requirements. So you could look at that as a tax credit increase, although really it’s a different way of getting to the old 30%, with a couple of other social policies mixed in. But net-net, the answer is yes, we do have increases, particularly for geothermal and solar, in 2022. Although, as I said, for storage, you have to really slow down and pay attention to make sure that if it’s stand-alone, you’re not putting that in service until 2023.
Thanks, Lee. I’ve also heard that there are certain circumstances where the energy credit might be increased over the regular percentage, and some of these new rules might apply to affordable housing. What are some of these “additive” credits, if you will?
Right, and I’m glad you put it that way, Beth, because what you’re talking about are what have become known as “adders.” Now that’s contrasted with a redesign of the credit. One of the things that’s changed, as soon as we get some guidance from Treasury on what are called “prevailing wage and apprenticeship requirements,” is that the tax credit was changed from a straight flat rate, say like 26% before the Act or 30% now, to what’s called the 6% base rate and a 24% bonus rate, which is what you have to do in order to get the full 30%, by paying prevailing wage and/or meeting apprenticeship requirements. So those are not really adders, they’re called bonus credits.
But once you get past the bonus, as the quote-on regular rate, then we talk about what you’re asking about, Beth, which are the adders. And these are literally additional tax credit percentages above the 30% that you would get assuming you’ve complied with prevailing wage and apprenticeship rates. And some examples of how you can get an additional credit is, you can get a 10% additional credit for what’s called domestic content. If you can prove that your project has a sufficient amount of certain kinds of domestic content – mostly steel, but there are some other nuances – you can get 10% on top of the 30%, which means you’re now at 40%, which is a really big deal. And then in addition to that, there was another 10% adder, which can stack on top of the base and the adder. So if you have a 30% eligible project which meets the domestic content requirement, that gets you from 30 plus 10 is 40. And then the energy community, if you locate this facility in an energy community, which is defined in the code, you can get an additional 10% added. So you’re 30 plus 10 plus 10. That’s really powerful.
And then another adder – and this is where I think it’s going to be most important for this particular audience – is the low-income adder. Now the low-income adder also will stack on to the base rate and to any domestic content or energy community. But the adder for low-income is one of two kinds. You can get either a 10% adder for having this facility located in a low-income community, which is defined essentially by cross-reference to the New Markets Tax Credit definition for purposes under 45 cap D, and you get 10% for just locating it generally in that area. But if you do something particularly precise, which is what’s called building a qualified low-income residential building project, which again is defined by multiple cross-references in the code, or do what’s called a qualified low-income economic benefit project, again defined by other certain criteria as it relates to the poverty line, you can get a 20% adder. So if you have the base credit of 30, the domestic content adder, the energy community adder, and let’s say that you can get the 20% adder for either a qualified low-income economic benefit project or qualified low-income residential product, you get another 20, that means your investment tax is now 70%, which is just truly amazing.
That’s super helpful, Lee. So just to clarify, the 30% credit is also available for the smaller-size projects that we might be seeing on a residential building, not just ones that are using the prevailing wages and apprenticeship, right?
Yeah, absolutely. And that’s actually an additional nice new feature of the law. The new bill, IRA, put in a small system, a carveout if you will. For systems that are under a megawatt AC, you basically are not even required to worry, if you will, about the prevailing wage and apprenticeship program. It just so happens that in many cases the size of system you’ll likely do on an affordable housing project may very well fit within that sort of safe harbor, if you will. And that’s another nice benefit of this particular change in the law.
Great, thanks. So speaking of nice changes related to the low-income tax credit basis, generally, these energy credits have reduced depreciable basis and also the eligible basis. Are there new rules related to this basis adjustment? And when do they become effective?
Excellent question. And the key is the latter part of your question, when they become effective. Yes, one of the things that was really nice to see in the change under the IRA was that the mandatory Investment Tax Credit basis reduction under Section 50 of the code, which often caused not only reduction to depreciable basis of the energy asset, but if you were using the energy asset basis as part of your LIHTC basis, that mandatory ITC basis would also reduce your LIHTC basis to the same extent. Now the new law, which of course takes effect next year – so what I’m about to say does not apply now or for 2022, but going forward in 2023 – that mandatory ITC basis reduction will not apply in the case of affordable housing. And that’s a really nice little piece of extra relief that I think was a really astute policy change, which is very favorable. Even though it arguably may be small, every little bit helps. And so I’m very encouraged to see that change again next year.
Are there other credits that have this sort of favorable lack of basis adjustment that somebody might want?
That’s a great question. 45L is another one – I should say 45 capital L, the energy efficient home credit, if you will – has also been modified to basically make that exact point. And it’s interesting. As I said, the basis reduction for the ITC as it relates to LIHTC, those rules don’t take into effect till next year. Same is true for 45L basis relief, in the case where it’s twinned with a LIHTC project. So you have to wait until next year (2023) to get the ITC basis reduction relief and to get any 45L basis reduction relief.
