The Solar REIT: An Investment-Driven Solution to Solar Development Problems: IV of V

This post is Part 4 in a series and is excerpted from my research on the applicability of the REIT tax structure to large-scale solar development. Parts 1 through 3 may be found at the following links: Part 1, Part 2, Part 3. Part 5 may be found here.
Creating an Immediate Impact – Using the Tax Structure to Stimulate Development

Assuming, arguendo, that an S-REIT tax regime becomes a legal reality, whether by administrative declaration or legislative changes to the tax code, it is not clear that this would be enough to ensure optimal short-term development of solar facilities. It is true that such a structure could entice some first-movers to action. Additionally many in the industry believe that solar could become competitive on a large scale anywhere from 5 to 15 years from now. 1 Having the S-REIT structure in place ahead of such technological advances could certainly prove helpful. However, In order for the S-REIT regime to have its highest present impact, it will be necessary for changes to be made to the incentive structure for solar developers.

Though under an S-REIT plan, investors would provide some capital which could be used to finance projects, the costs of solar energy without subsidy are still currently too high to be competitive with cheaper forms, so long as fossil fuel sources continue to receive federal and state subsidies. The current solar regime, which includes investment tax credits, evens the playing field somewhat and allows developers to start projects with a lower risk level than would otherwise exist. But ITCs and rebates have proven to be inadequate tools to fully stimulate solar development. Further, there are the negative incentives noted above for developers to game the system in certain circumstances, focusing on smaller, more expensive installations to the detriment of both energy production and progress. Finally, it is not entirely clear that the current investment tax credit structure would be allowed to co-exist with an S-REIT model. 2

Because stimulus in addition to investor capital will be required, and because the current ITC regime has proven to be an ineffective and inefficient means to provide this stimulus, a new structure will be required to ensure that the S-REIT can meet its full potential. Although it is possible that this stimulus could come in one of many forms depending on what legislators determine the best route may be, this paper proposes the enactment of a refundable production tax credit (PTC) for large-scale solar projects, available only to developers organized under the S-REIT structure. Though PTCs have been explored in the past, the lack of early stage incentives lead to ineffective results. However, the up-front capital provided by REIT investors could go some way toward facilitating this later stage tax benefit.

In order to be most effective while remaining palatable for legislators and their constituents, a PTC would need to be well-structured. This paper proposes the following:

1. A credit which could be passed through to investors, and would replace the ITC and any other existing cash grant plans. 3 This would both increase investment in the space and ensure that this investment would be used efficiently, incentivizing production rather than high-cost development which is susceptible to system-gaining. Notably, the publicly traded REIT would be a particularly good vehicle for a PTC due to the high levels of disclosure that would be required per Securities and Exchange Commission regulations.

2. The proposed PTC incentive would be phased out over a specified time period and at a certain rate. Based on many projections, a 10-15 year phase out would be appropriate as this would track the projected cost reduction trends for solar technology. 4

3. The REIT structure would remain in place even after the PTC is phased out. The structure itself will remain attractive at the point that solar production is competitive with fossil fuel-produced energy. This will provide certainty for developers and investors and ensuring that development continues beyond the initial PTC phase.

4. Though not a part of the incentive structure, an additional tax issue is the treatment of depreciation for S-REITs. This paper proposes that S-REIT investors should be allowed to take advantage of depreciation in the same way that commercial real estate investors can. This would mean a reduction in taxable income on the investor’s 1099 Div commensurate with the depreciation claimed by the S-REIT. This additional benefit would allow developers to recognize the deterioration of their solar arrays to the benefit of investors. 5, 6

5. Finally, it is worthwhile to note that this proposal would have no impact on the current 30% tax incentive for individuals installing residential solar arrays. This would leave the current structure in place and would allow local generation free to continue growth at its current rate.

1. Interviews with Jigar Shah, CEO, The Carbon War Room, in Washington, DC (3/23/2010) and Ken Zweibel, Director, The GW Solar Institute, In Washington, DC (4/14/2010).
2. For example, it seems that the current law would not allow REITs to take full advantage of tax credits. According to tax lawyer David Jacobson, tax credits would only apply to the 10% of funds that are not annually distributed, meaning that the current tax law structure for REITs does not provide the financial incentives necessary to ‘marry’ REITs with potential tax incentives. Telephone Interview with David Jacobson, Partner, Troutman Sanders, LLP (Apr. 23, 2010). However, H.R. 4599 , The Renewable Energy Expansion Act of 2010, introduced by Congressman Blumenauer (a member of the House Ways and Means Committee), appears to address the problem above on page 7 (line 4-6) of the bill. According to Rep. Blumenauer’s floor statement in early February 2010, his “legislation adopts changes that will increase the ability for real estate investment trusts to access investment.”
3. The initial REIT concept to spur solar energy investment was recommended by Ken Zweibel, Director of The George Washington University Solar Institute. The overall recommendations involved a collaboration of the author with Ken Zweibel, Debra Jacobson, Co-Director of the Institute, and Joseph Cordes, Associate Director of The George Washington University’s Trachtenberg School of Public Policy and Public Administration.
4. For some projections on how a PTC could work to improve the competitiveness of PV, see Ken Zweibel, The Arithmetic of Solar Trusts, available at http://thesolarreview.org/2010/04/21/the-arithmetic-of-solar-royalty trusts/?utm_source=feedburner&utm_medium=email&utm_campaign=Feed%3A+TheSolarReview+%28The+Solar+Review%29.
5. For examples, see Year End Tax Reporting Data (1099 Div), 2009 Tax Year, available at http://www.reit.com/IndustryDataPerformance/YearEndTaxReportingData/tabid/88/Default.aspx.
6. One possible legislative vehicle for such a provision would be the legislation concerning energy tax incentives and the
green job economy that is currently under development by the House Ways and Means Committee.

1 comment:

  1. Great post. I am writing a paper on 1099-div so I have been doing as much research as possible, that is how I came across your post. I am glad I did because this was very helpful. Thanks so much for sharing Josh.