Renewable Energy, Companion Incentives Offer Opportunities for Developers, Owners
By Caitlin Jones & A. J. Johnson
10 min read
Renewable energy tax incentives, another part of green building, are increasingly being used in affordable housing, historic rehabilitation, and economic development projects, benefiting developers, owners, and residents.
These projects can be quite varied, as is illustrated by a sampling of developments. (See article on p. 7.)
Also, there is a current cloud of uncertainty about the future. Current federal tax credits for renewable energy systems/production – from solar, wind, geothermal, fuel cells, etc. – will expire or be cut back for equipment placed in service after 12/31/08, unless Congress and the president by then enact legislation to extend them. (See related article on p. 2.)
Available Incentives
Tax and financial incentives for investment in renewable energy equipment are available at the federal, state, and local level.
At the federal level, one of the most popular is the 30% solar investment tax credit a taxpayer can claim this income tax credit for qualified equipment (e.g., solar panels) that uses solar energy to generate electricity (photovoltaic, or PV systems), to heat or cool, to provide solar process heat (such as solar thermal, to heat water), or to power fiber optic lighting distribution systems. The credit is equal to 30% of the cost of equipment placed in service before 2009; 10% for subsequent installations. The credit amount is fully claimed in the first year. Eighty-five percent of the cost of the equipment is depreciable over five years.
The federal tax credit that the solar credit has been most commonly paired with has been the low-income housing tax credit (LIHTC). There are no prohibitions in tax law against pairing the solar credit with the LIHTC, nor against pairing it with the federal historic or new markets tax credits.
Also available are federal tax credits for the production of electricity from certain other renewable energy sources, such as wind, geothermal, and biomass. These “production” tax credits are based in size on the amount of electricity produced, and equal to a specified number of cents per kilowatt generated. These generally haven’t been paired with housing or historic tax credits. More often, production tax credits are being claimed on energy-producing facilities (e.g., solar or wind “farms”) financed with the help of the new markets credit.
Taxpayers can claim federal solar or production energy tax credits without having to obtain an allocation of tax credits, unlike with the LIHTC.
State incentives for renewable energy systems/production vary widely, and can include tax incentives, rebates, or other financial assistance. Some states with attractive solar incentives are California, New Jersey, Massachusetts, Hawaii, Connecticut, and Oregon.
In addition, some states authorize renewable energy credits or certificates, which owners of renewable energy equipment – such as solar – earn for the power generated. They can then sell these “RECs” to utility companies for cash.
Finally, some localities and utilities offer various incentives for renewable energy. (For a comprehensive state-by-state listing of all available energy incentives, go to http://www.dsireusa.org.)
Build Green First
Sources interviewed by TCA said developers and owners, before adding renewable energy to a housing project, should first design the building (if new construction) or retrofit it (if an existing building) to a “green standard.” This means making sure the design and the development will utilize energy- saving and sustainable components, features, and materials to make the building as energy efficient as possible. Steps might include installing Energy Star appliances, compact fluorescent lights, and better insulation, or sealing gaps around duct work to minimize heat loss/gain.
Developing a building in a “green” manner in the first place will reduce energy use and costs, and permit installation of a smaller HVAC system. As a consequence, the size of, say, a solar photovoltaic system installed on the building can be smaller as well.
“Build a green building, in terms of building envelope, in terms of energy efficiency, etc. And then if you enhance that a little further, by adding solar, that’s great,” says Scott Hoekman, of Columbia, MD-based tax credit syndicator Enterprise Community Investment, Inc. (For more on green building, green retrofitting, and use of solar panels in LIHTC projects, see Tax Credit Advisor, April 2008, pp. 1, 12; May 2008, p. 16; June 2008, p. 1.)
Most Popular, Benefits
In a solar photovoltaic (PV) system, sunlight hits solar panels installed on the roof of a building (or elsewhere on the property) to produce electricity. This passes through an “inverter” that converts it to household current, which can be used to power appliances, lighting, mechanical equipment, and other devices.
There are no rules of thumb for determining the appropriate size of a PV system in an affordable housing project, according to solar industry officials Mark Pearson, of Borrego Solar Systems, Inc., and Adam Stern, of The Gemstone Group. They noted the size of a particular system will be shaped by various factors such as sponsor’s budget and preferences, available incentives, system efficiency, space constraints (i.e. the total area available and suitable on rooftops or elsewhere for installation of solar panels), and number of “peak sun hours” per day at the site. Systems may produce electricity to meet all or a portion of a property’s total electric needs.
Pearson said the average size of solar PV systems that Borrego has installed on affordable rental housing projects in California (average project size, 70-80 units) has been 50 kilowatts. The average cost for systems, he noted, has been about $8,500 per kilowatt of power produced.
