Impact of Transferable Energy Tax Credits on Private Equity Investments

HOST: Welcome to The Drawdown, a podcast by Cherry Bekaert's Private Equity Practice. In each episode, we explore the latest trends in the private equity sector, as well as challenges and opportunities in the ever-changing investment environment.

CHRIS TRUITT: In this episode, we'll be diving into a topic that has been gaining traction recently: the transferability of energy tax credits and how they are impacting the private equity industry. As the world becomes increasingly focused on sustainability and renewable energy, transferable energy credits have emerged as a valuable asset for private equity firms to invest in. I am Chris Truitt, Cherry Bekaert partner and Transaction Tax Practice leader. Join us as we speak with industry experts and explore the opportunities and challenges of investing in energy tax credits. Let's have our speakers introduce themselves.

MARTIN KARAMON: Hi, I'm Martin Karamon. I am the head of our Tax Credits and Incentives Advisory Group, and I'm joined by three of my other colleagues who will introduce themselves now.

WILL BILLIPS: Hello, everyone. My name is Will Billips. I'm a tax partner with Cherry Bekaert in the Nashville office and the firm's leader for Tax Provision Services. Thank you for joining us today.

TIMOTHY DORAN: This is Timothy Doran. Great to be talking on this topic today. I'm a director in our TCIA practice.

DAVID MOMANI: I'm David Momani. I'm a manager in our Tax Credit Investment Advisory practice, and I have a specific focus on energy credits.

MARTIN KARAMON: Okay, great. Thank you. Let's set the stage today with a little background, specifically around the Inflation Reduction Act and how transformative that was. Timothy Doran, if you wouldn't mind taking us through a bit of history with the IRA and the opportunities it now provides to our clients.

TIMOTHY DORAN: This is an interesting space because many incentives have long been available for acquiring clean energy assets and seeking federal support. David and I have worked in this area for many years, but the Inflation Reduction Act changed the landscape dramatically. Many people are familiar with the expansion of technologies eligible for federal energy credits and the increase in credit amounts. What we're discussing today is an entirely new regime for how these credits can be funded. We haven't seen anything like this at the federal level before. The IRA changed the way taxpayers can reduce federal taxes while indirectly investing in clean energy technology. When we say transformative, it truly changed how we think about federal tax incentives.

MARTIN KARAMON: Will, it seems private equity–owned clients have strong appetite for purchasing credits. You work a lot in that space. Could you explain why they are such good candidates to purchase these credits and how you've seen that marketplace evolve? We'll talk next with David about how he's seeing the marketplace.

WILL BILLIPS: This is the biggest tax planning opportunity we've seen in a very long time. It provides an avenue for private equity to manage cash and reduce effective tax rates for portfolio companies. The IRS has indicated these should be considered passive credits, which creates limitations for individuals who must have passive income, but that does not apply to C corporations. We've been a leader in the market for strategies to reduce cash tax payments and manage tax rates. Every PE firm we've worked with views this as a compelling opportunity and wants more information. There are operational considerations beyond portfolio companies, with potential applications at the fund level and above.

MARTIN KARAMON: David, you've been working with a number of taxpayers looking to purchase credits and are working with some of Will's clients. For the benefit of listeners, could you discuss the current status of the transfer market, the availability of credits, and how you spend your time on a typical transaction?

DAVID MOMANI: Right now, credits generated in 2023—meaning the asset was placed in service in 2023—are largely accounted for and inventory is largely non-existent. A few credits came on late in the year, but with the 10/15 filing deadline approaching, most of those deals have been completed. We are seeing a healthy amount of 2024 inventory across several marketplaces we work with, and I expect credits to come online throughout the year as some owners add their credits later. I anticipate a larger influx in the first two quarters of 2025, and there are already some 2025 credits being listed. Overall, inventory for 2024 and 2025 is healthy.

In transactions, I typically work with clients to source credits that fit their needs and price range. I spend a lot of time engaging with various markets to understand what is available and the terms each seller offers. Once I identify a potential fit, I get into due diligence, reviewing documentation provided by the seller to ensure the credit is legitimate and there are no issues that would cause concern about purchasing the credit.

MARTIN KARAMON: Just to clarify, what are you seeing from a pricing perspective right now? Is it still approximately 85 to 90 cents on the dollar?

DAVID MOMANI: Prices vary based on several factors. Entities looking to secure a credit early in the year, to guarantee they have a credit and avoid year-end risk, tend to pay a bit more—around 92 to 93 cents on the dollar. Smaller credits are trading closer to the 85-cent range at this time.

MARTIN KARAMON: For our last topic, I'd like to turn to Timothy Doran to talk about our buy-side due diligence process. This is clearly the most important work we do for companies and portfolio companies looking to purchase credits. We analyze the type of credit, the costing, and so on. Timothy, can you discuss what we do on buy-side due diligence and what we look for?

TIMOTHY DORAN: Buy-side due diligence is crucial. To provide context, before the IRA, credits were available to incentivize investment in clean energy, and many large institutional players without federal tax liability structured sophisticated tax equity partnerships with advisors and CPAs to monetize credits. Congress was aware of this when passing the IRA. Part of the intent of the new transferability scheme was to allow a broader set of taxpayers to transfer credits at a smaller scale, where previously transactional costs would have been too high.

All the traditional due diligence considerations still apply. Key technical code requirements include: when the asset was placed in service; when construction began; whether the technology qualifies; and how the credit amount is computed. These matters are important because the code makes the transferee—the buyer of the credit—responsible if a recapture event occurs. After placing an asset in service, there is a five-year window during which an owner cannot sell the asset without triggering recapture. If the asset is sold or otherwise disposed of during that five-year period, recapture occurs pro rata over the life of the five-year window, and the buyer of the credit would be responsible for that recapture.

Market mechanisms have emerged to address these risks, including insurance and seller indemnities. While the risk is not necessarily high in many cases, it is essential to have an advisor to analyze these risks, confirm the type of credit being purchased, and ensure the credit is qualified and calculated in the correct amount.

MARTIN KARAMON: Yes, it used to be primarily institutional investors in the tax equity market. It still isn't for very small companies, given the expense of due diligence, but the IRA opened the market to many taxpayers who couldn't previously participate. Thank you.

CHRIS TRUITT: Thank you for joining us on The Drawdown and for the opportunity to discuss this topic. Thank you to our speakers for joining the discussion. If you have further questions about the benefits and transferability of energy tax credits, please reach out to any of our speakers.

HOST: Thank you for listening to The Drawdown, Cherry Bekaert's private equity podcast. The views presented by our guests do not necessarily represent the views of their respective firms. For more information on how Cherry Bekaert serves as a guide forward to private equity funds and their portfolio companies through accounting, tax, and advisory services, please visit CBH.com.