The Inflation Reduction Act of 2022 restored and enhanced more than two dozen clean energy tax credits. But how can these tax credits be applied to Opportunity Zone projects?

Marc Schultz, partner at Snell & Wilmer, joins the show to provide a visual presentation on how the Inflation Reduction Act may interact with certain OZ projects, particularly those that participate in renewable energy initiatives.

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Episode Highlights

• How tax credit financing can represent a significant portion of a project’s capital stack.
• How Opportunity Zones fit into tax credit financing expertise and private equity expertise.
• How the Inflation Reduction Act has made it easier to combine the Opportunity Zones tax incentive with renewable energy tax credits.
• Production tax credits vs. investment tax credits, and how the Inflation Reduction Act restored and enhanced these credits.
• Investment tax credit applications on solar, fuel cell, combined heat and power (CHP), energy storage, hydrogen production facilities, waste energy recovery properties, interconnection properties, biogas conversion properties, and microgrid controllers.
• Production tax credit applications on wind, closed-loop/open-loop biomass, geothermal, solar, landfill gas, trash facilities, hydropower, marine/hydrokinetic renewable energy facilities, hydrogen production, and carbon sequestration (per Section 45Q).
• Step-by-step computation of the tax credits (including multipliers and adders), and the impact that these credits can have on an Opportunity Zone deal’s returns.
• How losses from cost segregation and depreciation pass through in a typical sponsor equity investor model.
• Specific examples of Opportunity Zone deals that include a solar component.
• Whether the Opportunity Zone policy is creating enough of a community impact.

Featured On This Episode

• Inflation Reduction Act of 2022 (Wikipedia)
• Internal Revenue Code 45Q (Cornell Law)

Today’s Guests: Marc Schultz, Snell & Wilmer

• Marc Schultz on LinkedIn
• Law Offices of Snell & Wilmer

About The Opportunity Zones Podcast

Hosted by OpportunityDb.com founder Jimmy Atkinson, The Opportunity Zones Podcast features guest interviews from fund managers, advisors, policymakers, tax professionals, and other foremost experts in opportunity zones.

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Show Transcript

Jimmy: Welcome to the Opportunity Zones Podcast. I’m Jimmy Atkinson and joining the show today is Marc Schultz, partner at Snell & Wilmer Law. Marc is a regular speaker and panelist on tax credit finance and on opportunity zones. He’s also the author of numerous articles covering these subjects. Marc is also involved or was involved in the advising and drafting of a number of comment letters that were submitted to Treasury during the initial opportunity zones’ regulatory process. I met him recently or, I should say, I was reintroduced to him recently at the OZ Expo in Phoenix, Arizona just a few weeks ago, and that’s where he joins us from today. Marc, great to see you again, and welcome to the show.

Marc: Thank you, Jimmy. Really appreciate it. It was great seeing you here in Phoenix, which was terrific for me because I didn’t have to jump on an airplane to attend that conference. So, it saved me some travel time.

Yeah, I’m a partner here at Snell & Wilmer. We’re a law firm with 16 offices of about 450 plus attorneys based in the Phoenix office, which is our largest office. We have about 250 attorneys here in Phoenix, and we just moved offices after being in the same place for 30 years. So, we just moved on Monday, so we’re in new offices, and I don’t have anything, you know, on my walls yet. So, although you can see there’s a blue tape, so we have a lot of blue, you know, because it’s new construction, so we have a lot of blue tape everywhere. We’re not supposed to touch the blue tape. That’s supposed to get fixed. And so you could see a little blue tape on the wall behind me.

Jimmy: A blank slate for you moving forward.

Marc It is nice.

Jimmy: I wish you the best of luck with your new offices there.

Marc: Thank you, thank you.

Jimmy: Marc, so you and I had a discussion at that OZ Expo a few weeks ago in Phoenix. Always beneficial if you don’t have to travel too far. And you just had to walk down the street, I think, to get to the conference. You and I were discussing the Inflation Reduction Act and its potential impact and how it may interact with certain opportunity zone projects. So, I wanted to center a lot of our discussion around that topic today.

And just to start us off, the Inflation Reduction Act was signed into law by President Biden earlier this year on August 16th of 2022. And it’s really a mashup of a few different priorities. I’m not sure personally if the name is all that accurate. I think it seems to be a little bit of a misnomer. It seems like the act is mostly a slimmed-down version of Biden’s Build Back Better plan as well as…there are some efforts in there that are designed to curb inflation. But putting that aside, we’re talking today mostly about the act, Renewable Energy Initiative. So, Marc, I’ll turn it back over to you. Can you summarize the act or the important parts of the act that we’ll be discussing at least? And what are your overall impressions of it?

Marc: Sure, and my background, how I got into renewable energy, is I spent a number of years working for a very large law firm in Chicago before moving out to Phoenix, and I did a lot of tax credit financing. So, we represented a number of investors that invested in tax credit projects, low-income housing tax credits, new markets, historic tax credits, and then renewable energy.

