Expansion of the Production Tax Credit and Investment Tax Credits
The Inflation Reduction Act (IRA) included a range of energy tax credits designed to encourage transitioning to clean energy production, advanced manufacturing, the adoption of clean vehicles (CVs), and reduced greenhouse gas emissions through alternative fuels and energy-efficient technologies. The expansions of the production tax credit (PTC) and the energy component of the investment tax credit (ITC) are major elements of the IRA. These include extending and modifying the carbon oxide sequestration credit and tax credits for clean hydrogen production and zero-emission nuclear production.
Section 6418: Monetization of Tax Credits
While the ITC and PTC existed prior to the IRA, the ability to monetize these tax credits via transferability did not. The IRA added Section 6418, which allows an eligible taxpayer to transfer all or a portion of an eligible tax credit to an unrelated transferee taxpayer in exchange for cash. Prior to the IRA, the monetization of these credits was typically completed via alternative and complex structures, including tax equity transactions and sale-leaseback transactions.
Tax Equity Transactions
In a typical tax equity transaction, there are two members: (1) the investor member and (2) the sponsor (developer) member. The most common structure used to facilitate a tax equity transaction is known as a partnership-flip structure. In these transactions, the investor provides capital investment into the partnership (approximately one-third of the capital stack for a solar development) in exchange for 99% of the tax benefits or attributes (tax credits, depreciation, etc.). The investor also receives a portion of the cash distributions until:
- The amount of those distributions reaches the yield stipulated in the partnership agreement (yield-based flip)
- A defined period of time set forth in the partnership agreement (time-based flip)
At this point, the benefits associated with the partnership interest will flip, and the investor will then typically receive 5% of the tax benefits and a lesser portion of cash distributions. After the flip, it is typical for the sponsor to buy out the investor member at the fair market value of its post-flip membership interest. Many of the features of this structure are carefully and specifically designed to respect the federal tax rules that govern both the tax attributes and credits as well as partnership entities.
The sponsor member benefits from the capital investment provided by the investor in exchange for the deductions and credits it is not able to utilize in the short term. Generally, the tax equity market has been made up of a relatively small number of institutional investors along with large developers and energy generation firms. Given the complex nature of the transactions and the associated costs, these structures were usually reserved for large-scale projects.
Transferability
The introduction of transferability under Section 6418 has allowed certain eligible credits to be monetized without a tax equity transaction structure. Instead, a taxpayer may now purchase and sell these tax credits to an unrelated party. The transfer must be purchased with cash and is not included in the seller’s income, nor is it deductible by the transferee buying the credit. Once the transfer has been made, the credit may not be transferred again. The tax credit is purchased at a discounted rate, which provides an arbitrage opportunity for the buyer. For example, a buyer can purchase $100,000 of solar ITC credits at a discount of 10% to 20%. The buyer receives $100,000 of credit to reduce its tax liability while paying $80,000 to $90,000 for the tax credit. The seller of the credit receives cash from the sale, which is excluded from income in exchange. Several marketplaces have been launched to facilitate these transactions. The following table highlights some of the nuances between tax equity and transferability.
Comparison: Tax Equity vs. Transferability
| Tax Equity | Transferability |
| Receive both tax credit and depreciation | Receive only tax credit |
| Established market | Reduced barriers to entry |
| Typically, large-scale project | Variability in project size |
| Limited investor pool | Open marketplace |
| Complex structure | More streamlined transaction |
Eligible Tax Credits for Transfer
The tax credits eligible for transfer include:
- Section 30C Alternative Fuel Vehicle Refueling Property
- Section 45 Renewable Electricity Production
- Section 45Q Carbon Capture Equipment
- Section 45U Zero-Emission Nuclear Power Production
- Section 45V Production of Clean Hydrogen
- Section 45X Advanced Manufacturing Production
- Section 45Y Clean Electricity Production
- Section 45Z Clean Fuel Production
- Section 48 Clean Energy Property
- Section 48C Qualifying Advanced Energy Project
- Section 48E Clean Electricity Investment
Conclusion
The introduction of transferability for the above-listed eligible tax credits provides an alternative to the tax equity space, but each developer and taxpayer will need to determine which strategy is right for it. Transferability is not a replacement for tax equity, but it has removed some of the barriers to entry that existed prior to the IRA for both investors and developers. Additionally, not all income can be offset by the credits. Therefore, it is imperative that you speak to your tax advisor prior to the purchase or investment of either option.
Your Guide Forward
Reach out to a Cherry Bekaert team member today to learn more if you are eligible for any of these tax credits and how you are able to take advantage of these opportunities.
Related Thought Leadership
Article: Inflation Reduction Act Credit Transferability Final Regulations Released
Webinar: Energize Your Organization: Direct Pay and Transferability of Energy Tax Credits and Incentives
Case Study: Optimizing Tax Incentives for Real Estate & Construction Firms
