A deep dive on the IRA energy community bonus credit adder
The IRA created three bonus credits, including the location-based energy community adder. As developers make siting decisions based on the energy community bonus, corporate taxpayers should familiarize themselves with the credit's mechanics and scope.
The latest energy community guidance, which meaningfully expanded the number of qualifying areas, placed the 10% adder back in the spotlight for the transferable tax credit marketplace. At the same time, Reunion has observed a marked increase in the number of projects in our marketplace claiming the energy community bonus.
While our transferable tax credit handbook goes deep on energy communities, we wanted to share a comprehensive (and refreshed) look at the adder.
Our guide begins with the basics, so we invite you to jump ahead.
- Background and scope
- Credit and project eligibility
- Diligence
- Guidance
- Annual updates to areas qualifying as energy communities
- Resources
The Inflation Reduction Act created three bonus credits, or "adders"
The Inflation Reduction Act (IRA) created three "bonus" credits that can increase the value of a clean energy project's transferable tax credits:
- Domestic content: 10% bonus
- Energy community: 10% bonus
- Low-income community: 10% or 20% bonus
The energy community adder provides a 10% bonus credit
The energy community bonus provides a 10% increase to a project's credit value if the underlying project is located in an energy community (and meets prevailing wage and apprenticeship requirements).
A utility-scale solar project, for instance, that meets PWA requirements would receive tax credits worth 30% of its eligible cost basis. If the same project is located in an energy community, it would receive tax credits worth 40% of its eligible basis.
The IRA defines three types of energy communities
To qualify for the energy community bonus, a project must be located in at least one of three energy community "categories."
Category 1: Brownfield
A brownfield site is defined in 42 U.S.C. § 9601(39)(A) as "real property, the expansion, redevelopment, or reuse of which may be complicated by the presence or potential presence of a hazardous substance, pollutant, or contaminant" (as defined under 42 U.S.C. § 9601), and includes certain "mine-scarred land" (as defined in 42 U.S.C. § 9601(39)(D)(ii)(III)). A Brownfield site does not include the categories of property described in 42 U.S.C. § 9601(39)(B).
Three types of sites qualify as a brownfield under a safe harbor:
- Existing brownfield: Brownfields that are already tracked by a federal, state, territorial, or federally-recognized Indian tribal brownfields program. Many states, like Idaho and New York, have their own brownfields programs with supporting maps. A valid brownfield site could be tracked by a state program but not a federal program, and vice versa
- Phase II assessment: A Phase II Assessment has been completed with respect to the site and such Phase II Assessment confirms the presence on the site of a hazardous substance as defined under 42 U.S.C. § 9601(14), or a pollutant or contaminant as defined under 42 U.S.C. § 9601(33)
- Phase 1 assessment (for projects with a nameplate capacity of not greater than 5MWac): A Phase I Assessment has been completed with respect to the site and such Phase I Assessment identifies the presence or potential presence on the site of a hazardous substance, or a pollutant or contaminant.
Category 2: Coal closure
A census tract (or directly adjoining census tract):
- in which a coal mine has closed after 1999; or
- in which a coal-fired electric generating unit has been retired after 2009
Category 3: Statistical area
A "metropolitan statistical area" (MSA) or "non-metropolitan statistical area" (non-MSA) that has (or had at any time after 2009):
- 0.17% or greater direct employment or 25% or greater local tax revenues related to the extraction, processing, transport, or storage of coal, oil, or natural gas; and
- has an unemployment rate or above the national average unemployment rate for the previous year
The scope of "direct employment" is determined by ten NAICS codes.
No double bonus for multiple energy communities
If a clean energy project is located in two energy communities – a brownfield site within a coal community, for instance – the bonus remains 10%. Developers cannot double up.
Bonus credits cannot be sold in stand-alone tranches
Bonus credits are not treated differently from base credits for the purpose of transferability. Treasury guidance released in June 2023 specified that all transferable credits must be sold as “vertical slices” and be pari passu to one another, as opposed to “horizontally” bifurcating bonus credits from base credits.
