Navigating federal tax credits as an early climate startup or developer

Tax credits are the main incentive to support clean energy deployment in the US, but the nuances of accounting mean they have minimum upfront value, because climate projects often require a major capital investment upfront, but generate revenues that are spread out over 20-25 years. This can delay the point at which the project becomes tax liable, meaning you won’t reap the benefits of renewable energy tax credits for a while. However, there’s another way to monetize these tax credits – by selling them to an entity that has the tax liability to take advantage of them. In the past, this was only a viable option for huge corporations, but it’s becoming increasingly accessible for smaller companies.

Erik Underwood is CEO of Basis Climate. We sat down with him to discuss how climate startups and small developers can leverage tax credits, the eligibility criteria for these types of transfers, and what to expect from the process.

Tax credits: a brief introduction

The tax credit you’ll receive from your project is proportional to either the level of investment in the project (“ITC”), or the production of clean energy that it generates (“PTC”). Tax credits can be carried back three years, allowing a business to amend previous tax returns, or carried forward, though from a time-value-of-money perspective, the buyer then risks missing out on more immediate ways to put that money to work.

The process of transferring tax credits to another party is broadly similar to a purchase and sale agreement. In terms of pricing, with a $1m credit generated by a solar project, you can typically assume  an actual sale price price to the buyer ranging between 85 and 95 cents, but net proceeds north of 80 cents on the dollar, after transaction costs (lawyers, brokers, advisors).

Doing your diligence for a tax credit transfer

Get your project up and running
You can't sell a tax credit if it hasn’t been generated yet, so first, the facility that’s eligible for the credit will need to be up and running. This generally means you’ll need to have received a Permission to Operate letter from your local electricity grid operator and have regular operations underway. 

Once it’s online, you can apply to receive a project ID number from the IRS, which serves as a unique identifier for your project. This number is included in the transfer agreement between you and the buyer, and used in all related paperwork, such as claiming, confirming, transferring, and utilizing the credit. This paper trail combats fraud by ensuring companies are transferring legitimate credits, and confirms the agreed-upon credit amount.

The five year rule
Another criteria is that your facility remains in service for five years – it needs to make a real impact on clean energy generation. The buyer holds the ball here, because if the project goes offline in that time period, the credit will no longer be valid. This means buyers are actively looking for credits generated by projects they  can reasonably expect to be in operation in 5 years. If your project does go offline permanently, you’re contractually obligated to notify them.

Speak to your tax accountants
In most cases, as long as you’re tax-paying entity – meaning your business pays corporate taxes and isn’t a pass-through entity – you’ll be eligible for to transfer tax credits. However, it’s crucial that you speak to your accountants to confirm your eligibility. Municipalities, non-profits, and tribal entities are not able to sell credits from projects they own themselves.

Make sure your paperwork is in order

For the transfer to be successful, you’ll need to be sure your record keeping is exceptional – think of it as building a data room for your tax credit. This will include permits, leaseholding information, proof of ownership of the asset, and construction contracts. Tax credit buyers will also want to see a Cost Segregation Report as part of the diligence package, confirming which capitalized expenditures qualify as investment tax credits. Work with your installer to make sure your contract contains the necessary level of detail to write this report.

Advice for tax credit transfers

The market is still flourishing 
The long-term feasibility of these credits is somewhat in question, given the change in administration. However, it’s not expected that there’ll be any retroactive adjustments around tax credit eligibility, or that projects starting construction – and especially those finishing construction – in 2025 won’t be eligible. 

…But finding a buyer may be difficult
The unfortunate reality is that the smaller the investment, the fewer the options there are available in terms of buyers. This process is complex and time-intensive, so many buyers simply won’t be interested in a transaction under $10m. There is a still a market at this level, so be sure to reach out to brokers and advisors in the space to see if your projects is a good fit.

Do your homework
Put the time in to make sure you really understand the steps involved in transferring tax credits. These are not straightforward financial assets, and the agreements involved are far from simple. Even lawyers themselves can balk at how much legal work goes into completing these transactions. By doing research upfront, you won’t waste time on asking questions once the documents start hitting your desk.

Find lawyers who’ve been here before
Make sure your lawyers are familiar with the process, and they aren’t learning on the job – it will be much more expensive otherwise.  

Erik is the CEO and Cofounder of Basis Climate. Erik has supported the financing or acquisition of nearly $2bn worth of clean energy projects across North and South America. In his free time, he enjoys cooking, swimming, traveling, or just lazing around with his husband and french bulldog “Baco”.