And so my practice out here in Phoenix, a lot of it is developer-based. I represent a lot of developers, and tax credit financing when it comes to renewable energy is super important because monetizing those tax credits represent a pretty significant portion of your capital stack in addition to debt and then your typical sponsor equity. So, opportunity zones was a nice fit because I also do a lot of private equity transactions, a lot of real estate private equity, and so when OZs came out, it was, kind of, a combination for me of tax credit financing and…in particular, the new market tax credits where the rules are very, very similar to the OZ rules. So, it’s a combination of my practice in the tax credit financing space and in the private equity space as well. And so that’s what took me into OZs.

And now with the Inflation Reduction Act, and I go through different pieces of it so folks can get at least a basic understanding of how this works, I see a huge fib between renewable energy and OZs. And I think the Inflation Reduction Act has made it easier to do a combination of those two incentives. So, that’s just a little background. And if it’s okay with you, Jimmy, I can provide you a PowerPoint I can go through.

Jimmy: Yeah, you have a visual component to this.

Marc: I do.

Jimmy: I did want to warn anybody who’s merely listening to today’s podcast episode. If you may be listening on iTunes or Apple Podcasts or Spotify or any other listening platform, you may want to switch over to the visual version, which you can find on either Spotify or on YouTube. You can find us on youtube.com/opportunitydb because, Marc, please go ahead and share your screen when you’re ready and walk us through the deck that you have prepared for us today.

Marc: Okay. So, this is a presentation that we did with our friends from Novogradac. And this was about a few weeks after the Inflation Reduction Act came out. And so I’m just going to talk about the basics here, but there are two different incentives that we see in renewable energy. One is a production tax credit, the other is an investment tax credit. So, production tax credit is a tax credit based on a certain price per kilowatt hour that’s produced by the renewable energy system over a certain period of time. And investment tax credit is a tax credit essentially a certain percentage of your cost to construct the project. So, those are the two different tax credits.

We saw production tax credits. We see that more in the wind space. And in the solar space, we see more the investment tax credit. What has changed in the Inflation Reduction Act, what we see… For solar actually, we didn’t get the production tax credit, but now we do with the Inflation Reduction Act. So, if you’re doing a solar project, you have the ability to choose between an investment tax credit or a production tax credit. So, where we were heading at the time, prior to the Inflation Reduction Act passing, was we’re phasing out the investment tax credit and the production tax credit had been phased out. So, the Inflation Reduction Act restored these credits and then added, and really enhanced those credits, really focused on domestic jobs and domestic content with the equipment.

The beauty of the Inflation Reduction Act is the runway that we have. So, these credits are now restored to the later of 2032 or the date that greenhouse gas emissions from the production of electricity in the U.S. have been reduced by at least 75% of the greenhouse gas emissions for the 2022 year.

Jimmy: So, that could potentially push us well beyond that 2032 date.

Marc: Well beyond, yes. The potential. And not only that, even when that gets achieved, we still have a phase down. So, you know, the next year is still at 100%, then it goes to 75%, then 50%, then it, at that point, terminates the credit. So, we have a long runway, which is enough to really build this industry. I mean, the renewable energy industry is fairly mature now, but this gives us a lot of runway. And it allows a lot of folks to be entrepreneurial and set up their… because the financing’s here and so it allows you to set up…you know, maybe you install solar equipment, but now you can do a development company. So, it’s going to give folks the ability to be entrepreneurial with their business outlook. And so that’s what’s so great about this.

The other thing it does is it adds the ability for nonprofits to get a direct pay option from the government. So, it used to be a nonprofit. They don’t qualify for the credits and so nonprofits had to just buy power from a third-party company that would own the equipment and sell them the power. Now a nonprofit can get the subsidy by actually owning the system themselves so they can apply to the government and get a check equal to the amount of tax credits that they would get if they were a for-profit. So, that’s a nice feature.

And then the other feature is the ability to freely transfer these credits instead of doing this complicated tax equity structure, and we were working on a couple before the Inflation Reduction Act passed that were very complex structures involving inverted leases. And now with the Inflation Reduction Act, we’re looking at the option of just simplifying everything and just transferring the credits to a third-party purchaser of the credits. So, that’s kind of the components here unless you have any other questions, Jimmy.

Jimmy: Yeah. So, the new production tax credit, let’s focus on that for a second. I’m sorry. Maybe you’re going to get to this, but what is the amount per kilowatt hour for that?

Marc: Oh, yeah. I will get to that in a second.

Jimmy: Okay, and I think you’re going to be covering the different percentages that you’re going to acquire in the investment tax credit as well.

Marc: Yes, correct.

Jimmy: Okay, great. Well, carry on then.

Marc: Okay. So, the nice thing here is, with the Inflation Reduction Act, it provides a tax credit for energy storage. Actually, the term is energy storage technology. That’s something we didn’t have before. You had this ability to get a tax credit when you combine solar and energy storage as long as the solar equipment was producing enough electricity into that battery. I can’t remember if it was 75% or 80% of the energy in the battery had to come from the solar equipment. What is fantastic is now you can have a standalone energy storage project that gets the investment tax credit, so that’s something that’s new.

