ENERGY INVESTMENT TAX CREDITS

1. ENERGY INVESTMENT TAX CREDITS LEARNING THE BASICS: HOUSING TAX CREDITS “101” IPED, INC. San Francisco, California July 24-25, 2008 James F. Duffy, Esquire Nixon Peabody LLP 100 Summer Street Boston, MA 02110-2131 (617) 345-1129 jduffy@nixonpeabody.com

2. CALIFORNIA SOLAR EMPHASIS • Over the last decade, California has been the nation’s leading state in promoting solar energy • The California Qualified Allocation Plan and tax credit application encourage and reward sustainable building methods – and every point counts in a 9% application • California’s solar rebate program (essentially a grant) encourages the use of solar energy

3. CALIFORNIA SOLAR EMPHASIS • Recently, other states have jumped on the “green” bandwagon, and others are planning to follow suit, so the concepts here are by no means limited to California • Solar energy can be used for common areas to reduce property operating expenses or can be master metered to the tenants • To the extent that using solar energy reduces tenant utility allowances, that generally allows rents to increase by an equal amount

4. FEDERAL ENERGY TAX CREDITS • Start with the federal tax credit for solar • Energy Tax Credits (sometimes called “ETCs”) under Section 48 of the Internal Revenue Code are investment tax credits which constitute the principal federal incentive for developing and installing solar power

5. SECTION 48 TAX CREDITS • Available, generally, for energy property using solar energy to generate electricity, to heat or cool (or provide hot water for use in) a structure, or to provide solar process heat (except for swimming pools), or to produce, distribute or use solar energy to illuminate using fiber-optic distributed sunlight, or qualified fuel cell property, or qualified microturbine property • So this is a primarily described as a solar energy tax credit -- Photovoltaic “PV”, Concentrated Solar Power (“CSP”) and fuel cells

6. As an investment tax credit, the ETC (for solar, etc.) is based on the cost of the energy facility, not on how much electricity is produced • In contrast, Federal tax credits for wind, biomass, geothermal, etc. are under Section 45 of the Internal Revenue Code and are based upon electricity production) • For the ETC, there is no requirement that electricity be sold, just that the facility generate electricity for heating, cooling or lighting

7. The ETC is generally 30% of the cost of the “facility” (which does not include ancillary aspects like transmission lines and substations, but can include a reasonable development fee) • The ETC is claimed in full in the year the facility is placed in service (although in certain circumstances it could be claimed based on “progress expenditures” over more than one year) • Recapture possible for 5 years (credit vests 20% per year)

8. ETCs are generally claimed by the owner of the solar facility • A lease can be used so that the tenant claims the tax credits, but most solar facilities are too small to justify the additional transaction costs of documenting a transaction as a lease, at least under the master lease structures used for historic tax credits • ETCs follow “profits” – Unlike LIHTCs which generally follow depreciation losses (be careful with any incentive fees)

9. The use of grants, bonds, “subsidized energy financing” and other tax credits can reduce the ETCs pro rata based on the percentage of the facility funded by these items • ETCs (like LIHTCs) cannot reduce Alternative Minimum Tax liability • There is a basis reduction of 50% of ETCs claimed, which reduces depreciation losses

10. Facilities are generally depreciated over 5 years (5-year MACRS) • Facilities placed in service in 2008 can claim 50% of the total depreciation in 2008 • Under current law, the facility must be placed in service prior to January 1, 2009, or ETCs are reduced from 30% to 10% • Credit extension legislation is under consideration now in the Congress

11. ETCs ON LIHTC PROPERTIES • The same property can take advantage of both ETCs and LIHTCs • If the solar facility is being included in the initial construction or rehabilitation of a LIHTC property, then the solar property can be included in the basis for both tax credits • If the solar facility is being added to an up and running LIHTC property, the LIHTC basis is already established, so only the ETCs can be claimed on the solar facility

12. To qualify for both LIHTCs and ETCs, the tenants cannot be charged for the electricity, as that would cause the panels to be “commercial property” and excluded from LIHTC basis • When combining LIHTCs and ETCs, make sure the ultimate investor (which may be the syndicator’s investor) is in the deal before the solar property is placed in service (possible 3-month lease exception under Code Section 50(d)(4))

13. The LIHTC partnership could own the solar facility and the LIHTC investor could pay additional capital for the ETCs • An affiliate of the developer could own the solar panels and (i) sell electricity to the LIHTC partnership or (ii) lease the panels to the LIHTC partnership; in either case, the developer could syndicate the ETCs to a tax investor

14. ADDING SOLAR TO AN EXISTING LIHTC PROPERTY • The LIHTC partnership could own the solar facility and the LIHTC investor could pay additional capital for the ETCs • An affiliate of the developer could own the solar panels and (i) sell electricity to the LIHTC partnership or (ii) lease the panels to the LIHTC partnership; in either of these situations, the developer could separately syndicate the ETCs to a tax investor

15. Example: Combining ETC and LIHTC *Plus 5-year MACRS (and **Plus S/L depreciation 50% bonus depreciation if PIS in 2008)

16. Often, the ideal transaction structure depends on whether or not the solar facility can be included in LIHTC basis and on the available state incentives • Also, some LIHTC investors and syndicators are more receptive than others to also investing in ETCs 11088199.1