Benefits from Solar
The federal solar tax credit when paired with the federal housing credit has most commonly been claimed on the costs of installing solar PV systems, generating electricity just for the common areas of a project and not also for the apartment units. Solar thermal systems have been less common, with one source suggesting this opportunity is often overlooked.
Benefits from installing solar PV systems in LIHTC properties can include:
- An additional developer’s fee. This fee is usually 15% to 20% of the cost of the solar system and isn’t subject to caps, according to Daniel Smith, a partner in the accounting and consulting firm of Novogradac & Company LLP.
- Federal solar tax credits and depreciation losses that the developer or owner can claim and sell to raise extra equity.
- Additional tax incentives, rebates, or other incentives or assistance (e.g., sales tax exemption), where available, from the state, locality, or utility companies.
- Reduced electric costs for the property, as well as a hedge against future utility rate hikes. Pearson said a solar PV system can cut the utility bill for an affordable housing project anywhere from 20% 100%.
- Added value for the property, from the equipment itself and from increases in net operating income (NOI) due to reduced energy costs. Matt Ferguson, a principal and head of the renewable energy practice at the Reznick Group, an accounting and consulting firm, said increased NOI can support a larger mortgage from lenders.
- Additional housing credits on the solar equipment generating extra housing credit equity. (For details, see Tax Credit Advisor, April 2008, p. 1.)
- A possible edge in winning an allocation of housing credits.
- Lower rents for residents, because of reduced common area energy costs.
- Resident pride from living in a “green,” solar-powered building, and enhanced market appeal.
“I think we will see, in the future, much more solar being used with low-income housing,” predicts Washington, DC attorney Herbert Stevens, a partner in the law firm of Nixon Peabody LLP. He noted, “affordable housing projects have an incentive to be green because most state QAPs reward you and favor those kind of projects that are sustainable. So adding solar to a project can well advantage you in the competition for low-income housing credits.”
Stephen Tracy, a partner in Novogradac & Company LLP, noted the combined equity generation by the solar and housing credit tax credits can fund “upwards of 75 to 80 percent” of the cost of a solar system in an LIHTC project. The fraction is share is much larger in 9% housing credit projects than in 4% projects.
The economic viability of a solar PV system and the projected payback period will vary according to multiple factors, one of which is current and anticipated future electric rates.
Sources said federal solar tax credits generally carry a premium in pricing, akin to that for federal historic tax credits. But several said it is often tough to identify the precise price for solar credits, because when combined with the housing credit the projected yield is based on the mix and the solar credit typically is but a very small part of the overall benefit mix.
When combined with housing credits, solar tax credits have generally been purchased by the same equity investor (i.e. syndicator of direct investor) buying the housing credits.
Other Issues
Several precautions are necessary when combining solar and housing credits.
For example, Tracy warned that the costs of a PV solar system won’t be includible in LIHTC eligible basis if the owner of the property sells the electricity to the tenants. Otherwise the solar equipment will be classified for tax purposes as commercial property, he explained. This disincentive has been the primary reason why solar PV systems installed in LIHTC projects so far have provided power for only the common areas of the project and not also the housing units. Another disincentive has been the current utility allowance rules for the LIHTC program.
Novogradac’s Dan Smith also warned that if the solar equipment is financed by proceeds of tax-exempt private activity bonds, the solar credit amount will be reduced in size. As a consequence, he advised developers and owners contemplating the use of tax-exempt financing for an LIHTC project to make sure the bond documents specify the tax-exempt bond proceeds won’t be used to fund, or to be collateralized by, the solar equipment. The solar equipment should be financed with other funds, he recommended. A recent IRS private letter ruling validated this concept of “tracing” in a completed housing project where solar was to be installed later. (For details, see Tax Credit Advisor, July 2008, p. 16.)
If the solar tax credit is to be paired with the federal historic tax credit, a practical challenge is how to design the rehabilitation project to hide the solar panels so they aren’t visible from the street or compromise the structure’s historic appearance, in order to be able to win approval from National Park Service and state reviewers.
Affordable housing transactions utilizing solar energy and solar tax credits can be structured in different ways. Most common is for the entity that owns the housing project and claims the LIHTC to also own the solar equipment and to receive the solar tax credits and any other financial incentives. An alternative is for the owner of the LIHTC project to lease the solar equipment, either from an energy company set up by the developer/owner, or from a third-party company. Another approach is for the LIHTC partnership to enter into a “purchase power agreement” with a firm that owns the installed solar system to buy power at a lower, set rate over a specified contract period.
Sources advised developers and owners contemplating the installation of solar energy equipment in affordable housing project to first contact an expert in the field, such as a solar equipment installer, solar integrator, accountant, or similar practitioner with knowledge of solar energy systems and solar tax credits. They advised integrating a solar professional early in the design process for a project.