Big thing that we’re heavily involved in up in our Salt Lake City office is hydrogen production. So, there’s something called blue hydrogen, and green hydrogen, and hydrogen production, which I don’t know too much about, but we have folks at my firm that know quite a bit about it. That gets a tax credit as well. That gets both an investment tax credit or a production tax credit. You can’t get both on the same facility, but you get to pick either one. And then the other thing that it does is it enhances what’s called the carbon sequestration tax credit. So, it enhanced that. That’s under 45Q of the tax code. Folks are super excited about that as well. In the carbon sequestration business, it’s got a lot of applications for that as well.

And now to get down to the credits themselves. So, the production tax… So, what they’ve done here is, again, they’re very focused on domestic workers and domestic content. So, they basically say, if you build one of these facilities, you automatically will get a 6% tax credit on the investment tax credit or it’s 0.3 cents per kilowatt hour, and then it’s, kind of, technically… There’s a technical feature to this. On the production tax credit, you multiply it by this annual inflation factor that comes out. I think it’s each April of each year. And right now, it’s 1.7593, so that takes it, for this year, your production tax credit at its base is 0.52 cents. And then you have this weird thing where you round up to the 0.05. So, it rounds up to 0.55 cents per kilowatt hour.

And then at the investment tax credit, we start off at 6%, right, which doesn’t seem like much in either case, but this is where we get into what we call the five times multiplier. Here, if you meet one of these three requirements, you automatically multiply that base credit by five times. And one of them is the size of the project. So, if your project is less than 1 megawatt, and I’ve been told AC is better, you know, the fact that they’re using it on AC versus DC gives us even more wiggle room. But if it’s less than 1 megawatt, you automatically get that five times multiplier. So, that would take you to a 30% tax credit, which right now, this year we have a 20… Without the Inflation Reduction Act, we were looking at a 26% tax credit and next year was dropping down to 22% tax credit.

So, right now, small project. One megawatt is not too small. I mean, most rooftops’ going to be less than a megawatt, most commercial rooftop is going to be less than 1 megawatt. So, that’s a favoritism towards these smaller projects, but these aren’t too small. I mean, it’s a lot larger than what you would see on a home.

Jimmy: Why do they cap that at 1 megawatt? What’s the thought process behind that?

Marc: I think, you know, they want to see… The hardest thing to do are small projects, transactional costs, having to align with the tax equity investor who’s… Most of these folks are more interested in bigger projects. There was some preference to getting some of these smaller projects off the ground, but again 1 megawatt, this is not a rooftop residential project but, you know, rooftop commercial is going to fit nicely. Hospitals that have rooftop solar, that would be under 1 megawatt. So, there’s this preference for making it easier for smaller projects to not have such big transactional costs.

And the big thing here to get to this, and I’ll explain, if you’re more than 1 megawatt, what you have to meet so you can understand this. If the project is more than 1 megawatt, then you’re going to have to meet a prevailing wage and apprenticeship requirement. So, the preference was with these smaller projects to not have to require a prevailing wage/apprenticeship requirements for the smaller projects. So, it’s making it a lot easier to get the smaller projects off the ground without having to rely on the construction contractors being paid prevailing wages.

Jimmy: Got it.

Marc: These smaller projects cost more per watt to build than the utilities scale and the solar farms you see when you’re driving on the highway and you see this big solar project. It’s a lot easier to build that. You don’t have all the racking issues you have with rooftop and carports. Just simpler to lay solar down in the desert, you know, in a rural area.

Jimmy: And maybe in an opportunity zone, but we’ll talk about that in a few minutes, I think.

Marc: Yeah, so you have this. If you’re over 1 megawatt, you got to meet prevailing wage/apprenticeship requirements. They have this safe harbor. So, if you commence construction, and that’s a term of art, commencing construction, you can do it by incurring a certain amount of cost or starting some physical work on the project. But if you commence construction within the day, about 60 days after guidance is published by Treasury on the prevailing wage requirement, then you’re accepted out if you’re more than 1 megawatt.

So that right there I’ve been told by Treasury might even have this guidance out by the end of the year. So, that might not be as relevant for a lot of projects, unfortunately. But the bottom line is, in some states, it’s not going to be hard to meet the prevailing wage requirement as I’ve been told by my labor and employment folks. But in other states, it could be a huge burden to meet that. It’s going to increase your cost.

So, let me just explain the five times multiplier for PTC. So, for PTC, if I go 5 times 0.55, that takes me to 2.75 cents per kilowatt hour. So, that’s pretty generous right there. When I talked to folks at Novogradac, they do say that there is some folks that take a different position that that rounding up you do after the multiplier and that would take it to…actually, I think it’s 2.65 cents, not 2.75 cents. So, there’s some question of whether it’s 2.65 or 2.75. I think it’s 2.75 cents. So, that’s what we would get. With a smaller project or meeting the prevailing wage, we’re at 2.75 cents.

