The IRA is expected to yield over $5 trillion in global economic benefits by reducing greenhouse gas pollution from now until 2050. It also improves local air quality, providing significant health and productivity gains domestically. Since its enactment, the IRA has created over 170,000 clean energy jobs and driven over $110 billion in clean energy manufacturing investments. By leveraging the opportunities presented by the IRA, businesses can significantly offset their tax liabilities while contributing to a greener future through a structure known as an Investment Tax Credit (ITC).
Traditionally, the ITC market has been dominated by large financial institutions with substantial tax liabilities. VerAleo is democratizing access to the ITC market by partnering with smaller groups through a variety of innovative structures, including aggregation of liability, project purchase, and credit transfers. As small to medium-sized businesses navigate the complexities of tax liabilities, the Inflation Reduction Act (IRA) presents a significant opportunity to offset these burdens with ITCs.
Large development projects typically source capital for large projects in multiple forms. For qualified clean energy projects under the IRA, the “capital stack,” as it is typically described, is made up of three components:
1. Debt Investments
2. Equity Investments
3. Tax Equity Investments
This article focus on #3. In exchange for up-front investment, tax equity investors are awarded what is called a “Investment Tax Credit” (ITC) that can be used to offset federal tax liability. In this structure, investors contribute capital in exchange for tax benefits generated by the projects, helping to fund clean energy initiatives while earning returns on their investment.
For growing businesses with recurring annual tax liability, tax equity investments provide a reliable mechanism for keeping total liability as low as possible while simultaneously contributing to the development of sustainable energy infrastructure.
Participating in this program requires businesses to first identify an investment strategy. There are three strategies businesses utilize to access clean energy incentives, including but not limited to solar development projects.
1. Tax Equity Investments for ITCs: Businesses with large tax liabilities can make direct investments into solar projects as sole ITC investors. Traditionally, larger entities (i.e., banks) have had the greatest appetite for ITC investment given their large annual tax liabilities. By partnering with VerAleo, smaller groups can aggregate tax liability to participate in larger projects as a collective, making the process more accessible and financially viable.
Note: Tax-Exempt Entities are eligible for “direct pay” cash receivables: Tax-exempt entities, such as non-profits, can benefit from direct pay opportunities. Instead of receiving a tax credit, these entities qualify for cash refunds, ensuring they can benefit from tax equity investments.
2. Project Purchases: Groups with a stronger appetite for solar investment may also opt to engage in full project purchases, which, in addition to ITCs, provide the purchaser access to monthly cash flows based on the energy generated from the project and sold on the market through power purchase agreements (PPAs). Full project purchases typically present greater risk but can deliver outsized returns when risks are effectively mitigated. Cash flows from PPAs vary depending on market conditions and purchase price.
3. Buy/Sell Credits on the Transfer Market: The IRS now allows tax equity investors to sell credits on the transfer market. This transferability means that businesses can purchase and sell tax credits, providing flexibility and liquidity in managing their tax liabilities. This path is recommended for groups with smaller tax liabilities or a lesser appetite for ITC investment; however, the purchase price for transfer credits is typically higher than the price paid for a direct ITC investment.
The typical return on investment (ROI) for solar tax equity varies depending on the project and market conditions but can generally be understood as follows:
- Tax Equity Yields: Tax equity yields for solar projects have been mainly in the 6% to 8% range. After reaching this yield, the investor’s economic interest in the project usually drops to around 5%.
- Internal Rate of Return (IRR): The IRR on a typical solar tax equity investment is typically in the 15% range. In most cases, once a tax equity investor achieves a certain target return, the sponsor may buy back the project from the investor, and the investor would receive a buyout payment at the end of the project.
Example:
For instance, a solar tax equity investment of $226,180 might include:
- $100,000 in ITC tax credits
- $90,180 from depreciation deductions
- $24,048 in cash payments as a preferred return
- $12,000 in cash payments as a final buyout
Taken together, this results in an 88% ROI with ~16% IRR over 5 years.
The Inflation Reduction Act (IRA) offers unprecedented opportunities for businesses to offset tax liabilities through Investment Tax Credits (ITCs). By engaging in tax equity investments, businesses not only benefit from substantial tax incentives and stable returns but also contribute to environmental sustainability and portfolio diversification. VerAleo facilitates access to these benefits for small to medium-sized businesses by offering innovative structures like aggregation of liability, project purchases, and credit transfers. Understanding these investment strategies and the associated returns can help businesses leverage the IRA effectively, ensuring both financial gains and a positive environmental impact.
To learn more about the best strategy for your business to benefit from IRA incentives, contact us to schedule a consultation.
