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
available sources of capital that, with some tinkering, may provide unregulated utilities with a helpful source of capital in a market and political environment that was unforeseeable six years ago.
Although REITs, MLPs, and Up-Cs are all promising capital vehicles for an owner of a renewable energy project, they have a number of differences, and the best choice for a given project will depend on the owner’s particular operating and financing model.
The REIT Vehicle
A REIT is, from a commercial and legal perspective, just like a regular corporation. But REITs have a crucial advantage over other corporations: unlike other corporations, REITs don’t pay federal corporate income tax on REIT-level income that is distributed to shareholders. Thus, for example, if a REIT earns $100 of income and makes a $100 distribution to its shareholders, the REIT isn’t subject to tax. And because a REIT is required by the tax law to distribute at least 90 percent of its income every year, a REIT is, by definition, a yield vehicle.
In order to qualify as a REIT, an entity must meet a number of requirements, the most important of which are the REIT asset tests and the REIT income tests.
The REIT asset tests, which must be satisfied at the end of each calendar quarter, consist of three parts. First, at least 75 percent of a REIT’s assets must consist of cash and cash items, U.S. government securities, and real estate assets such as interests in land, buildings, and other permanent structures (including fee ownership, easements, and leases), and loans secured by mortgages on real estate (real estate securities). Second, not more than 5 percent of a REIT’s assets may consist of the securities of a single issuer. Third, a REIT can’t own securities representing more than 10 percent of the voting power or value of a single issuer. The 5-percent and 10-percent asset tests don’t apply to real estate securities or the securities (including stock) of a taxable REIT subsidiary (TRS), which is a regular—and thus generally fully taxable—corporate subsidiary of a REIT.
Previous IRS guidance is insightful on the question of which renewable energy assets qualify as real estate assets. For example, the IRS has ruled that a system for the transmission of energy from a generation source to end users can qualify as a real estate asset to the extent it consists of “physically connected” and “functionally interdependent” immovable assets. The qualifying components of such a system generally include interests in land (as described above); towers or poles that are permanently affixed to the ground; lines or wires attached to the towers or poles or buried underground (including gathering lines); substations, switching stations, and distribution transformers; electric meters that are affixed to buildings; and interconnection systems (collectively, “gathering and transmission assets”). Similarly, under the IRS’s past rulings, certain components of a power generation facility (a facility) are likely to qualify as real estate assets. In particular, wind towers and the pads on which those wind towers sit likely qualify as real estate assets. So, too, do the permanently affixed racking