And then what’s nice is we have this concept called adders. So, if you satisfy certain requirements, you get to add to the credit. First one being, let me skip up here, domestic content. So, remember I said that there’s a preference for domestic content. So, if you meet the domestic content requirements, then you get to add 10% to that tax credit. So, we’re going to need regulations here. I mean, right now when I talk to my import-export folks, they tell me that they’re thinking that domestic content is going to be very similar to the Buy America Provisions that we’ve seen for quite a while now.

And so there’s a certain percentage, you know, the steel and the iron have to be U.S. sourced, but the component parts, there’s a 40% requirement that have to be domestic. And then that ramps up to, I think, it’s 55% over the next few years, so they start us off at 40 and take us up to, again, I think it’s 55 cents. I don’t know if I have a slide for the ramp-up. I do not, and this is not my area. I’m a tax attorney.

Jimmy: But the bottom line is you can get your investment tax credit with that or number one up to 40% now. And then the production tax credit gets bumped up by an additional 10% of that number of cents per kilowatt hour.

Marc: Correct.

Jimmy: There was some question as to…

Marc: You’re getting closer.

Jimmy: …how much that might be, but yeah.

Marc: Yeah, you’re getting close to 3 cents per kilowatt hour. So, that’s pretty generous. I mean, you know, a lot of folks buy retail energy at anywhere from 8 to 10 cents per kilowatt hour, maybe a little bit higher. And if you think about that, getting almost 3 cents per kilowatt hour for 10 years on your production, that’s very generous, so that’s something you can… You can make the numbers work.

The next adder here is a place-based incentive, which, you know, OZ is place-based, right? So now we’re, kind of, in the same thing. It’s where you build it, right? And so this is another 10% for building something in an energy community, and there are three ways you have an energy community. The second way we absolutely need guidance on but the first two are pretty simple. It’s a brownfield site or it’s an area that, after 2009, had a retired coal-fired facility or a retired coal plant. For that coal-fired facility or coal plant, it’s based on the census track. So, like the Opportunity Zone incentive, it relies on census tracks. In the United States, we have about 75,000 population census tracks, and that’s what we use for OZ as we have our, what is it, 8,800 opportunity zones are all based on census tracks. So, here, it’s the same thing.

So, if you have a retired coal mine, that census track would be an energy community or the census tracks that are adjacent to that would also be energy communities as well.

Jimmy: And I would imagine that some of those may also be an opportunity zone census track.

Marc: A lot of them, yes, yeah.

Jimmy: And then you can layer that on top as well. And then this adder number… Sorry to interrupt, but adder number two here could take the incentive up to 50%. If you get the base 30 plus adder number one of 10 plus adder number two, another 10, it’s all additive, right? So, are we up to 50% potentially now?

Marc: Yep.

Jimmy: Okay, great.

Marc: We’re up to 50%. So, that’s, again, very generous. And then the third component to energy community is where we look at metropolitan statistical areas. So, I can’t remember how many there are, but different metropolitan areas are considered MSAs. So, I’m based here in Phoenix, so it’s like Phoenix and Mesa are an MSA. And then you look at whether that MSA had has an industry for coal, oil, or natural gas. That’s kind of the key thing, right? And then if you’re not in an MSA, although this is unclear, but we think it’ll be based on counties that are not in MSAs, you’d look at that county and you’d say, “Okay, was there an industry or is there an industry for coal, oil, or natural gas? And is it extraction, processing, transport, or storage?” So, if it’s any of those things, then keep looking at the data. So, the data, you’d be looking at whether it’s…0.17% of the direct employment is in that industry. And it’s any time after 2009, so we think you’d look and say… You know, 2010, ’11, ’12, you look at all this data and say, “Okay, in that year, did we have enough direct employment in one of these three industries? If so, then we might be an energy community.”

And then there’s another way to meet that, and this is based on the local tax base if it came from that industry. This is an area that it’s almost impossible at this point. We’ve looked at certain counties and tried to look at the data that’s available and tried to figure this out, whether that…a non-MSA county, whether that would be an energy community. We’re just having a hard time figuring this out. It’s going to take the Bureau of Labor Statistics, and it’s going to take probably the U.S. commerce department and data that they have, that they’ll probably have to work with Treasury and how to designate these energy communities.

There’s another factor here, and that’s also, even if you meet that test, you still have to look at your unemployment rate, and you have to say, in my area, was my unemployment rate higher than the national average for the year before? So, you still have to do that, too.

So, like opportunity zones, I’m sure there’s going to be a mapping tool where you’re going to look and go on it and say, “Okay, is that an energy community? Yes, it is. So, good. I get another 10%.”

Jimmy: Got it. That makes sense. Are there any more adders?

Marc: One more.

Jimmy: One more, okay.

Marc: This one’s pretty exciting. This is this environmental justice allocation. So, this is a 10% adder, could be up to 20%, okay? Now this is all based on population census tracks, okay, or at least for the 10% adder. And so the way this works is this is going to be some type of application process that folks are going to apply. I think it’s going to function application-wise a lot like the new market tax credit. There’s a limit on how many projects can be part of this adder. It’s 1.8 gigawatts per year and to an extent not used. It’s going to carry over into the next year. I’m told by my client that they think 1.8 should be sufficient for this, but if your project is located in a low-income community, which is the same definition that we have our OZ, it’s the same definition that we had for OZ tracks that were eligible to be nominated by each governor. So, again, this is place-based.

