Tax Equity
What is tax equity?
Tax equity is a low-risk means of investing in solar projects using a financing approach called project finance. Project finance is the way most energy generating assets are financed in the US today. A successful project finance transaction is based on predictable, reliable cash flows that are more than sufficient to service operational expenses and financing costs.
Tax Equity investment returns are based on a combination of cash flow from the project and federal tax benefits (tax credits and tax deductions). For solar assets, these benefits include:
- An Investment Tax Credit (“ITC”), which is equal to 26% of the eligible cost of the project;
- Accelerated depreciation deductions, including 5-year MACRS depreciation and/or Bonus depreciation; and
- Interest deductions (available only in transactions with leverage at the asset or project level).
Why is tax equity used?
Tax equity has significant benefits for developers and investors.
For Developers
Tax equity is an important source of capital for solar projects, yet many developers do not have enough taxable income to take advantage of the available federal tax incentives themselves. In addition, tax equity is generally less expensive than other sources of capital when measured in pre-tax cash terms – a key metric for most developers.
For Investors
Tax equity offers an attractive after-tax return from a combination of cash yield and tax savings. The cash returns are based on stable, long-term, fixed-rate cash flows from underlying customer contracts with creditworthy off-takers of solar power. In addition, the federal Investment Tax Credit (ITC) offers a dollar-for-dollar reduction in taxes, allowing tax equity investors to keep cash they would otherwise pay to the IRS. Investors can also claim accelerated depreciation deductions for most of the cost of the solar assets. These tax benefits are realized soon after the initial investment is made and generally are not dependent on the energy production levels achieved by the project. Finally, building on stable cash flows and low-risk tax benefits, TEA’s preferred equity structure offers investors an attractive risk/reward investment profile.
Who are the parties in a tax equity investment?
Project Development
Project Sponsor /
Developer
Responsible for project siting, permitting, design, and development, and often installation, interconnection, and operation as well
Equipment Suppliers
Providers of solar equipment (panels, inverters, and other system components) and warranties
Construction / Operations
Host
In distributed generation, the site host may be the owner of the solar systems (typical for installations on commercial rooftops and parking structures) or may be leasing the site to a project entity set up by the developer
EPC Contractor
Developers may outsource engineering, procurement, and construction services to a contractor that will guarantee their work, while some larger developers may perform these functions in-house through an affiliated EPC contractor
O&M Contractor
Similarly, developers may either outsource ongoing operation and maintenance of the facility or perform this service through an affiliated O&M provider
Financing
Developer Equity
Responsible for development costs, securing construction financing, and all project costs not provided by tax equity investors or lenders (typically debt is raised outside of the project company and does interfere with tax equity access to project cash flows)
Tax Equity
Provides ~40% of eligible project costs in exchange for cash and tax benefits
Debt Financing
Construction financing; term debt (raised at the developer level in most projects with tax equity)
Power Off-take
Utility
Approves interconnection and transmits and delivers power generated by the project to consumers (including the site host in distributed generation projects that make use of “net metering”)
Energy Off-takers
Creditworthy parties who commit to buy solar power (or lease solar systems) under long-term contracts