Four IRA credits are eligible for the energy community bonus
The IRA created 11 transferable tax credits, four of which are eligible for the energy community bonus:
- §45 PTC: Electricity produced from certain renewable resources
- §45Y PTC: Clean electricity production credit
- §48 ITC: Energy credit
- §48E ITC: Clean electricity investment credit
§48 and §48E ITC eligibility determined on placed-in-service date
For projects that claim an investment tax credit under §48 or §48E, eligibility for the energy community bonus credit is determined on the date that the project is placed in service (PIS) and is not tested again.
Because eligibility is determined on a PIS date that is subject to potential delays, developers should think carefully about how to incorporate the statistical area category into their financial assumptions.
The statistical area category is determined annually, based on the prior year's unemploment rate. As the IRS FAQs state, "Because an MSA's or non-MSA's status as an energy community depends on its unemployment rate for the previous year, an MSA or non-MSA that qualifies as an energy community in one period might not qualify as an energy community in a later period if its unemployment rate for the previous year falls below the national average."
§45 and §45Y PTC eligibility determined annually with a beginning-of-construction safe harbor
For projects that claim a production tax credit under §45 or §45Y, eligibility for the energy community bonus credit must be determined every year during the ten-year PTC period. Theoretically, a wind project could qualify one year under the statistical area category but not qualify the following year because of a change in employment rates.
However, the IRS created a safe harbor for PTC projects with beginning-of-construction dates on or after January 1, 2023. If the project owner determines that the project is eligible for the energy community bonus credit on the date construction is considered to have started for tax purposes, then the project will qualify for the bonus credit for the entire ten-year PTC period and is not tested again.
"Legacy" §45 PTCs are not eligible for energy community bonus
Projects that generate §45 PTCs that were placed in service before December 31, 2022 are not eligible for the energy community bonus, even if the project happens to be located in an energy community and is within its ten-year period of credit generation.
The December 31, 2022 date is set in the IRA itself (H.R.5376).
50% of a project's nameplate capacity (or square footage) must be in an energy community
A project qualifies for the energy community bonus if at least half (50%) of its nameplate capacity is in an energy community. According to the IRS, nameplate capacity is the DC capacity that a project is capable of producing on a steady-state basis during continuous operation under standard conditions.
For battery storage projects, at least half (50%) of the storage capacity, as measured in megawatt hours, should be in an energy community.
Lastly, for projects that do not generate nor store energy, like biogas, the 50% threshold is measured on a square footage basis.
When performing due diligence on the energy community bonus, it's helpful to approach the process based on the credit type and energy community category.
Credit type
ITCs
Tax credit buyers should request documentation that demonstrates when and where the project was placed in service. Then, buyers and their advisors should crosswalk that location to an appropriate energy community siting resource, like one of the IRS's appendices. (We provide links to these appendices in the guidance section of this post.)
When validating a project's location, it's important to keep the "50%" rule in mind.
PTCs
Due diligencing the energy community bonus for PTCs is effectively the same as ITCs, although buyers will want to validate when and where the project began construction (versus when and where the project was placed in service). Once again, it's important to keep the "50%" rule in mind.
Energy community category
As far as each category is concerned, the statistical area and coal closure categories are relatively straightforward from a due diligence standpoint: the IRS has published lists of areas that qualify for each. The brownfield category, however, may present a slightly more nuanced due diligence process.
Statistical area
It's important to recall that the statistical area category changes every year, based on the prior year's unemployment rate. As we'll discuss below, the IRS is obligated to publish updates to this category every year, generally in May.
Coal closure
Unlike the statistical area category, the coal closure category cannot shrink – that is, once an area qualifies as a coal closure, it remains as such for the duration of the energy community bonus.
However, the coal closure category can expand, and we fully expect it to do so. According to a 2022 analysis by the Energy Information Agency (EIA), nearly a quarter of the operating U.S. coal-fired fleet is scheduled to retire by 2029. Every closure will add more census tracts to the list of areas eligible for the energy community bonus.
Brownfield
The IRS has not published – and, as far as we know, has no plans to publish – a consolidated list of areas that qualify as brownfields for purposes of the energy community bonus. In fact, the DOE energy community map doesn't even include federally-recognized brownfield sites. (The EPA, however, maintains a list of federally-recognized brownfields in its cleanups in my community map.)
