Alan Morales, MJLST Staffer
Solar energy has come a long way in the last few decades as the cost of producing photovoltaic (PV) cells, the main technology used in converting sunlight into electricity, has significantly decreased. Furthermore, there is a federal tax credit program available, which allows investors in solar energy to claim 30 percent of their solar energy installation cost as a credit on their taxes. This has led residential, commercial and industrial property owners to slowly increase their solar usage.
However solar developers, in many cases, will not have enough tax liability to make immediate use of the tax benefits. An essential financing mechanism for solar developers is a “tax equity” transaction, where tax benefits are sold to raise capital to build the solar project. This demand for cash, has caught the attention of private equity firms, pension funds and foreign investors.
To start, these cash investors must invest through a “blocker” corporation – a US entity treated as a corporation for tax purpose. Cash investors should understand how the tax equity works since they will be investing alongside it. It will also affect what the cash investor can get out of the deal. Then a cash investor might use a sale- leaseback to finance the project. Sale-leasebacks are common in the commercial and industrial rooftop and utility-scale solar markets. In a sale-leaseback, the developer sells a project to a tax equity investor for its fair market value and then the investor leases it back to the developer. In this case, the investor keeps all of the tax benefits, and receives cash in the form of rent from the developer. The developer has taxable gain on the sale to the extent the value of the property exceeds what it cost to build. Although a lessor position is not ideal for some cash investors, it can prove beneficial if they can purchase the project, lease it back to the developer, and sell a portion of the lease to a tax equity investor.
The main benefit to a cash equity investor is the flexibility. Cash investors are in a position to sell as much of its lease position as it wants, and retain as much cash flow as it wants. Sale-leasebacks are enticing for developers because it offers financing for the project while freeing up cash for their other business needs. The tax equity investor is least benefited and would have to become a member of the lessor before the asset is placed in service, which means having to take on some degree of construction risk.