wa tax equity 101
TRANSCRIPT
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Woodlawn AssociatesM a n a g e m e n t C o n s ul t i n g
Tax Equity 101: Structures
Josh Lutton, Managing PartnerMarch 8, 2013
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Introduction
he three main 'illars o( com'etiti)eness in the solar industr$ are the a*ilit$ toac#uire customers at low cost, install ine!'ensi)el$, and achie)e low cost o( ca'ital(or leases or 'ower 'urchase agreements+ o realie a low cost o( ca'ital solar
dealers and de)elo'ers must o(ten 'artner with so-called .ta! e#uit$/ in)estors dueto the structure o( (ederal solar incenti)es+ his 'a'er summaries the mainnancial arrangements used (or such nancing% sale-lease*ac, 'artnershi' i', andin)erted lease which is also called lease 'ass-through4+
he e!am'les in the 'a'er are 'rimaril$ (rom residential solar, *ut the same
'rinci'les a''l$ to nancing utilit$ and commercial 'ro5ects using mostother (orms o( renewa*le energ$+
The tax and accounting rules for these structures are extremely complex. You
should not proceed with any tax equity investment without consulting a qualiedtax attorney and accountant.
Federal Incentives for Solar
here are three (ederal incenti)es (or *usinesses that in)est in solar s$stems%
1+ 6n)estment a! Credit .6C/4 7 Purchasers can tae a ta! credit e#ual to30 o( their *asis in a new solar s$stem+
2+ 9onus :e'reciation 7 9usiness owners o( solar s$stems 'ut in 'lace *e(orethe end o( 2013 are eligi*le to de'reciate ;0 o( their *asis in the rst $ear+
3+ Accelerated MAC1 million in income ta!es in the a*sence o( an$ solar in)estment, *ut it nowin)ests >?00,000 in solar s$stems+ 6t taes a ta! credit@that is, a direct reductiono( its ta!es@o( >180,000+ 6t also claims *onus de'reciation o( >2;;,000 and
accelerated MAC
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1 According to 6?00,000 - ;0 G >180,000, or>;10,000+
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Future Chanes
Hnder current law, *onus de'reciation will e!'ire at the end o( 2013 and the 6C will
decrease (rom 30 to 10 on Januar$ 1, 201+
!ast Incentives
he American
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2 A reasur$ summar$ o( these three a''roaches is a)aila*le athtt'%KKwww+treasur$+go)Kinitiati)esKreco)er$K:ocumentsK20")aluatingCost9asis(or&olarPVPro'erties 20nal+'d(+
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http://www.treasury.gov/initiatives/recovery/Documents/N%20Evaluating_Cost_Basis_for_Solar_PV_Properties%20final.pdfhttp://www.treasury.gov/initiatives/recovery/Documents/N%20Evaluating_Cost_Basis_for_Solar_PV_Properties%20final.pdfhttp://www.treasury.gov/initiatives/recovery/Documents/N%20Evaluating_Cost_Basis_for_Solar_PV_Properties%20final.pdfhttp://www.treasury.gov/initiatives/recovery/Documents/N%20Evaluating_Cost_Basis_for_Solar_PV_Properties%20final.pdfhttp://www.treasury.gov/initiatives/recovery/Documents/N%20Evaluating_Cost_Basis_for_Solar_PV_Properties%20final.pdf
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he maret a''roach is *ased on the sale o( com'ara*le 'ro'erties+ 6n otherwords, the 'rice that similar s$stems in similar locations ha)e sold (or *etween
unrelated 'arties+
=inall$, the income a''roach uses the discounted )alue o( (uture cash ows o(
the 'ro5ect+ reasur$ is least com(orta*le with this a''roach *ecause it relies onassum'tions that are diEcult to )eri($ or that re#uire a lot o( 5udgment+ =ore!am'le% the a''ro'riate discount rate we ha)e seen de)elo'ers usee)er$thing (rom ? to 104, the terminal )alue o( the s$stems, and (uture rateso( ination and ta!es+ Although reasur$ is uncom(orta*le with the incomemethod, we understand the 6; -100 million within one $ear+ 6n the residential conte!t de'lo$ing that
much ca'ital re#uires a dealer to sell at least 2300-3000 s$stems in a $ear+3 hereare onl$ a hand(ul o( dealers that large, eBecti)el$ (orcing all *ut the largest towor through third 'art$ nance com'anies such &un
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3 Assuming a t$'ical s$stem 'rice o( >;+;0 'er Watt and a)erage s$stem sie o( ? W,>; million would nance 222 s$stems and >100 million would nance 3030 s$stems+
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Fiure 1 & 'esidential Solar Tax Equity Investors ()010*early)01+,
Tax Equity Investor "ene-ciaries
9an o( America Merrill L$nch &olarCit$
Citi*an &unge)it$, &unPowerCredit &uisse &un
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a! "#uit$ 101%&tructures
Fiure ) & Illustrative Sale*.ease/ac$ Structure
Qe$ ste's%
Consuer1+ :e)elo'er nds consumers and gets
them to sign lease agreements
1 2 ;