Jimmy: Right, so there’s 8,700 and change opportunity zones. There may be, what, 35,000 roughly low-income in this track. I’m just kind of guessing ballpark, is that right?

Marc: Yeah, 39% of 75,000. So, that should all be low-income communities. So, yeah, we’re going to have at least 97%, 98% overlap with OZ, because in OZ, we had that 5% carve out, but I’m not aware of any state that actually used the full 5%, so it’s like 2.7% used. But the bottom line is there’s a very, very good chance that if you’re in an OZ, you’re also in one of these low-income communities for this particular adder. And, again, it’s going to be an application process. We don’t know if it’s going to be first come, first serve, or if it’s going to be based on criteria. That actually is part of the comment process that we’re in right now where Treasury has asked folks to comment on these provisions. Comments are due a week from this Friday. They only have 180 days to establish this program from when the act was enacted, so that was August.

Jimmy: So, it’s possible by the time that this episode airs, we will have passed that deadline.

Marc: It’s very possible.

Jimmy: A note for our listener, we’re recording this toward the end of October.

Marc: Yes, yes. So, this is another 10% and…

Jimmy: And we’re up to 20%, right?

Marc: Up to 20%. I’ll explain that one too.

Jimmy: So, that can potentially take the total investment tax credit up to either 60% or as high as 70%. Am I understanding that correctly?

Marc: You’re 100% correct.

Jimmy: That’s impressive.

Marc: You gave the percentages.

Jimmy: Wow, yeah.

Marc: So, the nice thing is this 20% adder. Now this one, oh, I don’t have a… I’m sorry. I don’t have a slide for that, but that would be a situation where you’re… I’ll give you a classic example. You’re putting a solar on a low-income housing tax credit project, so that would get you the 28%. And that’s not based on being in a low-income community. That is more project-based. And if I remember correctly, low-income housing tax credit projects, those are four folks that make 60% or less of the adjusted median income for the state. But it’s more expansive. If I remember correctly, we can go up to 80% and still get that 20% adder. So, you might see more workforce housing, which is probably more in line with what we see in OZ. You know, so some of these OZ multifamily projects may qualify for this particular 20%.

So, now we’re up to 70%, if you can get that. So, at that point, we’re at a 70% credit and now the question is what do you do with the credits, you know, if you can generate that.

Jimmy: Well, yeah, let me ask you that. How do you monetize those tax credits upfront? Because if I understand correctly, there’s some sort of marketplace or ability to transfer the tax credits. How does that work exactly?

Marc: Correct. So, what they changed is the ability to transfer the credits. Now there’s something called direct pay. I’m not going to go into that only because that’s for nonprofits and governmental entities and that’s not going to work with OZ. But I’ll talk about transferring of credit. So, they added this ability…the way it was before is you would do this tax equity deal where you would bring in a tax equity investor that would invest cash in exchange for credit. So, it would be credit, cash flow, depreciation, those are the three things that they would get, because this tax equity investor would be in our ownership structure.

And so it’s very complicated. And so the tax equity investor would come in, make an equity contribution, and then get a 99% allocation of the tax credits, get the depreciation deductions or at least some of them. And then they needed some cash flow in order to meet what they call the economic substance task. So, these deals were super complicated. They had to stay in the deal for five years, and then you had this call option where they would elect to be bought out for fair market value. And, again, we’re getting into some real technical stuff, but they would go from a 99% interest to a 5% interest. We call it a partnership flip. And then the sponsor would buy them out at fair market value for 5% interest, which is nominal compared to the fairly nominal compared to the original equity investment that they made.

So, very complicated. I mean, what I’m describing probably sounds super complicated. These deals were very complicated. And now it’s easier, in a sense, that you just transfer the credits. So, that industry is evolving as we speak. I think it’s going to be a lot of the same players that buy state income tax credits. A lot of state income tax credits are transferable. That’s what this is going to be like where you’re going to find an investor that you can transfer those credits to and they’re going to pay you. They’re not going to pay you more than a dollar a credit. They’re going to pay you probably anywhere from 80-something cents a credit to 90 cents a credit.

A lot of that might be dependent. That price might be dependent upon your ability as an owner of the project to stand behind an indemnification with the transferee of the credit because there is a five-year recapture. So, if you were to take the system on a service at any point during those five years where the system was destroyed but not replaced, the transferee of the credits, they’re going to get hit with recapture. So, they’re going to want the seller of the credits to be able to stand behind an indemnification. So, probably the more creditworthy you are, the higher the price of the credit that you’re going to get.

We project the market’s going to be 80 to 90 cents, somewhere in that range, and it will be a lot simpler of a process but probably less subsidy. So, you know, when you bring in a tax equity investor, you know, they’re paying for depreciation, cash flow, and credits. So, they’re going to pay you more per credit of subsidy than you’re going to get if you just transfer the credits. So, any questions on that? Because this is a loaded concept with lots and lots of interesting tidbits and different things to discuss as it pertains to OZ.

