Solar Outlook Positive on Treasury’s Proposed REIT Regulations
On May 9, 2014, the Treasury filed a series of proposed regulations that would open Real Estate Investment Trusts (REITs) to solar energy investment by defining real property to include land, inherently permanent structures, and structural components. Under the proposed regulations, each distinct asset would be tested on an individual basis to determine whether or not the distinct asset is real or personal property.
The proposed regulations define land to include not only a parcel of ground, but the air and water space directly above the parcel. Therefore, water space directly above the seabed is land, even though the water itself flows over the seabed and does not remain in place. Land includes crops and other natural products of land until the crops or other natural products are detached or removed from the land.
The regulations further clarify that inherently permanent structures are structures, including buildings that have a passive function and are inherently permanent. These proposed regulations supplement the definition of inherently permanent structures by providing a safe harbor list of distinct assets that are buildings, as well as a list of distinct assets that are other, inherently permanent structures.
These regulations define a structural component as a distinct asset that is a constituent part of, and integrated into, an inherently permanent structure that serves the inherently permanent structure in its passive function and does not produce or contribute to the production of income other than consideration for the use or occupancy of space. The regulations provide that structural components are real property only if the interest held in such structural components is included with an equivalent interest held by the REIT in the inherently permanent structure to which the structural component is functionally related.
The regulations do not retain the phrase “assets accessory to the operation of a business” but, rather, adopt an approach that considers if a distinct asset serves a passive function common to real property or the inherently permanent structure to which it is constituent in that structure’s passive function.
Certain intangible assets are real property for REIT purposes as long as they derive their value from tangible real property and are inseparable from the tangible real property from which the value is derived.
These proposed regulations contain several examples to demonstrate the application of the proposed rules. These examples specifically address solar energy sites and solar powered buildings. In the example cited for a solar energy site, the overall site is separated into land, modules, mounts and exit-wire and the example concludes that each is real property, except for the modules. In the example provided for a solar-powered building, the regulations conclude that all of the solar assets constitute real property. The Treasury expressly mentioned the investment tax credit for solar under Internal Revenue Code (IRC) §48, making it clear that the definition of real property that would include solar under these proposed regulations is a definition that is expressly limited to REITs and only for REIT purposes.
Note that these proposed regulations do not indicate how non-occasional sales of either electricity, non-electrical solar energy (i.e., heat), revenues from the sale of renewable energy certificates, or other types of solar related income not in the form of rents are to be treated.
Additional clarification on these matters may be required from the Treasury. The IRS and the Treasury Department are considering guidance to address the treatment of any income earned when a system that provides energy to an inherently permanent structure held by the REIT also transfers excess energy to a utility company.
The Treasury Department and the IRS have sought to balance the general principle that common terms used in different provisions should have common meanings with the specific policies underlying the REIT provisions. As such, these proposed regulations define real property only for REIT purposes, specifically IRC §856 through §859.
These proposed regulations are intended to become effective for calendar quarters beginning after these proposed regulations are published as final publications in the Federal Register.
For more information, please contact Timothy Kemper, Partner and Renewable Energy Industry Practice Co-National Director, at 404-847-7786, Anton Cohen, Partner and Renewable Energy Industry Practice Co-National Director, at 301-280-1822, or Lee Peterson, Senior Manager, at 404-847-7702.
For more information on CohnReznick’s Renewable Energy Industry Practice, please visit our webpage.
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