Lease 6nstallation Lease'a$ments
evelo2er
3 N ?
&ells Leases Lease
s$stem *ac 'a$ments
andcontrac
t
2+ :e)elo'er installs s$stems
3+ a! "#uit$ 6n)estor *u$ss$stems and associatedcontracts (rom :e)elo'er+ Asthe owner o( the s$stems, a!"#uit$ 6n)estor is eligi*le torecei)e 100 o( 6C andde'reciation *enets
N+ :e)elo'er leases the s$stems*ac (rom a! "#uit$ 6n)estor
;+ Consumer 'a$s :e)elo'ermonthl$
?+ :e)elo'er 'a$s a! "#uit$'er their agreement
Tax Equity
Investor
&ale-lease*acs ha)e the (ollowing ad)antages and disad)antages(or de)elo'ers%
&im'lest o( all the structures
Allows trans(er o( 100 o( ta!*enets to ta! e#uit$ in)estor
o nancing ca'italre#uired (rom de)elo'er
&tructure can *e 'ut in 'laceu' to I0 da$s a(ter assets are
'laced in ser)ice
9asis (or 6C and de'reciation istransaction 'rice *etweende)elo'er and in)estor, whichma$ *e higher than de)elo'erscost
Cost o( ca'ital (rom ta! e#uit$in)estors ma$ *e higher than(rom other sources+ &ince ta!e#uit$ is 'ro)iding 100 o( thenancing ca'ital in thisstructure, this ma$ not *eeEcient
:e)elo'er must meet !ed rentschedule (or its lease o( theassetsF i( 'ro5ects under'er(ormand de)elo'er does not meetrent 'a$ments there can *e *adconse#uences
6( de)elo'er wants to own theassets in the long term, it has to'urchase them *ac (rom the ta!
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e#uit$ in)estor at (air maret)alue at the end o( the lease
Lease must *e structured so=MV at end o( lease is at least20 o( initial )alue
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!artnershi2 Fli2
6n 'artnershi' i's the de)elo'er and ta! e#uit$ in)estor (orm a 5oint )enture'artnershi' and the allocation o( 'rots, cash, and ta! *enets .i's/ *etween the'arties one or more times during the li(e o( the 'artnershi'+ =li's allow the
de)elo'er to in)est alongside ta! e#uit$ so it retains a residual interest in thes$stems a(ter their installation, and the$ allow the trans(er o( most t$'icall$ II4o( ta! *enets to the ta! in)estor+ he$ also allow the de)elo'er to regain 100ownershi' o( the assets at reasona*le cost a(ter all the ta! *enets ha)e *eenused *$ the ta! in)estor+
he 'artnershi's are organied as a limited lia*ilit$ com'anies so there are noincome ta!es at the 'artnershi' le)elF ta!es are 'aid *$ the in)estors on their owncor'orate ta! returns+ he )ast ma5orit$ usuall$, *ut not alwa$s, II4 o( the'rots, losses, and in)estment ta! credits (rom the 'artnershi' ow to the ta!e#uit$ in)estor (or the rst se)eral $ears, a(ter which these attri*utes .i'/ and thede)elo'er gets the ma5orit$ o( them usuall$, *ut not alwa$s, I;4+
he i' is designed to ha''en as earl$ as the end o( $ear ; or as late as $ear I,and is su''osed to coincide with a time when the ta! e#uit$ in)estor will ha)erecei)ed a certain target rate o( return, net o( all ta! *enets and cash it isdistri*uted+ he i' cannot ha''en *e(ore the end o( $ear )e or the go)ernmentwill reca'ture a 'ortion o( the 6C+
!ro-t Share oes 3ot Equal Cash Share
Dne im'ortant conce't to understand when dealing with 'artnershi' i's is thatthe cash generated *$ the 'artnershi' can *e distri*uted to the 'artners in acom'letel$ diBerent ratio than the ta! 'rot or loss+ =or e!am'le, while the ta!e#uit$ in)estor ma$ get II o( the ta! 'rot or loss *e(ore the i'@ and it isusuall$ a loss, which is what reduces its net cor'orate ta! 'a$ments@it usuall$gets a minorit$ o( the cash generated *$ the 'artnershi' (rom lease 'a$ments andother sources+ he ma5orit$ o( the cash goes to the de)elo'er+
"uyout 42tion
he de)elo'er usuall$ has the right to 'urchase the ta! in)estors 'osition a(ter thei'+ he *u$out 'rice is usuall$ the greater o( (air maret )alue at the time o( the*u$out or the amount that would gi)e the ta! e#uit$ in)estor its re#uired rate o(return+ 6n an$ e)ent, since a(ter the i' the ta! in)estor onl$ gets a small minorit$
o( cash distri*utions the *u$out 'rice is #uite reasona*le, com'ared with the 'ricein a sale-lease*ac+
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Fiure + & Illustrative !artnershi2 Fli2 Structure (/efore5i2,
Consuer
3
Lease
Lease ;6nstallation
&uccess =ee Pmts
evelo2er E!CN
Leas
e
? "PC cost R 1;-20 'rot
1
evelo2er
S;0o(
Ca'ital
Fund
(2artners
hi2,
2
T;0
o(
Ca'it
al
TaxEquity
Investor
I 8
1 o( 6C ta!