Jimmy: No, it is indeed. I did want to see if we could move the conversation along and talk now specifically about how this act and particularly how these renewable energy tax credits are going to interact with opportunity zone projects, what kind of impact might it have on opportunity zone projects, or how can opportunity zone projects take advantage of some of these new tax credit programs.

Marc: Well, if I could show you another slide, let me just show you kind of… So, this is what I think we’re going to see on the transferring of credits. And I think this is where OZ can really come into play. So, I envision this special purpose entity here to be a qualified opportunity zone business, and these sponsor equity investors, let’s just say that this is a Qualified Opportunity Fund, okay? I could see a situation where we call these EPCs. So, EPC stands for engineering, procurement, and construction. It’s like a general contractor. So, you have a solar company that builds a project, sells that project to a qualified opportunity zone business. That qualified opportunity zone business, that enters into a Power Purchase Agreement for 25 years. And the panels are warrantied. Most panels are warrantied for 25 years, so we typically see a power… And, to be honest, I see appraisals that tell me that the panels are good for 35 years, but we have a long-term revenue source for the qualified opportunity zone business.

And now what we have is a situation where the credits can be sold to a third-party investor who pays you for the credits and that qualified opportunity zone business, when they get cash for those credits that they sell, that is tax exempt income. So, they’re not going to be taxable in the sale of the credits. And what we think is the nice thing is it’s going to increase your tax basis for the owners of the qualified opportunity zone business, and then that increase in tax basis will flow up to also the investors in the Qualified Opportunity Fund. And, again, not to get too technical, but we have that basis increase, which is always a factor in OZ deals, because when you invest in a Qualified Opportunity Fund on your deferred gains, you’re not going to get any tax basis until you have to recognize that income that you just deferred. And that’s going to be at the end of 2026

Jimmy: Right, your basis is typically zero until the end of ’26. Right, yeah.

Marc: Sterile. Unless you have debt, you have no basis. So, you can get allocated the losses but you can’t use those losses. So, they just sit there unused until basis appears at the end of 2026 unless you have the right type of debt structured into these deals. So, you get basis for borrowings of the qualified opportunity zone business if it’s structured the right way. So, here, on the sale of the credits, we’re going to get this basis increase.

Jimmy: And you get it much sooner than ’26.

Marc: Yes, you’re going to get it as soon as you sell those credits. So, you’re going to have that basis increase, which is nice. And the beauty of it is renewable energy, unlike real estate where it’s 27 to 39 years, 27 years on multifamily, 39 for almost everything else, the depreciation, renewable energy right now is bonus depreciation. So, this year or next year, it’s 100% depreciation in the year, place and service. And then after that, it’s five-year property. So, the depreciation period is a lot faster than you’re going to see in real estate even if you do these things called cost seg studies that a lot of people do.

So, there are going to be a lot of losses to transfer. And so in this in this structure here, you’re going to see the losses are… The tax credit investor’s not ending up with the losses. The depreciation deductions are going to stay in this entity and allocate it out to the owners of the entity. So, the question then is, can you use those losses? Because most investors, it’s going to be what we call a passive loss. So, they’ll be able to use that loss against passive income. They’re going to get allocated this loss, but they can only use it against passive income. If you’re an individual, if you’re a C corporation, so if you’re a car dealership and you’re structured as a C corporation, you can use those losses against both your passive income and your active income.

So, there’s three types of income. There’s portfolio, passive, active. Two types of losses, active or passive. So, for a typical investor who’s not in the solar business, those losses are going to be passive. If you’re an individual, you can use it against your passive income. If you’re a C corporation, you can use it against your passive or active income. And if you’re a widely held C corporation, like one of the big financial institutions, if you’re a widely held C corporation, you’re not even subject to the passive loss rules. So, that’s why in the tax equity world, we typically see in the tax equity world the usual suspects that invest in tax equity deals are folks like Chase, and U.S. Bank, and Goldman Sachs. I mean, these are widely held C corporations, so they don’t have to worry about passive loss rules, which also apply to credits as well.

So, that’s the thing that’s so interesting here is, you know, if you go and invest in… You’re investing in the economics of the solar project, which gives you this almost like an annuity, right? It’s this revenue stream with usually great offtakers. You know, a lot of times they’re municipalities or, you know, you see a lot of them on Walmarts and, you know, very good credit-worthy offtakers buying the power and they’re long-term agreements. And so the nice thing is you got this revenue stream coming in, so you know this money’s coming in. You’re going to get a bunch of losses. The question is, can you use those losses?

Now, here’s the beauty. If you can’t use the losses now, you will have passive income coming in, and that is from the revenue stream from the Power Purchase Agreement. So, that will be passive. And so at the very least, you’ll be able to at least use those losses to offset the income you have coming in. It’s a question of how many years it’s going to take the use off those losses. So, if it’s seven or eight years, at least you can look at that and say, “All that income coming in for seven or eight years is going to be tax-free to me, because I don’t have to pay tax on it. I’ve got the losses to offset that income.”