We doubt the IRS or any federal agency will publish a definitive list of brownfields. There are simply too many moving parts across federal, state, local, and tribal brownfields programs.
So, an opinion from an environmental attorney may be warranted, and the scope of the opinion will vary based on which of the three brownfields safe harbors a project is claiming.
Latest guidance expands the number of areas that are eligible for the energy community bonus
The most recent IRS guidance, Notice 2024-30, broadened eligibility for the energy community bonus through two key changes:
- Expansion of the "nameplate capacity attribution rule"
- Inclusion of two additional NAICS codes – which are in our list above – for determining the fossil fuel employment rate for a statistical area category
Expansion of the nameplate capacity attribution rule
The "nameplate capacity attribution rule" pertains to projects with offshore generation – namely, offshore wind – that have a nameplate capacity but are not located within a census tract, an MSA, or a non-MSA. The rule, essentially, allows developers to allocate their offshore nameplate capacity onshore for purposes of qualifying for the energy community bonus.
Prior to Notice 2024-30, the attribution rule generally allowed offshore wind projects to qualify for the energy community bonus if their power-conditioning equipment closest to the point of interconnection was in an energy community.
Notice 2024-30 expanded the nameplate capacity attribution rule to include not only power-conditioning equipment, but also supervisory control and data acquisition (SCADA) equipment.
SCADA equipment must be owned by the developer and located in an "energy community project port." To qualify as an energy community project port, a port must:
- Be used "either full or part-time to facilitate maritime operations necessary for the installation or operation and maintenance" of the project
- Have a "significant long-term relationship" with the project, meaning the developer owns or leases all or part of the port for a minimum term of ten years
- Be the location at which staff employed by, or working as independent contractors for, the project are based and perform functions essential to the project's operations. Essential functions include "management of marine operations, inventory andhandling of spare parts and consumables, and berthing and dispatch of operationand maintenance vessels and associated crews and technicians"
Inclusion of two additional NAICS codes
Notice 2024-30 added two additional NAICS codes for determining the fossil fuel employment rate for a statistical area category:
- 2212: Natural gas distribution
- 23712: Oil and gas and pipeline and related structures construction
These NAICS codes cover workers in local gas distribution companies and construction workers on oil and gas pipelines.
According to Norton Rose Fulbright, "The biggest additions to the list of potentially eligible counties are in six Midwestern states: Minnesota (57), Missouri (57), Illinois (28), North Dakota (23), Wisconsin (23) and Indiana (20)."
The IRS has released five pieces of energy community guidance, with regulations to come soon
Energy community regulations should arrive by June 30, 2024
As Notice 2024-30 notes, proposed regulations are forthcoming. Until then, "taxpayers may rely on the rules described in sections 3 through 6 of Notice 2023-29, as previously clarified by Notice 2023-45 and modified by section 3 [of] this notice, for taxable years ending after April 4, 2023."
Based on the Q2 update to the IRS 2023-2024 Priority Guidance Plan, energy community regulations should arrive before the end of the current "plan year," which concludes on June 30, 2024.
Where to find the latest guidance
The IRS and Treasury maintain lists of IRA-related guidance, including guidance specific to the energy community adder. Although the lists generally overlap, there may be differences based on when each website was last updated.
Below is a close look at all the guidance that's been released through March 2024.
Notice 2022-51: Request for Comments on Prevailing Wage, Apprenticeship, Domestic Content, and Energy Communities Requirements under the Inflation Reduction Act of 2022
- Date: October 5, 2022
- News release: IRS
- Companion documents: N/A
Notice 2023-29: Energy Community Bonus Credit Amounts under the Inflation Reduction Act of 2022
- Date: April 4, 2023
- News release: IRS
- Companion documents: Appendix A, Appendix B, Appendix C
Notice 2023-45: Energy Community Bonus Credit Amounts under the Inflation Reduction Act of 2022
Notice 2023-47: Energy Community Bonus Credit Amounts or Rates (Annual Statistical Area Category Update and Coal Closure Category Update)
- Date: June 15, 2023
- News release: IRS
- Companion documents: Appendix 1, Appendix 2, Appendix 3
Notice 2024-30: Energy Community Bonus Credit Amounts under the Inflation Reduction Act of 2022
- Date: March 22, 2024
- News release: IRS
- Companion documents: Appendix 1, Appendix 2
Expect energy community eligibility updates every May, beginning in 2024
According to Notice 2023-29, "The Treasury Department and the IRS intend to update the listing of the Statistical Area Category based on Fossil Fuel Employment annually. These updates generally will be issued annually in May."
