Combining Housing and Energy Tax Credits
Combining tax credits from the low income housing tax credit (LIHTC) program with energy tax credits (which are most associated with solar panels) raises a variety of issues for developers of housing projects. With the help of Forrest Milder, an attorney at Nixon Peabody and an expert on tax credit financing, we tell you what the issues are and how you can avoid mistakes that could cause an owner to forfeit its entire allocation of tax credits.
Energy Tax Credits
Section 48 of the Internal Revenue Code (IRC) provides an owner with an energy tax credit equivalent to 30 percent of the cost of energy property, Milder says. IRC §48 defines “energy property” as (among other things) “equipment that uses solar energy to generate electricity, to heat (or provide hot water for use in), or to cool, a structure.”
However, not all energy property qualifies for energy tax credits. For example, energy property that uses solar energy to heat a swimming pool is not eligible for tax credits, says Milder. He also notes that certain fuel cell, geothermal, and fiber optic equipment may also be eligible for an energy credit, although these types of equipment are not as closely associated with housing as are solar panels, he says.
According to Milder, one way of successfully combining housing tax credits and energy tax credits is to include in an application for a housing credit allocation the cost of the equipment qualifying for the energy credit. State allocating agencies often offer additional scoring points to developers that use renewable energy sources, including solar, he notes.
Blending Two Types of Credits
Unfortunately, energy credits and housing credits don't work together as perfectly as one might hope, Milder says. When an owner combines the two types of tax credits, its basis in the equipment qualifying for the energy credit (for housing and depreciation purposes) is reduced by 50 percent of the tax credit, says Milder.
The energy tax credit is typically 15 percent of the cost of the energy property, so the total housing credits that arise from the transaction will be reduced by 15 percent as well, he notes.
Furthermore, the state agency may not allocate additional housing credits for energy panels, Milder says. The reason is that some developers have already reached maximum eligible expenditures under the state “qualified allocation plan” before adding solar device costs into the mix, he notes.
Therefore, it can be important to assure that the cost of installing solar panels does not exceed a state's maximum permitted expenditure per unit, Milder says. Otherwise, the owner won't get an allocation of housing tax credits to go along with the energy credits, he notes.
Alternatively, an owner can also qualify for a new allocation of credits for an existing building, provided the cost of the panels exceeds the threshold of either $3,000 per unit or 10 percent of a building's adjusted basis within a 24-month period, Milder says. Or smaller expenditures on solar energy improvements might be eligible for housing credits if the owner combines the credits with other rehabilitation expenditures that further exceed the $3,000 and 10 percent thresholds, he adds.
Allocation of Credits
Different allocation rules for the housing tax credit and energy tax credit programs are another big concern owners face when seeking to combine the two types of credits, Milder says. The concern exists whether the owner is undertaking new construction or working on an existing tax credit project, he adds.
Housing credits are allocated according to an owner's share of depreciation, whereas energy credits are allocated based on a partner's share of profits, says Milder. Consequently, the amounts paid to the general partner on an incentive basis may be characterized as a share of profits, he notes. As a result, the energy credit gets allocated to the general partner rather than to the investor in a typical owner-partnership structure, he adds.
For example, in a typical housing-only deal, the lion's share of a tax credit project's cash flow goes to the general partner, and the limited partners get the bulk of housing credits because of their share of depreciation, says Milder. But when solar is added, the bulk of energy credits might have to go to the general partner when the partnership agreement states that the general partner is to get the bulk of the cash flow, he advises.
According to Milder, the tax community is concerned that the IRS will look at the allocation of the owner's cash flow to determine who is entitled to the energy credits, he adds. Therefore, a tax advisor must look closely at the cash going to the general partner as well as at other incentive payments that might be considered a share of the owner's profits, Milder says. A tax advisor must also be thinking about whether restructuring is called for, he adds.
The remedy is often to pay the general partner an annual fixed operating fee or a percentage of the owner's gross receipts, but not a percentage of the entity's cash flow, says Milder. This would assure that compensation to the general partner would be considered a fee rather than a share of the profits, he says. Consequently, amounts paid to the general partner would not apply to the allocation of profits, and the fee would not affect the flow of energy credits to investors, he adds.
Forrest David Milder, Esq.: Partner, Nixon Peabody LLP; Washington, DC
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