Then here’s the bonus. We get past the 10-year holding requirement, and now I go and sell this solar equipment with the Power Purchase Agreement that has 15 years left of revenue at least, and there might be some extensions. Then I go and sell this, this equipment and Power Purchase Agreement, and now I’m looking at what are my tax consequences because let’s just say I took all the losses, so I got to use the losses, so that’s terrific. The way it works with equipment is, if I buy a piece of equipment for $10 million, depreciate it down, and then go in solid for $4 million, I have depreciation recapture that I have to pay at ordinary income tax rates. And as we know with the Opportunity Zone incentive, even depreciation recapture, as long as it’s not a sale of inventory, when I go and sell this equipment at the end to someone on the secondary market, and there is a secondary market for these projects, when I go and sell that, it’s going to be tax-free. I’m not going to have to recapture that depreciation.

So, that’s the beauty of all this.

Jimmy: And there’s no tax on the gain either.

Marc: There’s no tax on the gain, yeah.

Jimmy: That part’s obvious, I guess, but I had to mention it.

Marc: If you think about it, this is a huge home run and it just seems like such a good fit with the Inflation Reduction Act and the Opportunity Zone incentive. It just seems like a good convergence of the two different incentives.

Jimmy: Absolutely, because so much of the Inflation Reduction Act, renewable tax credits are place-based, and those places, those census tracks often overlay with opportunity zones, it seems like a slam dunk. You might as well put some of these types of deals into opportunity zones. So, that was a great walkthrough, very thorough. Thank you, Marc, for walking us through both the renewable energy tax credits that are available through the Inflation Reduction Act of 2022 as well as how it can be applied to a typical opportunity zone deal. I know you’re working with a number of clients who are working on deals like this, solar deals. Do you have any specific examples of any deals that you’re working on that you’d like to kind of share with us today? Just a couple of anecdotes perhaps?

Marc: Yeah, I mean, I’ve got a deal in Puerto Rico that’s both OZ and solar. And it’s an interesting deal. It was a deal that we were structuring using what’s called an inverted lease, which is a very…it’s a complex way of transferring the tax credit. So, you’ve got your entity that owns the solar equipment, and then we have this master lease where we lease it to this other entity that’s owned by the tax equity investor and then the sponsor of the project. And they have this special rule in the renewable energy area where, if you have this lease, you can pass through the tax credits at fair market value the equipment. You know, so you would get an appraisal for the equipment, and it allows you to pass through those tax credits based on… You know, we were looking at 26% of whatever the fair market value of the equipment was. And then at that point, that entity, we call it the master tenant, has the Power Purchase Agreement, and it’s a complex structure. With the Inflation Reduction Act, we’re looking to simplify things.

And, again, it’s an OZ deal. So, we’re looking to simplify it and using something like what I put up in the structure chart. And it’s a nice-sized project. Energy in Puerto Rico is super expensive. It’s like 30 cents per kilowatt hour. So, it’s up there. You know, so solar makes a lot of sense there. You know, I don’t know what the price per kilowatt hour is going to be on the Power Purchase Agreement, but let’s just say it’s 11 or 12 cents. You know, that saves folks a lot of money, you know, knowing that their power for 25 years is going to be at that 11, 12 cents per kilowatt hour range compared to what they pay there because I think a lot of their energy is diesel-generated, diesel fuel, and so that’s super expensive, especially right now. So, that’s an interesting project and exciting project, a very much-needed project. It’s in an opportunity zone as 97% of the island is. And maybe that would be the classic inflation reduction.

Jimmy: Yeah, that’s true.

Marc: That might be.

Jimmy: That’s a good point. That might actually make the title of the act accurate in that specific case. And any other examples, maybe one or two others?

Marc: Yeah, I have a deal that’s on tribal land, and that’s an interesting one that we’re structuring because we’ve got a lot of things to look at because we’ve got a direct pay option for tribal ownership of projects. But we’ll probably structure that with a third party that will sell energy to a business located on tribal land. And so there we’ve got OZ, and we’ve got low-income communities, so we can take that 30% up to 40%. We don’t have the energy community. We may have domestic content, you know, so that can get us up to 50% on that one as well. And then there’s a bunch of different financing options because it’s on tribal land as well. So, for our debt financing, we have a bunch of options as well. So, a very impactful project. Most stuff in an OZ is, you know, impactful. We’ll talk about that as well, but that’s an exciting one too because of the offtaker here. I can’t go into too much detail because of confidentiality, but that’s an exciting one.

Jimmy: Sure. Well, hopefully, we see a lot more of these deals come to fruition over the course of the next several years of this program. I wanted to talk briefly toward the end of our conversation here about the Novogradac Opportunity Zones Working Group. You and I are both members of that group. I just saw you on the monthly call yesterday. How are you working with the team at Novogradac on any of their OZ Working Group initiatives?