The first update should arrive in May 2024 – that is, next month.
DOE, EPA, and IRS have provided energy community eligibility and project siting resources
U.S. federal agencies who are responsible for administering or managing parts of the energy community bonus credit have published several key resources that are valuable to buyers, sellers, and their advisors:
- Department of Energy (DOE): Energy community map
- IRS: Frequently asked questions
- DOE National Energy Technology Laboratory (NETL): Frequently asked questions
- Environmental Protection Agency (EPA): RE-powering America's land initiative
- EPA: Cleanups in my community
- Interagency working group: Energy community tax credit bonus
To learn more, you can download our 100-page transferable tax credit handbook or start a conversation with our transactions team.
Related Articles
Reunion is excited to host quarterly “office hours” for clean energy developers who would like to learn more about our marketplace and get a pulse on the overall transferability market.
We'll hold office hours on a quarterly basis
We will generally hold office hours on a quarterly basis and open registration one or two months in advance. Each session will be limited to 50 developers on a first-come, first-served basis.
Designed for clean energy developers and manufacturers
Our office hours are designed for clean energy developers and manufacturers who have transferred, or are planning to transfer, IRA tax credits over the next 12 months. Developers need not have projects in Reunion's marketplace to participate.
Co-hosted by Reunion's founders
Reunion's founders, Billy Lee and Andy Moon, will co-host the hour-long sessions.
Billy and Andy pioneered solar financing structures with tax equity and private equity investors, leading some of the first solar transactions with institutions such as US Bank, JP Morgan, Wells Fargo, Bank of America, Key Bank, PNC, Nord/LB, D.E. Shaw, and First Reserve.
Questions welcome!
We want our office hours to be interactive, so please bring any questions you have, whether related to current market conditions, pricing, or commercial terms.
You're welcome to ask questions beforehand.
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First Solar's sale of $700M of §45X advanced manufacturing production credits (AMPCs) to Fiserv in the closing weeks of 2023 rightfully made headines. Although nine-figure tax credit transfers had closed earlier in the year, First Solar's deal seemed to be the harbinger of big things to come for the IRA's transferability mechanism.
It's easy to see why. Unlike established credits, like the §45 PTC and §48 ITC, the §45X AMPC was created by the Inflation Reduction Act. First Solar, in fact, sold their §45X credits within days of IRS guidance that effectively unlocked the credit. What's more, the deal was between two multi-billion-dollar public companies.
But the media attention, while welcomed across the clean energy industry, potentially overshadowed a broader trend: tax credit transfers had been closing at a steadily increasing rate throughout 2023. First Solar's deal came nearly 11 months after what we believe was the first publicly announced tax credit transfer.
The clean energy tax credit market has further accelerated into 2024. To bring the full story to life — to highlight the range of credits, technologies, and structures — Reunion is maintaining a list of publicly announced tax credit transactions. (And if we're missing a deal, we invite you to let us know at the bottom of this post.)
Check back from time to time. We'll keep the list going.
Publicly announced IRA clean energy tax credit transfer deals
Summary of data
- Quarter: The quarter in which the deal closed. Occassionally, deals are announced in the quarter after which the deal closed.
- Credit: The type of credit(s) involved in the transaction. Although most transactions involve a single credit type, like a §48 ITC, some deals involve multiple credits.
- Technology: The clean energy technology, like commerical and industrial solar or battery storage, behind the transaction. Emerging technologies, like hydrogen, can meaningfully impact pricing.
- Amount: A deal's amount represents the total, lifetime value of the transaction. When a range is provided – for instance, Broadwind's estimate of $12M to $14M per year – we use the lower bound.
- Source: The primary source from which we collected transactions data. In some instances, we rely on multiple sources for the data we've presented.
