In October 2024, a monumental milestone occurred on Navajo and Hopi land in the southwestern United States. Navajo Power Home, a local solar provider for off-grid homes on the Navajo Nation, partnered with Basis Climate to complete one of the smallest tax credit transfers to date — a $355,000 ITC tied to 100 homes on Navajo and Hopi lands. Inconspicuous and unknown to many, this tax credit sale serves as a testament of the democratization and progressive nature of the new tax transferability regulation. A standalone deal of this size would not have been previously possible with traditional tax equity, but more importantly, the benefits of clean, affordable energy would not have been realized for this often overlooked and marginalized community if not for tax transferability.
Traditional Tax Equity Structure
Credit: Nextracker
The traditional tax equity structure has been in place since 2007 when the IRS released Revenue Procedure 2007-65. While there have been many adaptations of this tax equity partnership throughout the years, the mechanics remain largely the same. The sponsor, who oftentimes lacks sufficient tax capacity to fully take advantage of these tax credits, receives upfront capital and avoids the need to seek additional debt or equity financing. The investor reduces its tax liability via the project’s tax credits and accelerated depreciation deduction, as well as fulfills the increased public demand for clean energy credits for ESG goals.
Tax equity has been at the core of financing strategy for most developers and typically covers around 40% of the cost of a solar project. With legal fees, accountants, engineers, and contract and data rooms compliance and diligence, the initial cost for establishing a tax equity partnership starts at $100,000 and can easily escalate to the millions. These costs and complexities would make any financing arrangement for smaller projects and developers not financially feasible. The result is a limited space that only established large developers and corporations can participate in. For 2023, the average tax equity deal was around $100 million and the tax equity market was around $23 billion, with domestic banks representing over 80% of investors. The two largest investors, J.P. Morgan Chase and Bank of America, account for more than 50% of the entire tax equity market. The lack of accessibility on both the supply and demand side in tax equity is a problem tax transferability hopes to solve.
Democratization by Transferability and Solar
The new tax transferability regulation (Section 6418) in the IRA has drastically increased the ease for smaller developers to monetize as well as smaller investors to purchase these tax credits. Through this direct sale or “transfer” of tax credits in an open market, buyers can purchase these tax credits at around 10% discount, while the seller can receive needed capital upfront and avoid the complexities and costs of a tax equity partnership. Compared to the typical tax-equity transaction of $100 million, more than 80% of transferability deals were below $50 million for 2023. Tax transferability has given smaller players the ability to monetize tax credits for projects that were not financially feasible in the past.
Tax transferability is applicable to many clean energy investments but is especially relevant to solar given its scalable nature. Wind energy, the largest source of renewable energy in the United States, has increasing returns the longer the rotor diameter. Solar on the other hand, does not require as high capex to develop and the technological fundamentals are largely the same whether it be a small behind-the-meter or a large utility-scale installation. This has led to the solar space being more apt for diversity in terms of developer and project size. The largest hurdle historically for smaller solar developers has been access to capital. Tax transferability equips these small developers with the financial tools that were once only available to the large and the few.
Transferability and Solar Rising
Since the U.S. Dept. of the Treasury provided guidance for tax transferability in June 2023, the tax transferability market has grown into an important pool of capital with great depth and liquidity. The size of the nascent tax transferability market now rivals that of the established tax equity market with an estimated $22-$25 billion of tax credit transactions occurring in 2024. The tax equity market for the same year will be between $21 and $23 billion. This dramatic rise in the utilization of transferability over tax equity is predicted to continue with the tax transferability market being forecasted at $60 billion compared to $33 billion for tax equity market for 2030.
According to the U.S. Energy Information Administration (EIA), solar and battery storage projects are forecasted to account for 81% of new electric-generating capacity in 2024 with an estimated 30 GW of new solar capacity expected to come online. Already, solar ITCs account for 35-40% of the total tax credit market; the largest share of the market by far. As more solar sponsors begin to familiarize and utilize tax transferability, the growth of solar will only quicken with more representation from smaller developers. The future of solar is bright, and now with tax transferability, it shines bright enough even for the little guys.
Gary Lee works in the project finance team for Trajectory Energy Partners, a solar developer based in Illinois focusing on Community Solar. Previously, Gary has worked in the finance team for a myriad of companies, ranging from an air quality monitoring startup in Peru to the largest bank in Japan. Gary is a graduate of Tufts University where he received his B.S. in Environmental Science and his B.A. in International Relations. In his free time, Gary volunteers for Dive Against Debris, an organization that combines his passion for scuba diving with marine conservation.
Disclaimer: The opinions expressed are those of the author and do not necessarily represent those of Trajectory Energy Partners.