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Do You Have a Solar Strategy?

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6 min read

The Inflation Reduction Act of 2022 (IRA) provides a broad range of new incentives to install solar energy equipment, many of which are available to Low Income Housing Tax Credit (LIHTC) projects and some that are uniquely available for affordable housing. As you begin the development process for a project, do you have a strategy that identifies the potential financial and non-financial benefits of solar, how are you going to monetize those benefits and what are the potential drawbacks and risks associated with installing solar energy equipment in your project?     

Benefits
Why should you include solar equipment in your next affordable housing project, other than the overall benefit to the environment and an increased commitment to renewable energy? First, over 30 states have some form of green building incentives in their Qualified Allocation Plan. Getting an allocation of nine percent LIHTCs has always been competitive, while the tax-exempt bond allocation and four percent LIHTCs that come with them have also become competitive throughout most of the country, making every point matter more than ever. If you aren’t getting points for green building design, your competitors are.  

In addition to the QAP points, electricity is expensive. The cost of electricity in an apartment can vary if the building uses electricity for heat or not and can vary from state to state, but there is no denying electricity is expensive. The average monthly cost of electricity for an apartment can range from $85 in Utah to $246 in Connecticut. Solar equipment provides free electricity to an apartment project even if it does not eliminate the need to draw electricity from the grid. If the landlord pays the electrical expense, any savings go directly toward saving on operating costs, which will either allow for higher mortgage loan proceeds or increased cash distributions to the owner. If the tenant pays for his or her electricity, power generation from solar will reduce their overall electrical costs and could result in a lower utility allowance.   

The passage of the IRA provides some robust new benefits for LIHTC developers wanting to install a solar facility in their projects. No longer do developers need to remove the cost for the solar facility from the eligible basis. Meaning those costs are eligible for both the Investment Tax Credit (ITC) and LIHTCs. This may not be an issue for a nine percent LIHTC project, but it does make a difference for a four percent LIHTC project. In addition, the amount of the credit can be increased from six to 30 percent, and potentially up to 70 percent of the cost of the solar facility installed. That 70 percent credit amount includes a 20 percent increase due to a solar facility being constructed as part of a qualified low-income housing project, which includes LIHTC projects. The 20 percent increase is limited and subject to an application process that was announced on Sept. 27, 2023. If a project receives the full 70 percent ITC, and depending on LIHTC pricing, it is possible that the credit-affected cost of the solar facility could be $0. 

Monetization of the Energy Credit
A free solar facility sounds great, but developers will need to monetize the ITC to make that happen and the IRA also intends to simplify the monetization of those credits. Since the passage of the IRA, in about 50 percent of transactions with the ITC, we have seen the federal low-income investor pay for and take an allocation of those credits. In the other 50 percent of those transactions, the federal low-income investor was not willing to pay for the credit and the developer/sponsor took those credits for themselves. If the financing stack requires investment in the ITC from parties outside the developer/sponsor group, have a discussion with your Federal LIHTC investor right away to determine its appetite for the ITC.   

Not all developers are in a tax position to benefit from the ITC, so what alternatives might be available if their federal low-income investor is not interested in purchasing the ITC? First, it is permissible for the owner of the solar facility to transfer those credits to a third party who would be willing to pay for the ITC. Only one transfer of the ITC is permitted, but any partnership that purchases credits may allocate the purchased credits to its direct or indirect partners without violating the “no second transfer” rule. Allocations of the purchased credits to partners of the transferee (buyer) partnership are permitted with generous discretion. A partnership transferor (seller) should not have any taxable income from the sale of credits and the buyer should not get any deduction related to what it pays for such credits. The third-party purchase cannot be a related party to the LIHTC owner; specifically, that buyer must have less than a 50 percent interest in profits and capital of the LIHTC partnership.  

Second, it may be possible for the solar facility to be owned by an “applicable entity” (i.e., tax-exempt entity, political subdivisions, etc.). Such applicable entity could enter into a joint operating agreement or other arrangement with the apartment owner where the project would still receive the benefit of the produced energy and the applicable entity could make an election to treat any applicable credit as a “direct payment” in an amount equal to the credit amount. As part of any agreement between the project owner and a nonprofit, it may be necessary for the project owner to compensate the applicable entity for the gap between the actual costs to install the solar facility. The downside to this arrangement is that the cost of the solar equipment is unlikely to be includable on a LIHTC basis or be depreciable by the LIHTC partnership.

Important Considerations to the ITC
As part of your solar strategy, there are a few important considerations to keep in mind. First, even though the eligible basis is not reduced by the costs of the solar facility, investors may require the depreciable basis to be reduced, meaning the LIHTC investor will not be able to take losses on those costs. Second, be mindful about using tax-exempt bonds to finance your project; you may need to reduce the ITC by 15 percent. Third, the 20 percent adder available to LIHTC projects is not automatic and subject to a brand new allocation process that opened on Oct. 19, 2023. Fourth, the ITC can only be transferred one time and may not be transferred to a “related party.” Fifth, the ITC can be subject to recapture. Sixth, is your solar strategy easy to replicate for the next project? Or will this need to be recreated every time? Finally, the IRA is a relatively new law with fresh guidance from the IRS and the Department of Treasury and the industry is still working to process the changes.  

Conclusion
For many LIHTC projects, the benefits received from the ITC may only be “gravy,” but having a good solar strategy in place before you start your development can reduce operating costs, increase loan proceeds, reduce utility costs to tenants and decrease the use of fossil fuels all at little to no cost to a LIHTC project.