With the renewable energy market continuing to expand, the popularity of transferable tax credits for funding projects and reducing corporate tax liabilities is becoming increasingly common. The signing of the Inflation Reduction Act in 2022 has further fueled interest among both developers and investors in this space, which has resulted in increased fraud that the IRS has recently addressed.
When properly transacted, transferable tax credits allow businesses to lower their tax liabilities and spur investment in the development of new clean energy projects. While these credits can be bought or sold between taxpayers, the appeal to developers with minimal tax liability is that they can monetize eligible credits and increase their cash flow.
To help avoid fraudulent transactions, KBKG has addressed some of the common misconceptions surrounding the selling and buying of transferable tax credits.
No. 1 - No Risk for Buyers of Transferable Tax Credits
Many project developers and potential investors believe that transferable tax credits are like other tax credits in that they are 100% risk-free, which is not the case. Each transferable tax credit carries its own set of risks and penalties for excess tax credits claimed. For instance, clean energy investment tax credits (ITCs) are subject to recapture risk for five years after the project is operational.
No. 2 - Buyers of Transferable Tax Credits Can Offset All Tax Liability
Buyers need to work with qualified tax professionals to evaluate their ability to utilize transferred credits. The passive activity loss and credit limitations under Sec. 469 will affect a buyer’s ability to use the credit but will not affect the amount of credit eligible to be sold.
The final regulations treat transferred credits in the hands of a buyer as a passive activity tax credit. Buyers that are subject to the passive activity limitations must have a tax liability attributable to passive income to utilize the purchased renewable energy tax credit.
No. 3 - Due Diligence and Management are Unnecessary
Effective risk management for transferable tax credit transactions requires a comprehensive investment strategy, including:
- Thorough due diligence on the project to ensure compliance with all requirements
- Engagement with experienced tax professionals, like KBKG, for proper transaction structuring and certifying
- Regular monitoring and compliance to prevent recapture events
- Diversification through managed funds to spread risk across multiple projects
Due to the recapture risks and potential penalties involved with the transfer of renewable energy tax credits, buyers should consider negotiating indemnification terms with the seller, discussing whether credits are insured to cover recapture risk and performing thorough due diligence on each transaction.
No. 4 - Basis Reduction Travels with the Tax Credits
In structures where part of the tax credits is sold under transferability provisions, the basis reduction for the entire credit amount remains with the selling entity as well as the depreciable interest of the underlying energy property. Sponsors and investors should work with third-party tax consultants to correctly account for this in their transactions.
As the renewable energy sector continues to grow, more businesses will discover how transferable tax credits can be used as a valuable financing tool. It is essential for investors to understand and manage the risks associated with selling and buying credits by consulting with a third-party tax specialist, like KBKG.
The complexities of this market are complicated and working with experienced tax professionals, whose knowledge and expertise in these transactions is essential to a successful transfer of tax credits.