The New Tax Equity
In order to encourage the development of wind energy projects, the government has created a number of tax incentives designed to make those projects economically attractive. These incentives include a production tax credit (PTC) that’s contingent on the amount of energy produced and sold by the project, an investment tax credit (ITC) for money invested in certain energy property, a cash grant from the U.S. Treasury in lieu of tax credits, and accelerated depreciation—including bonus depreciation—for certain types of machinery and equipment used to produce wind energy.
The power of these energy tax incentives to attract capital for wind energy projects has proved remarkable. Industry sources estimate that the PTC alone is responsible for two-thirds of wind energy investments in the United States.
In addition to spurring significant investment in wind energy projects, the structure and power of the various energy tax incentives threaten to create a new set of challenges for the industry. First, the most powerful energy tax incentives—tax credits and cash grants—were enacted as temporary measures with sunset dates that are rapidly approaching. Given our renewed national focus on fiscal austerity, many industry participants worry that the ITC and cash grants won’t be extended, and some fear that even the PTC, which has had its sunset date extended on a regular basis for the past 20 years, might be allowed to expire as well. Second, the boom in wind investments has produced a large number of wind project owners who, having exhausted their tax benefits, now wish to exit those projects.
These challenges have led many industry participants to ask two questions: Who will provide the equity necessary to develop new projects, and who will buy the mature projects?
The search for answers has led to a potential capital source that would have seemed unlikely a few years ago: the real estate investment trust (REIT). In the current environment, REITs might become an important source of start-up and exit capital for new and existing wind projects for two reasons. First, REITs don’t pay corporate tax. Second, REITs are extremely investor-friendly vehicles that provide access to three groups of investors who don’t currently participate in wind projects—U.S. tax-exempt investors ( e.g., private pension funds), U.S. retail investors, and foreign portfolio investors ( e.g., foreign pensions and sovereign wealth funds). Put differently, because a REIT doesn’t need energy tax incentives to reduce its tax bill and can offer access to an untapped pool of investors, a REIT vehicle might, under the right set of circumstances, prove to be an ideal investor for the development of new wind projects and an ideal buyer for existing wind projects.
Key Tax Benefits
The key tax benefit of REIT status is that a REIT, unlike a regular corporation, isn’t subject to the 35 percent federal corporate income tax on REIT-level income that’s distributed to shareholders. Thus, for