Great. Thanks. So a lot of the deals that we work with are financed by tax-exempt bond financing. Is there anything we need to sort of keep our eye on there? Maybe these bonds could have a negative impact on the credits?
Yeah, that’s a great point. There’s a “zombie provision” in the new bill. Back in the day, I can’t remember if it was 2006 or 2008, there used to be a rule called a Subsidized Energy Financing rule in the Investment Tax Credit, which said that if you had subsidized energy financing, usually equaling tax-exempt bond financing, that was covering the capital cost on the basis in your ITC-eligible asset, that the bond financing would have a negative impact on the tax credit amount, the ITC credit amount. Those rules had been repealed previously, but now have been reenacted in a modified form. So now we do have a tax-exempt bond haircut in the Investment Tax Credit provisions. So that basically translates into, if you have a tax-exempt bond deal and you’re using the proceeds from that bond to pay for the capital costs of the solar or other ITC-eligible equipment, there’s a calculation that you need to do, which essentially functions as a 15% reduction in the ITC basis of the solar equipment. So, again, the key is source of funds, tracing of funds. We think there may be some structuring that we can do in some cases to avoid that consequence. But what’s really interesting is that even though there’s this new arguably burdensome rule, with these adder credits, you can in many cases maybe make up for it, if not still exceed it, by just qualifying for some of the additional adders. So it ends up becoming an interesting planning and structuring transactional opportunity. But it is important for folks to note that this new tax-exempt bond rule is part of the new Investment Tax Credit regime, and that is a new change that the law took effect immediately.
And finally, this is an area where, once upon a time, it was sort of an ironclad rule that you couldn’t sell federal tax credits. There are a few provisions related to both transfer of credits and direct payment for credits. All that sounds really great. Again, we’re talking about the energy credits, not just general credits out there. But are there any drawbacks to these new programs that we know of? Again, I know this is super complicated and we need tons of guidance related to these areas because they’re absolutely brand new.
That’s right. We do need tons of guidance. But yeah, I mean, there are some drawbacks. One, which is sort of I guess a permanent drawback, is that these new rules, whether direct pay or transferability, really don’t override the recapture rules. And particularly in the case of transferability, it’s not at all clear, as a matter of statute, who’s responsible for the recapture. Common sense and general business practices and normal federal tax income accounting would indicate that if you buy a credit as the transferee, because you’re the one using the credit, you’ll probably likely have to do some recapture true up with the federal government. So that means that if you sell a credit to somebody, there is this recapture risk that presumably the buyer has to have, so negotiating that risk contractually as well as financially is going to be an interesting piece of this. Another piece of it is pricing. You know, selling a credit is a unique transaction. Monetizing tax credits through a partnership is a fairly well-known procedure: We know how to price it, we know how to calculate yields. It’s a fairly straightforward thing even though it’s a complicated transaction. But pricing the tax credits is not yet currently known. And when you sell the credit, that’s all you’re doing is selling the credit; you’re not able to sell the losses. So that arguably makes stranded losses, and then having those things efficiently used creates a problem. And then to add to some of the other unknowns is that even though the statute literally states that the sale of the credits – or I should say the proceeds from the sale of the credits – are not taxable at the federal level, they’re treated as tax-exempt income. That’s fine for the federal, but some states very well may decide to tax the proceeds at the state level. So when you add in how do you price it, the fact that you’re only selling credits, and there might be a state tax drag, it makes it somewhat challenging to compare the opportunity from an economic perspective, again assuming you’re using this to raise capital for your capital stack. It’s not yet clear how this whole thing is going to end up going, but at the end of the day, I guess you could argue that it’s good that we have one more tool in the toolbox, and there may be cases where it makes a lot of sense or maybe is actually helpful. And then one last point: When Congress was first putting some of these ideas in play way back at the beginning of the year, when this was all happening under the acronym of “Build Back Better,” BBB, direct pay was what folks were talking about when they were talking about being able to get a payment from the Treasury in exchange for the tax credit instead of monetizing the credit. But what Congress ended up doing as it went through all of its political morphing is they ended up with these two separate programs. Direct pay, which it’s important to understand only applies to tax-exempt entities and state and local governments and political subdivisions. So direct pay is not something available for a taxable taxpayer, or typical taxable partnership. Transferability is available only to taxable taxpayers, not available to the tax-exempt. So one of the things we’re trying to help folks is to sort out the difference between direct pay and transferability. Each is unique in its own way. As I said, they have some complexities. Both of them need guidance, so there’s a limit to how detailed of answer we can give you these days. But like I said, the good news is that we now have a new tool in the toolbox, and we’ll see how it all plays out, because for some of these opportunities, these opportunities for transferring credits exist for the next decade, assuming Congress doesn’t change them or revoke them between now and then.
Subject matter expertise
JD, Senior Manager
CPA, Partner, Affordable Housing Industry Leader
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Affordable Housing News & Views
Inflation Reduction Act: Key Tax and Renewable Energy Impacts
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