The IRS and renewable energy finance: the waiting game 

The IRS issued an important piece of guidance related to clean energy finance this week. It is the annual inflation adjustment for the Production Tax Credit (PTC) and it increased the credit from 2.2 to 2.3 cents per kWh for full qualifying energy property like wind and geothermal, while the partial credit for sources like open-loop biomass and incremental hydro remained at 1.1 cents per kWh (also adjusted were the inflation factors for Indian and refined coal).

PTC Rules

More important is what is still missing – despite widespread expectation for a first quarter release, the long awaited rules on how to determine the start of construction for purposes of determining what projects will be PTC eligible at the end of 2013 still have not been issued.

When the PTC was extended as part of the fiscal cliff deal during the holidays there was an important change in the method for determining whether a project would qualify for the credit. Historically, the qualification of property was based on the date the property was placed in service (and it’s worth noting that this rule is actually somewhat vague and the application sometimes very nuanced). Now, qualification is based on when construction for the facility begins. As long as construction starts before year-end, property is eligible for the credit.

The problem, and the new rules will address this – no one is exactly sure what it means to begin construction. There are some obvious assumptions that can be made, but at the edges, such as where a developer is contracting for facility components, the final vision or location of a project is not completely fixed, or instances where an adequate financial commitment is made to begin construction, the rules for qualification will be vital. Developers, vendors and especially investors are waiting for clarity before making key project decisions. While some projects are moving, this overhanging uncertainty has slowed countless projects.

REITs and Energy

Another piece of guidance that was expected from the IRS during the first quarter was a ruling on the use of REITs to own renewable energy assets. REITs are tax advantaged investment vehicles that are currently limited in use to certain real estate investments. If made available to energy asset ownership, REITs would present an enormous opportunity for an inflow of lower cost project capital, which is vital for future industry growth. Under current rules, the consensus view is that the application of a REIT to energy assets is quite limited (though increasingly some groups have started to work using REITs or energy without clear guidance from the IRS and at least one significant investor is purported to have a ruling that would allow the use of REITs for loans secured by renewable energy assets).

New REIT rules would be important, but will have more impact on future energy financing as the initial value remains limited while the tax credits are in place, but as year end approaches and concerns over the future of financing for wind, biomass, and hydro-derived energy will increase the focus on alternative tools like REITs.

May be that this post will need updating within a few days, but for now, the industry waits. Also, be on the look out here for a future discussion on new approaches to deal structuring using REITs (and possibly MLPs, which need a legislative fix to be expanded beyond current uses primarily in oil and gas).