Distribution utilities are well positioned to provide tax equity for renewable projects, but some state laws prevent it. Tapping the potential will require progressive leadership by utility...
Green REITs, MLPs, and Up-Cs
structures that support PV solar panels. But the tax status of other components of a acility, such as the turbines, blades and nacelles of a wind acility and the inverters of a solar acility, is much more uncertain. 2
In addition to the three REIT asset tests, a REIT is subject to two gross income tests that must be met on an annual basis. First, at least 75 percent of a REIT’s gross income must consist of real estate related items such as mortgage interest, rents from real property, and gain from the sale of real property and mortgages on real property. Second, at least 95 percent of a REIT’s gross income must consist of sources that qualify for the 75-percent income test and other passive income such as corporate dividends (including dividends from a TRS), interest on non-real estate debt, and gains from the sale of non-real estate securities.
Four salient points on the income tests are worth highlighting for renewable energy investors. First, if a renewable energy REIT receives rental income from a TRS, that income is treated as bad income for purposes of both gross income tests. Thus, no more than 5 percent of a REIT’s gross income can consist of rent received from a TRS and other sources of bad income. If, however, a REIT receives real estate mortgage interest from a TRS, that income qualifies for both income tests. Accordingly, in order to comply with the REIT income tests, a commercial relationship between a REIT and its TRS should, if possible, be structured as a creditor-borrower relationship rather than a landlord-tenant relationship.
Second, because TRS dividends are good income for purposes of the 95-percent income test, a TRS can be used to convert bad 95-percent income into good 95-percent income. And although TRS dividends aren’t good income for purposes of the 75-percent income test, a TRS allows a REIT to effectively net its bad 75-percent income against TRS deductions, rather than account for that bad income on a gross basis as it would have to do if it earned that income directly. A TRS can thus be an effective tool for managing the REIT income tests.
Third, any rental or mortgage interest income that is contingent on the net income of the tenant or borrower is treated as bad income for purposes of both income tests. If, however, such income were contingent on the gross income of the tenant or borrower, then the income would be treated as good income.
Fourth, as much as 15 percent of a REIT’s rental income may be attributable to personal property ( e.g., machinery and equipment) if that personal property is leased in connection with a lease of real property. For example, assume a REIT owns and leases a wind facility that consists in part of real property ( e.g., the land on which the facility sits and the tower and pad) and in part of personal property ( e.g., the blades, turbines, and nacelles). If the value of the personal property is 15 percent or less of the value of