What’s a Solar REIT?
Recently, the IRS made a so-called “private letter ruling” that—under certain conditions—allowed solar equipment to be a “good asset” as part of a Real Estate Investment Trust (REIT.) While this ruling is promising news for financing commercial solar projects, it’s not the “Solar REIT” that solar finance people were hoping would be approved.
REITs and Solar REITs
Traditional REITs (Real Estate Investment Trusts) are a longstanding financing method in which individual investors invest in a fund that buys property or makes loans for real estate assets or invests in other “good assets” applicable to real estate. As long as the REIT annually pay its investors at least 90% of the REITs profits, the REIT itself isn’t taxed. Instead, only the individual investors are taxed on their REIT dividends, thus avoiding double taxation.
Seeing this successful real estate development and financing model, the solar industry wanted to create Solar REITs (Renewable Energy Investment Trusts) that would bundle investors to fund solar projects or solar loans and pay out dividends to individual investors. For this model to be legal, it requires either Congressional action (difficult) to create a separate Solar REIT law, or it would require the IRS to simply redefine what a REIT is, and include solar energy as a “good asset.”
This most recent IRS private letter ruling does not open the floodgates to creating Solar REITs, but it does allow traditional real estate REITs the ability to invest in solar as an energy efficiency asset for the buildings owned by the REIT.
According to Kelly Kogan of Chadbourne & Parke, the main point of the IRS ruling is that the solar installation qualifies as a good REIT asset if it’s structurally and functionally integrated with a building, which most solar installs are. In addition, solar was part of other energy efficiency measures, not just producing electricity, which is a “bad” asset. The ruling also allows loans secured by such permanent energy efficiency equipment to qualify as good REIT assets, provided that the loan is also secured by the building with the equipment and that the lender (the REIT) has the right to foreclose on the building in the event of a borrower default.
Beyond this ruling, there are other ways that traditional REITs are funding solar projects under the current law, and it involves creating a Taxable REIT Subsidiary (TRS) to own solar PV projects or to develop projects.
As described by Jared Wiedmeyer in this National Renewable Energy Laboratory (NREL) blog post, REITs can create a TRS that can develop, finance, and own rooftop solar PV systems. The TRS can then receive the benefits of the 30% Investment Tax Credit and also make income by selling the power generated to the building tenants. The TRS then returns this after-tax income to the main REIT fund.
A second way for traditional REITs to finance solar is for the TRS to act like a developer and fund the construction of solar projects on land that it owns. The TRS cannot directly sell power, but it can sell its interest in the solar project to a utility or PPA company. Once again, the TRS income will be taxed, but the net proceeds will be transferred to the parent REIT.
A third way to utilize the REIT is by simply renting the actual land or rooftop space for the purpose of solar development. Here, no TRS is formed, but the REIT is leasing the land or rooftop to a solar developer, who can profit via a solar PPA or a local feed-in-tariff (FiT). Thus, the only income the REIT receives is real-estate related, and therefore a “good asset” that does not jeopardize the REIT’s non-taxable status.
All of the above methods are indirect ways to finance solar projects, but it is complicated and requires rigorous adherence to the detailed regulations and rules, plus the TRS work-around is a taxable entity. Please confirm all of the above with your tax attorney.
Should Congress or the IRS act to create an official Solar REIT dedicated to renewable energy, it’s likely that investors would fully embrace these funds as they have traditional real estate REITs. Solar REITs could not only fund commercial solar and utility projects, but also residential solar, significantly expanding solar development across the U.S… But that’s not the case yet.
If you’re a REIT or TRS and would like to develop solar projects under existing regulations, consult with REC Solar. With over 11,000 installations on homes, retail stores, and for utilities, the REC finance team can help develop, construct, and manage “good” REIT solar assets. Get started here.