II o( 6C ta!
PL, all cash PL, enough
remaininga(ter
cash to $ield
ste' 8 target 6
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8+ =und distri*utes most o( 6C and ta! 'rot or loss4 to a! "#uit$, 'lusenough cash to get it to its target 6
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Partnershi' i's ha)e their own set o( ad)antages and disad)antages%
Ver$ well understood structureused (or $ears in wind energ$deals
:e)elo'er can *u$ out theta! e#uit$ in)estor a(ter i'at reasona*le cost
D(ten no !ed 'a$ment, so i('ro5ects under'er(orm worst case(or de)elo'er is usuall$ a dela$ inthe i'
6ield*"ased Fli2s
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(unds (or this and owns II o( the tenant+ e!t, the de)elo'er and master tenant(und an .ownerKlessor/ to own and lease the s$stems to the master tenant+ hede)elo'er t$'icall$ owns ;1 o( the ownerKlessor+ &ome de)elo'ers 're(er thisstructure *ecause it
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allows them to ee' hal( the de'reciation ta! *enets+ Potentiall$ more im'ortant,howe)er, is that the master tenant must use an a''raised )alue (or its cost *asis(or the 6C since it is onl$ a lessee+ his could *e ad)antageous i( the de)elo'erscost is *elow industr$ norms+
Fiure 7 & Illustrative Inverted .ease Structure
Consuer
11 I 12
1 o( 6C
8 Lease II o( 6C
'a$ments&u*-leases
s$stem2
1 Tax Equityevelo2er 1 o( #aster
Tenant
IIo(
ca'ital ca'ital
Investor
N
; NI o( 10Leasesca'ital Lease6nstallss$stemwith
and 3 'a$ments
'assthrough
sells ;1 o( o( 6Cs$stem ca'ital
*enets 1N?
Pa$s (or NI o( a!PLs$stem 4wner8.essor
13
;1 o( a!PL
Qe$ ste's%
1 2+ :e)elo'er and a! "#uit$ 6n)estor mae ca'ital contri*utions to Master
enant so the$ own 1 and II, res'ecti)el$
3 N+ :e)elo'er and Master enant mae ca'ital contri*ution to
DwnerKLessor so the$ own ;1 and NI, res'ecti)el$
; ?+ :e)elo'er installs and sells s$stem to DwnerKLessor, who 'a$s :e)elo'er(or it
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8+ DwnerKLessor leases s$stem to Master enant, which su*-leasesto Consumer+ DwnerKLessor also maes election to 'ass through
6C *enets to Master enant
I 10+ Consumer maes monthl$ 'a$ments to Master enant, which .'asses
through/ a 'ortion o( them to DwnerKLessor
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11 12+ :e)elo'er and a! "#uit$ 6n)estor tae 1 and II o( 6C,res'ecti)el$, in 'ro'ortion to their ownershi' o( Master enant
13 1N+ :e)elo'er and a! "#uit$ 6n)estor tae ;1 and NI o( ta!a*le
incomeKloss including de'reciation *enets4, in 'ro'ortion to theirownershi' o( DwnerKLessor
Master leases are t$'icall$ 10 or 20 $ears+ With a 20-$ear lease the ta! e#uit$in)estor will 'ro)ide more o( the re#uired ca'ital, *ut this stri's out most o( thelong-term u'side (or the de)elo'er+
he ad)antages and disad)antages o( in)erted leases include%
Allows de)elo'er to ee' somede'reciation *enets ma$ not*e ideal (or all de)elo'ers4
Master tenant can claim =MV*ased on a''raised )alue (or'ur'oses o( 6CF it has noinsight into cost since it ismerel$ a lessee
=ederal go)ernment does not liein)erted leases *ecause there isno third-'art$ sale transaction+
hus, it (eels this structure ismost susce'ti*le to inated=MVs
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?+ What will *e the sal)age )alue o( the s$stems at the end o( the lease or PPAtermU
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+ What will the o'erating e!'enses (or the s$stems K (und *eU =or o'erationsand maintenanceU =or *illing and collectionsU =or (und management,accounting, and legal lingsU ow will this escalate or not4 o)er the li(e o(the leasesU ow will these e!'enses change o)er the li(e o( the leasesU
8+ ow should the s$stems *e de'reciated (or *oo and ta! 'ur'osesU
I+ What setu' e!'enses will each 'art$ incur to get the in)estment (und oB thegroundU
10+ow should the 'rots losses4 o( the 'artnershi's, in)estment ta! credits,and cash *e di)ided among the owners so as to gi)e them their re#uiredrates o( return while com'l$ing with 'otentiall$ com'le! 'artnershi' ta!lawU
11+Oi)en all the assum'tions a*o)e, what are the 6
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