Undisclosed data is flagged as "UD."
Submit a transaction
If you know of a tax credit transfer that is not on our list, please contact us. We want to keep our list up-to-date.
On January 19, the IRS released key guidance for the §30C alternative fuel vehicle refueling property credit. The guidance included two appendices that identify eligible census tracts depending on a project's placed-in-service date. Alongside the guidance, the IRS issued a press release and an FAQ.
Takeaways
- The Inflation Reduction Act extended and meaningfully modified the §30C ITC
- 99% of U.S. territory is included in eligible census tracts
- Eligible locations will vary depending on when a project is placed in service
- DOE published a mapping tool that shows eligible areas with placed-in-service filter
- Ambiguity around definition of "single item" with respect to credit qualification remains a gating factor
- Further guidance is coming
TAKEAWAY 1
The Inflation Reduction Act extended and meaningfully modified the §30C ITC
The §30C ITC existed prior to the Inflation Reduction Act (IRA), and the guidance reminds us of the ways in which the IRA modified the credit.
Added prevailing wage and apprenticeship requirements
The §30C is subject to the IRA's prevailing wage and apprenticeship (PWA) requirements. If a developer meets PWA requirements, the §30C credit value increases from 6% to 30% of eligible costs. Considering the economics, virtually all developers will meet PWA requirements.
Increased credit maximum
The IRA increased the maximum credit value that an eligible property can receive. For businesses, the cap is $100,000 per "item of property."
Modified eligibility scope
The IRA modified the scope of the §30C ITC "so that it no longer applies per location and instead applies per single item." Notably, although the guidance provides several definitions, it does not define what constitutes a "single item." We'll comment on this below.
Narrowed applicability to non-urban areas, low-income communities, and, with this guidance, U.S. territories
The IRA requires a §30C-eligible property to be placed in service in an eligible census tract – that is, any population census tract that is a low-income community, a non-urban area, or a U.S. territory.
TAKEAWAY 2
99% of U.S. territory is included in eligible census tracts
According to the guidance, three broad areas are eligible for the credit:
- Non-urban areas: For purposes of the §30C credit, the IRS defines a non-urban area as "any population census tract in which at least 10 percent of the census blocks are not designated as urban areas.” Many market participants have been referring to non-urban areas as "rural areas."
- Low-Income communities: The IRA defined a qualifying census tract as one described in Section 45D(e), which defines a low-income community for purposes of the new markets tax credit (NMTC). The guidance, however, notes that NMTC data was recently updated and provides a transition rule under which developers can rely on designations using the older or more recent data.
- U.S. territories: The guidance allows refueling properties located in U.S. territories to qualify for the credit. However, the property must be owned by a U.S. citizen, U.S. corporation, or a U.S. territory corporation. (Inhabited U.S. territories are American Samoa, Guam, the Northern Mariana Islands, Puerto Rico, and the U.S. Virgin Islands.)
According to the Electrification Coalition, an industry group, the areas in which eligible property can be installed "will include approximately 99% of U.S. land territory and 62% of the population."
This is particularly good news for expanding electric vehicle adoption because, without the §30C tax credit, installing EV charging infrastructure can be prohibitively expensive in rural areas where there are fewer vehicles in the first place.
TAKEAWAY 3
Eligibility of a census tract depends on when a project is placed in service
The guidance also provided two appendices that list qualified census tracts depending on when a project is placed in service (PIS):
- PIS after 12/31/22 and before 1/1/25: Appendix A or Appendix B
- PIS after 12/31/24 and before 1/1/30: Appendix B
TAKEAWAY 4
DOE published a mapping tool to streamline siting analyses
To strengthen implementation efforts, Argonne National Laboratory within the Department of Energy (DOE) published a §30C Tax Credit Eligibility Locator mapping tool and an FAQ.
To help developers select the appropriate census tract for their project's placed-in-service date, Argonne accompanied the map with a decision tree.
The mapping tool, however, is for informational purposes only and "may not be relied upon by taxpayers to substantiate a tax return position and will not be used by the IRS for examination purposes."
