Sunny Dispositions: Modernizing Investment Tax Credit Recapture Rules for Solar Energy Project Finance after the Stimulus

Sunny Dispositions

Author:  Meister, Joel

Organization:  GW Law School

Report Date: 2012



Since the addition of government grants (in Section 1603 of the American Recovery and Reinvestment Act) in 2009, solar energy projects had access to six possible layers of capital: 1603 grants, government-backed debt through the Department of Energy Loan Guarantee Program, commercial debt, tax equity, subordinated debt, and true equity. With the expiration of 1603 grants, solar energy projects will use tax equity from the Investment Tax Credit (ITC) that is subject to recapture rules formulated decades ago. The risk of recapture impedes financing solar projects with mixed pools of equity that contain tax equity from the ITC, delaying projects and increasing costs. The recapture rules for the ITC have not changed significantly as the credit itself has evolved fundamentally over the past five decades.  Following the precedents of recapture rules for 1603 grants and the Low-Income Housing Tax Credit, the ITC's recapture rules should be revised and modernized.      

Key Take-Aways: 

  • The Investment Tax Credit in the Revenue Act of 1962 was originially intended for broad economic stimulus, and the corresponding recapture rules sought to prevent two types of abuses: repeated purchases and resales of property only for tax benefits and purchases of extra equipment for the purpose of reslling to entities not qualified for the credit. 
  • While the ITC has been modified, expanded, repealed and reinstated and its scope has narrowed since 1962, the original language concerning early disposition remains -- even though only new solar energy property is eligible for the solar ITC.
  • If immediate resale to ineligible entities remained a concern for eliminating the early disposition provision, the revised rules could still prohibit such sales to disquaified entities as was done for the 1603 grants.
  • Modernizing the ITC recapture rules would also facilitate the potential introduction of new tax structures such as Master Limited Partnerships (MLPs).  

Key Facts: 

  • Section 50 of the Internal Revenue Code requires complete or partial recapture of the Investment Tax Credit (ITC) within the first five years of service if a project is "disposed of, or otherwise ceases to be investment credit property with respect to the taxpayer."
  • Some lenders report that the recapture risk often consumes two to three months of negotiations alone and can even "scuttle the entire deal."
  • ITC recapture rules decrease liquidity for projects placed into service and reduces the universe of willing investors in the first place.
  • The overwhelming consensus of interviewed developers, investors, and legal cousels is that the elimination of the early disposition provision would reduce recapture risk to tax equity investors and make them more comfortable incorporating other equity or debt.  
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