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U.S. wind farm developers know all too well that they cannot raise 100% of the costs of a project from one source. Developers rely on several tiers of capital to cover their needs. They start at the cheapest tier and move to each successive tier as they exhaust the cheaper sources. The tiers generally include the following: grants, government-guaranteed debt, pure debt, tax equity, subordinated debt and true equity.

One source of capital not included on that list is the real estate investment trust (REIT). One of the reasons why REITs are excluded is because they do not fit squarely into any specific tier. However, they are also missing from the list because there has been some debate over whether wind farms are considered real property.

There are viable structures in which a REIT could offer true equity or debt at a lower cost than other sources could. This is particularly important as the two cheapest tiers – grants and guaranteed debt – have become harder to access.

At its heart, a REIT is a corporation that can make efficient investments in real property. U.S. corporations generally are taxed on their income. Then, shareholders are taxed on dividends received from the corporation. Unlike a typical corporation, a REIT largely avoids this double taxation.

A REIT generally is taxed only on income it fails to distribute. The elimination of the corporate-level tax on distributed earnings was intended to give REIT investors the same tax treatment that they would have received if they had invested directly in the REIT’s assets.

The use of a REIT to fund a renewable energy project could lower the project’s cost of capital for two main reasons. First, most REITs distribute all of their taxable income annually, so they owe no corporate-level income tax. This means that a REIT can offer higher dividend yields than a regular corporation can. Second, because many REITs can be publicly traded without affecting this tax advantage, the shares of REITs tend to be highly liquid.


The capital stack

Although there are many benefits that REITs could bring to the renewable energy space, there are also some potential challenges and disadvantages. For instance, a REIT is not a viable vehicle by which to raise tax equity. Even though a REIT only is subject to a single layer of tax, it is not a pass-through entity. That means that tax benefits do not flow through the REIT to its shareholders in order to offset taxes on dividends.

In addition, a REIT would not be able to use production tax credits or depreciation efficiently because a REIT generally has no taxable income of its own. In fact, even if a REIT were to have a small amount of income (if it were to hold back a small amount of earnings), the investment tax credit would be available only to the extent a REIT were to pay tax on its earnings.

In some cases, REITs can provide cash equity. However, in order for that to happen, REITs must clear some hurdles. First, a REIT faces a 100% tax on any income it earns from sales of inventory. The Internal Revenue Service (IRS) treats power sales as the sale of inventory. That means that for any project that sells power to an off-taker, the REIT can only participate through a taxable subsidiary by lending to the project company or investing in an entity that leases the project to a third entity that sells the power.

In addition, a REIT must meet a number of requirements relating to its assets and income. At least 75% of the value of a REIT’s total assets must consist of real estate assets and certain cash type items. A REIT must also earn at least 75% of its income (with certain exclusions) from rents from real property, mortgage interest and other specified real-estate-sourced income.

In general, proceeds gained from leasing real property is good REIT income. This raises the critical question of whether a REIT’s assets consist largely of real property. The IRS defines real property as land, buildings and other inherently permanent structures. This definition does not include “assets accessory to the operation of a business.”

It is believed that the IRS views such excluded assets pertaining to equipment that generates electricity (e.g., a wind farm’s land, pads and towers) as acceptable REIT assets. Conversely, equipment above the tower (e.g., nacelles, blades and hubs) may not be good REIT assets. If a REIT can clear these hurdles, it can participate in a tax-equity transaction.

Like REITs, most project sponsors cannot use tax benefits efficiently, either because they do not have tax liabilities or because they are subject to special rules that make it hard for all but the wealthiest of individuals and large corporations to use them.

For this reason, project sponsors often barter the tax benefits to someone who can use them immediately as an efficient way to raise capital. This is the tax-equity tier of the capital stack. Project sponsors often find it difficult, however, to invest the needed equity to round out the capital structure. Venture capital and private equity are expensive relative to tax equity and straight debt, so REITs offer the hope of a low-cost equity or debt infusion.

