What Is Tax Equity Financing?

Since 2007 the principal financing structure for solar energy in the United States has involved the use of so-called tax equity.  This article explains this important concept and its implications.

Tax equity finance involves splitting the benefits of solar electricity production from the tax benefits and other incentives that flow from renewable energy and energy efficiency projects.  Property owners receive the benefits of solar and the financial institutions receive the benefits of tax credits, deductions, rebates and the like.

Tax equity providers are institutions – banks like US Bankcorp and Wells Fargo; financial institutions like Goldman, Sachs and Merrill Lynch; and major corporations like Google – that have heavy tax liabilities and can put to use the tax credits and accelerated depreciation that are thrown off by large renewable energy projects or portfolios of small projects.  (See Tax Benefits of Solar.)

The tax benefits for solar energy development are the most robust of any solution and so we tend to focus on solar projects.  But note that tax equity approaches can be used in other situations such as geothermal and storage battery installations where incentives help to subsidize the capital costs of a project.

Tax equity projects involve three major stakeholders:

1.   Developer. A developer (SunEdison, SolarCity, SunPower) identifies a project and undertakes the costs and risk of engineering, procurement, installation and commissioning.

2.   Solar Host. A commercial or residential building owner can make use of the benefits of the project.

3.   Tax Equity Participant. A taxpayer that can make use of the credits and other incentives available agrees to finance and own the project for a certain number of years.  In exchange for its financing construction costs the tax equity partner will receive the tax benefits and frequently other incentives generated by the project.

Frequently the tax equity participant does not want to hold title to a solar or other renewable project for the life of the contract.  In those cases, developers have often entered into what are known as “partnership flip” arrangements where the ownership of the project will be owned by both the tax equity participant and the developer.

In a partnership flip arrangement, at the start of the project the tax equity partner may hold, say, 90% ownership and the developer 10%.  After 5-7 years, following the exhaustion of the tax and other benefits received in connection with the project, the ownership will flip and tax equity participant will reduce its ownership share to 10% and the developer will go to 90%.

Tax equity investments and partnership flip structures require careful legal structuring by experts familiar with IRS standards for ensuring that the arrangements involve real and not sham risks to the parties.  Otherwise, the tax benefits and the tax treatment of those benefits might be lost.

To date all tax equity investors have been single companies or partnerships.  As demand for investment exposure to the renewables industry increases we can expect to see syndicated or securitized structures in which multiple investors such as individuals can participate in the ownership of renewable energy resources.