TAKEAWAY 5
Ambiguity around definition of "single item" with respect to credit qualification remains a gating factor
The guidance did not fully clarify what equipment constitutes a "single item" with respect to credit qualification. As Canary Media notes, electric vehicle "charging sites also have a lot of 'shared equipment' such as power conduits, switchgear, transformers and enclosures," and there are "still questions of whether [the credit] will cover just the charger, or additional factors to installation like upgrading power infrastructure."
The definitional ambiguity presents financial challenges for developers who want to transfer their tax credits because they don't yet know what their credits will be worth.
TAKEAWAY 6
Proposed regulations still to come from the IRS and Treasury
Fortunately, the guidance states that further guidance is forthcoming. Reunion believes this additional guidance will likely address the definition of a "single item," given the gating nature of its ambiguity.
Reprinted from the Novogradac Journal of Tax Credits
January 2024 – Volume XV – Issue I
Corporate income tax revenue was $425B in 2022, suggesting that if IRA tax credits reach $100B annually, monetizing these credits will require over 20% of annual corporate federal income tax to redirect into clean energy projects. Attracting new sources of tax-related capital into the market remains one of the major hurdles facing the renewable energy sector.
Congress attempted to lower the barriers to entry for attracting tax credit capital by introducing transferability – a transaction mechanism that allows for the purchase and sale of credits, rather than the more complex tax equity partnership structure.
So far, this solution appears to be attractive to corporate taxpayers. In 2023, the range of buyers interested in IRA tax credits has grown beyond the traditional appetite from banks, insurance companies, and some specialized financial services firms.
IRA credits bring significant optionality to tax credit buyers
There are many different types of tax credits from which to choose. For example, there are two credit types – Internal Revenue Code (IRC) Section 48 investment tax credits (ITC) or IRC Section 45 production tax credits (PTC) – and 11 sub-credits spanning electricity generating technology, low carbon fuels, carbon capture and sequestration, and advanced manufacturing.
There is also a range of pricing discounts available that reflect the risk profile of a specific project. Buyers now have far more optionality around the attributes of the credits they are buying, and the transaction process itself.
Buyers can also choose from two different tax credit structures – a single-year ITC or a ten-year stream of PTCs. Single-year ITCs apply to the tax year in which the project was placed in service. This gives tax teams the ability to buy credits year-by-year to offset fluctuating or unpredictable tax liabilities. PTCs are generated alongside the physical output of the project (e.g., electricity, sequestered carbon, manufacturing components, etc.). This allows tax credit buyers to contract for either a spot purchase – i.e., the credits from a single period of output (usually one year) – or a forward commitment to a stream of credits. For taxpayers with a predictable amount of tax over a multiyear period, committing to a forward PTC, or “strip,” purchase can improve the economics of the transaction versus a single-year purchase.
In the current market, spot PTC purchases offer the smallest discount to face value, since they carry less risk compared to ITCs which have a recapture provision, whereas PTCs do not. Single-year ITCs typically offer the median discount and PTC strips offer the largest discount.
Optionality also comes in the form of purchase timing. There are two considerations here – first, most transferable credits are not paid for until a project is placed in service. This approach gives buyers the ability to require key conditions precedent to be met before funding and greatly reduces construction risk to the buyer while isolating the buyer’s exposure to pure tax credit-related risks. Second, buyers can still contract for credits prior to payment. Treasury guidance released in June 2023 formally allowed taxpayers to apply their “intent to purchase” credits to quarterly estimated payment, creating an opportunity to save on quarterly payments prior to laying out cash for a tax credit purchase.
Structuring purchases or payments around quarterly estimated payment days can deliver the best internal rate of return and cash management value. Contracting early in the year can often help buyers secure the best economics, even for credits that aren’t generated until later in the year. Ultimately, buyers should consider the timing of credit purchases as an additional benefit of transferability and plan accordingly for their own tax position.
Transferable IRA credits carry discrete, manageable risks
For early investors in IRA tax credits, risk mitigation should be the primary focus of a transaction process. In general, IRA credits carry the same risks as investing in pre-IRA wind or solar PTCs or ITCs. When investors buy these credits using transferability, however, they eliminate the structure risk associated with tax equity partnerships. This results in cleaner transactions, where buyers need to primarily focus on de-risking the credit itself, rather than the operating profile of the underlying asset.