Marc: Well, I just marked up a letter that we have going to Treasury on the Working Capital Safe Harbor. We are seeing a lot of this these days where we’ve got projects that are in stall mode because of financing, right? Because interest rates keep climbing. Construction costs have gone up significantly. It’s not easy to find a guaranteed maximum-price contract. So, a lot of folks, they have a Working Capital Safe Harbor plan, and they’re going to be off, right? It’s either a timing issue, a pricing issue, and so we have comments going to Treasury on specifically what we think the word substantially consistent is because Working Capital Safe Harbor is incredibly important for a number of purposes. One, it sets forth your expenditure requirement on how fast you have to spend the capital contributions that are coming in from the Qualified Opportunity Fund to the qualified opportunity zone business. You have a 70/30 test, a good acid test. We test that at the end of the Working Capital Safe Harbor period for almost all deals, and so that Working Capital Safe Harbor plan is super important for that reason. And then basically when you have to finish your project when you have to get to completion.

So, it has those three components to it. And so, you know, it’s important to be able to get some direction from Treasury on just real-life examples on situations where people have created these Working Capital Safe Harbor plans and things have changed, especially things that were unforeseen, you know, such as maybe, “I don’t have enough money to build that original project. I was going to build a 250-unit residential complex, and now I got to scale that down to 200 units.” You know, there’s so many different situations that are now taking place where folks are saying, “My Working Capital Safe Harbor plan doesn’t say what we’re doing. It says what we were going to do when we created this a year ago, but it’s no longer applicable. And am I acting substantially consistent with that plan? Because if I’m not, then I don’t have a good qualified opportunity zone business.”

And so we’re talking about different situations where maybe projects are not feasible and maybe the project’s no longer feasible. I wanted to sell my land now, and I want to do a different project. And so can I kick the money back up to the Qualified Opportunity Fund and redeploy it? If I do that, I’m obviously not executing on the original Working Capital Safe Harbor plan, but again, that project’s no longer feasible. So, I’m still going to do something that’s impactful in an opportunity zone. It’s just not going to be this project. And it was unforeseen at the time that I created the plan.

And so that’s a letter that we hope to send to Treasury within the next couple weeks. And so I just marked that up over the weekend and talked to our friends over at Novo about it. And so hopefully we’ll get some guidance there.

Jimmy: Yeah, good luck with that. That’s very important. Of course, I’m sure we can spend a whole episode talking just about Working Capital Safe Harbor, but we’ll leave it at that for today’s episode. Maybe save that conversation for another time. To kind of round out our discussion today, Marc, I wanted to ask you about community impact. One of the main criticisms of the program is that it’s not doing what it was promised to do. There hasn’t been enough community impact. What are your thoughts? Has there been enough community impact? And how can we prove that?

Marc: Well, we’ve seen some terrific projects. One of our clients, another plug to someone out there, is Caliber and they’ve done some very impactful projects, behavioral health, charter school. And so others have as well. They’re not the only ones that we’ve seen with some very impactful projects. It’s very important we do this in the new market tax credit arena. You have a grand opening. You want to show off your project. Invite your congressional reps so that they can see what this incentive has done for their districts.

And new markets is kind of implicit. Like, everyone out there, you know, a lot of it is you have a tax credit investor and what we call a CBE that are involved in that project. So, you know, they might be the one sending out the invitation to the congressional rep. In the OZ space, we just don’t see enough of that. We don’t see enough of those grand openings that you get to attend. You’re all proud of the project, but you look around, you don’t have the congressional reps and, you know, local politicians.

And so we need to do that as an industry. If we do that, then these folks can see all the good that the incentive does, because what I’ve been told is, when a lot of the stories you see out there are hit pieces and when I’ve spoken to some of these reporters, you know, I’m like, “Well, how come you’re not writing about the good that it’s doing?” They’re like, “Well, that’s just not news.” The present-day media that we have these days, it’s not news unless it’s a hit piece, right? So, it’s up to us as an industry to get these folks in to see the good that the projects are doing, so that they can take that back to DC when we’re asking for an extension of the incentive. We have, you know, folks on board that you know, can see and can tell their colleagues, “I looked at that project. It’s in my district. If it wasn’t for the OZ incentive, I’m not sure that would get off the ground. Look at the good work that it did.”

Jimmy: Yeah, I’m hoping this podcast can play some small part in telling more of those success stories over time. Well, Marc, it’s been a pleasure speaking to you today. Thank you for all of your insights into the Inflation Reduction Act and specifically renewable energy tax credits and how they interplay with opportunity zone products. If we have any listeners or viewers out there watching us or listening to us right now and they want to learn more about you and Snell & Wilmer, where can they go to learn more and to get in touch with you?

Marc: Sure, website is swlaw.com, Snell & Wilmer, .com or some people say southwest because that’s where a lot of our offices are based. My phone number is 602-382-6358, and my email is [email protected].

Jimmy: Fantastic. For our listeners and viewers out there today, of course, I will as always have show notes available for today’s episode. You can find those show notes at opportunitydb.com/podcast and there I will have links to all of the resources that Marc and I discussed on today’s show. And please be sure to subscribe to us on YouTube or your favorite podcast listening platform to always get the latest from OpportunityDb. Marc, again, it’s been a pleasure. Thanks so much today.

Marc: And thank you, Jimmy, for everything you do for the industry.