The recently passed Inflation Reduction Act has changed the way municipalities can structure and finance their renewable energy projects. Local governments can now access renewable energy incentives directly, a means of financing projects historically unavailable to them.
Municipalities considering renewable energy projects for their communities just received a big boost from the Inflation Reduction Act (the Act) enacted by Congress in August 2022. Historically, development of renewable energy projects has been driven by federal and state incentives, including federal tax credits. Since municipalities and other 501(c)(3) organizations don’t pay taxes, they haven’t been able to take advantage of many of these incentives directly. As a result, most projects have been structured and financed through private ownership, at least for a period of time, in order to fully capture the benefit of these tax credits.
The newly created provisions of the Act changed all of this. Now there’s a new alternative that allows municipalities and tax-exempt organizations to access certain incentives directly through the receipt of direct payments from the U.S. Treasury in lieu of receiving tax credits. This provision seeks to level the playing field between taxpaying and non-taxpaying entities and eliminates the need for private ownership of renewable energy projects.
Direct payments in lieu of tax credits
The new provisions of the Act provide municipalities and tax-exempt organizations with a newly created direct payment option in lieu of tax credits. The amount of the credit will be paid to the municipality or tax-exempt entity when they make an election to receive the credit on a filing made in the year in which the project is placed in service.
This provision takes effect for tax years starting after December 31, 2022 and ending before January 1, 2033.
Financing with tax-exempt debt
Since private ownership of renewable energy projects is no longer necessary to capture the full value of the federal tax credits, local governments can now finance these projects with 100% tax-exempt debt and still be eligible for the direct payment in lieu of tax credits. However, if a project is financed with tax-exempt debt, the direct pay amount will be reduced by the lesser of (a) 15% of the credit or (b) the portion of the qualifying project that has been financed with tax-exempt debt.
This allows renewable energy projects to be financed 100% with tax-exempt debt while only reducing the direct pay tax credit by 15%. Compared to a privately-owned renewable energy project financed with taxable debt, the ability to finance these projects with tax-exempt debt can significantly reduce the financing cost of the project – even with a 15% reduction in the direct pay amount.
Investment tax credits – amount of tax credit
In general, for qualifying projects, the investment tax credit has a base rate of 6% of the applicable costs with an increased rate of 30% for projects meeting certain prevailing wage and apprenticeship requirements.
Projects that begin construction on or before the date that is 60 days after the U.S. Department of Treasury issues guidance on these prevailing wage and apprenticeship requirements will qualify for the increased 30% rate regardless of whether the qualified project meets the prevailing wage and apprenticeship requirements.
In addition, the investment tax credit may be further increased for qualifying projects if certain requirements are met, including:
- Domestic content – An additional tax credit up to 10% is available for qualifying projects incorporating sufficient domestic materials
- Energy community – An additional tax credit up to 10% is available for qualifying projects located in an “energy community”
- Low-income communities – Additional tax credits are also available for qualifying wind and solar projects located in certain low-income communities
Investment tax credits – types of projects
The Act provides for an investment tax credit for the following specific types of renewable energy projects:
- Small wind energy
- Energy storage (e.g., batteries)
- Fiber-optic solar
- Waste energy recovery
- Fuel cells
- Combined heat and power
- Microgrid controllers
- Heat pump
In addition, the costs of interconnection property for qualifying projects may also be included, as long as the maximum net output does not exceed five megawatts.
A complex, but significant opportunity
The law governing tax credits is complex and each municipality should consult their own legal counsel regarding whether a specific project qualifies to receive such tax credits and the amount of the tax credit that may be available for the project. However, the recent changes provided in the Inflation Reduction Act create a new opportunity for municipalities to directly take advantage of valuable incentives previously unavailable to them for renewable energy projects.
Learn more about how UMB Bank, n.a. Public Finance can support your organization’s financing and capital needs, or contact us to be connected with a public finance specialist.
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