For a transferable tax credit purchase, buyers must focus on two core risks:
- Qualification: Was the tax credit properly claimed?
- Recapture: Applicable only to Section 48 ITCs and Section 45Q PTCs (not applicable to other PTCs)
A Section 48 ITC is calculated on the cost basis of the energy property placed in service during the tax year. The IRS may challenge the cost basis of the energy property, and if this amount is ultimately reduced, the amount of ITCs from the project will be reduced as well, resulting in an excessive credit transfer tax to the transferee. Buyers will want to review detailed documentation that records the project’s cost basis, verified by a reputable third party accounting or legal firm. In addition, prevailing wage and apprenticeship requirements and any bonus credit adders will need to be verified.
To qualify for a Section 45 PTC, a project needs to generate electricity from a qualified energy resource during the ten-year period beginning on the date the facility was placed in service. Because the PTC is tied to production, the primary risk associated with PTCs is accurate production accounting. This risk is considered easily manageable because production is quantifiable and readily verified.
Recapture on a Section 48 ITC requires that (1) the property remains a qualified energy facility for five years, and (2) there is no change in ownership of the property for five years. In practice, there are three key risks that can be investigated with respect to recapture:
- Proper site control: ensure that the energy project will not be forced from the property by a current or new landlord, triggering a recapture
- Adequate property and casualty insurance: ensure that there is sufficient coverage such that the energy property will be rebuilt in the event of a casualty event
- Mitigate risk of recapture due to debt foreclosure: ensure that lender has agreed to forbearance agreement, or debt is structured in a way that does not trigger recapture in the event of a default
In addition, the seller will need to contractually assure the buyer that there will not be a change in ownership during the five-year recapture period, which the indemnity agreement will help ensure.
To protect against these risks, buyers will negotiate indemnifications from the seller, and may seek tax credit insurance as a backstop to protect the value of the credits. Working with experienced transaction partners familiar with renewable energy tax credits can ensure that risks have been properly diligenced and risk mitigation is in place in the event of a challenge from the IRS.
Common points of negotiation in tax credit transfer agreement
Unlike a tax equity investment where control rights are an inherent part of the negotiated partnership structure between a project developer and tax credit investor, transferable tax credits sold via a purchase-and-sale agreement don’t carry the same level of ongoing rights for a buyer. This means that buyers should identify the key points of negotiation they will want to include in a tax credit transfer agreement (TCTA).
Some common points of negotiation beyond price include:
- Timing of payments
- Audit participation rights
- Scope of buyer indemnification
- Tax credit insurance and who bears the associated costs
- Representations and warranties, and pre-close/post-close conditions precedent
Several of these are closely related to risk management and warrant additional explanation – namely, the scope of buyer indemnification and tax credit insurance.
Buyers will typically secure a broad indemnity that shifts most risks (and their associated costs) from the buyer to the seller. In a tax credit transfer transaction relating to a Section 48 ITC, the primary risks to which a buyer is subject are qualification and recapture. The price of the credit can vary depending on the strength of this indemnity – if a creditworthy guarantor or very large balance sheet (in comparison to the size of the credit) is providing the indemnity, tax credit insurance may not be required.
For instances where a buyer does want tax credit insurance, this cost is typically paid by the seller or the price of the credit is adjusted accordingly when the buyer is procuring insurance directly. Tax credit insurance can be a double-trigger policy that backstops the seller indemnity. So, if the seller fails to perform on the contractual obligations around a recapture or disallowance event, for example, the insurance policy steps in to make the buyer whole. Tax credit insurance is usually quite comprehensive and costs several pennies per dollar of credit.
Conclusion: discrete, manageable risks
The IRA created an attractive tax credit regime for corporate taxpayers to participate in the energy transition while managing their own federal tax liability over an extended period. While these credits are not certificated in the same manner as some state tax credits, they do bear the benefit of being transferable – vastly lowering the barrier to participation when compared with legacy tax equity investments.
The risks to these credits are not zero, but they are discrete and manageable through due diligence, seller indemnification, and products like tax credit insurance. Buyers can generally find ways to substantially de-risk these credits while still preserving sufficient value.
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