There are three common ways project sponsors barter tax benefits in tax-equity transactions: a partnership-flip transaction, a sale-leaseback transaction or an inverted lease. The potential role for a REIT in each of these types of transactions varies.

As long as a REIT can meet its minimum thresholds for income from – and holdings of – real property, it has a fairly free hand to invest in tax-equity transactions, provided that it does not sell power (inventory). If a REIT can meet these minimum thresholds, it merely has to be careful not to cause the tax-equity investor to lose its tax benefits.

Very large REITs will have significant space in which to operate within these rules because a power project’s non-real property could be a very small percentage of a REIT’s total assets or income. Special-purpose REITs designed to own a small portfolio of power projects will have a harder time meeting the rules.

These REITs can avoid investing in bad REIT assets altogether and instead focus solely on owning or lending against good REIT assets. For example, a REIT could lend to a wind project company and take as security only liens on the real property that is part of the project (e.g., the site, towers, pads and transmission assets).

Alternatively, a REIT could buy the real property that is part of a project and lease the property to the project company. This is easier to do in a world without tax credits because pulling a credit-eligible asset, such as a tower, out of the project company and putting it under a REIT would make the credit unavailable to tax equity.


Venture capital and private equity are expensive relative to tax equity and straight debt, so REITs offer the hope of a low-cost equity or debt infusion.


In a partnership flip, an investor would purchase an interest in a limited liability company (LLC) that owns the facility in exchange for an interest in the LLC. The economic returns (including the tax credit) – except possibly cash – would be allocated 99% to the investor. Once the investor reaches its specified return, its share of the deal would flip down to 5%.

Because most projects owned by a partnership sell power under a power contract – particularly in the wind energy sector – a REIT likely would have to invest in a partnership through a taxable subsidiary in order to avoid the aforementioned “selling inventory” restriction on REITs. The subsidiary’s entity level tax could be reduced or eliminated by taking an allocation of depreciation and tax credits. On the surface, taking some tax benefits from the tax-equity investor could seem inefficient. However, partnership tax rules often drag these items from investors anyway.

A REIT could take all or part of the sponsor-side partnership interest without affecting the tax benefits available to the tax-equity investor. A REIT would siphon off tax benefits to the extent of its share of profits prior to the “flip.”

However, that share would be very small (about 1%) – and a non-REIT investor would do the same – so there would be no net loss of value. That would mean a REIT could buy in (at a low price to the sponsor) for a fairly consistent share of the cashflows from the project.

In a sale-leaseback transaction, the sponsor would sell the project just prior to placing it into service and then lease it back. A REIT could come in as a partner with the sponsor or tax equity. The tax benefits would be wasted to the extent of its profit share in any partnership with the tax equity.

However, the partnership could be set up as a flip partnership, in which a REIT’s interest would become more substantial after the tax benefits were fully utilized.

As a partner in a lessee partnership, a REIT would not siphon off any tax benefits from a tax-equity partner. However, it would only get rents (qualifying REIT income) if the lessee were subleasing the project, as opposed to selling power. The rents payable by the partnership likely would be reduced because the lessor could claim tax credits and depreciation on the project.

An inverted lease would pass the tax credit to an investor, who would lease the facility from the project sponsor. The investor (lessee) could claim an investment credit, while the sponsor (lessor) claims depreciation. A special rule precludes a REIT from participating directly in an inverted lease. However, a REIT could lend to an inverted lease’s lessor or lessee if the security is real property that is part of the project. w


John Marciano III is a partner and Kelly Kogan is a senior attorney at law firm Chadbourne & Parke. They can be reached at jmarciano@chadbourne.com and kkogan@chadbourne.com, respectively.

Industry At Large: Project Finance

How Fixing REIT Rules Would Help Wind Projects

By John Marciano III & Kelly Kogan

As access to cheap capital becomes increasingly scarce, REITs could offer debt and equity at lower costs than other sources.








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