Managing greenhouse gas emissions is an inescapable reality in today's world. Whether mandated by law or voluntarily committed, many public institutions served by district energy systems are looking for ways to reduce their carbon footprint. For example, a number of IDEA's university members, have signed onto the American Colleges & University Presidents' Climate Commitment, requiring them to take immediate steps towards becoming carbon-neutral. On a regional level, hospitals, local governments and other non-profit entities are making similar commitments.

Unfortunately, the recent economic downturn has meant budget cuts and limited financing opportunities, making it harder to meet these capital-intensive, climate change goals. Tax incentives have been used since the 1960's to promote energy conservation and encourage investment in alternative energy resources. Recent legislation has expanded the application of these tax incentives to combined heat and power systems and a number of renewable energy technologies. For many businesses, these tax credits make investments in green projects possible. But what about tax-exempt organizations? Local governments, universities, hospitals and other non-profit organizations may not have the tax liabilities against which to claim these credits.

The ability to monetize these tax incentives through partnership with private developers may provide IDEA members an alternative means of funding investments in energy efficiency and renewable energy projects. This column will provide a brief overview of the tax incentives available and business structures that have been used to pass those incentives on to tax-exempt organizations.

Energy Investment Tax Credits
Investment tax credits are available for business investment in "energy property," which includes combined heat and power systems and equipment that uses solar energy to generate electricity, to heat or cool buildings, or provide heat for industrial processes. These credits also apply to geothermal, wind, fuel cell and other renewable technologies. Under the American Recovery and Reinvestment Act of 2009 (ARRA), Congress increased the credit to 30% of the equipment cost (up from 10%) for projects installed before January 1, 2017. The credit vests at a rate of 20% per year; if a taxpayer disposes of the property within 5 years of utilizing the credit, the IRS will recapture the unvested portion of the credit.

The ARRA also provides grants in lieu of the tax credit described above. Instead of the tax credit, businesses receive an upfront cash payment from the U.S. Treasury. However, any entity partnering with a local government or tax-exempt organization is not eligible to receive this grant. Additionally, as with the investment tax credit, the grant is subject to recapture if the property is sold within 5 years of the grant.

Another tax benefit applicable to certain renewable energy projects is the ability to accelerate depreciation. Combined heat and power facilities and some renewable technologies are deemed to be 5-year properties, meaning the applicable recovery period for depreciation purposes is only 5 years.

Energy Efficiency Tax Deductions
Building owners are also able to claim a federal tax deduction of $1.80 per square foot for reducing a commercial building's energy consumption by 50% or more. The deduction is available for modifications to heating, cooling, ventilation, and hot water systems, as well as other improvements to the building envelop and interior lighting. For publically-owned buildings, these tax deductions can be passed on to the person "primarily responsible for designing the property."

State Incentives
A number of individual states have also enacted tax incentives for both renewable energy projects and energy efficiency initiatives. The Database of State Incentives for Renewables and Efficiency contains a comprehensive list of the tax incentives available in each state. See http://www.dsireusa.org.

Monetizing Tax Credits
Over the years, private developers have utilized an assortment of business models to entice capital investment in renewable energy projects by monetizing tax incentives. For example, under the sale-leaseback model, the developer sells the project to investors, and the investors in turn lease the equipment back to the developer to operate and maintain the system. As the owner of the project, the investors are allocated the tax credits.

In a "partnership flip," the developer and investor form a partnership to own the project, and a majority of the income and loss of the project, along with the tax credits, are allocated to the investor. At some point in the future (generally at least 5 years after the property is placed in service so that there are no recapture issues for investment tax credits), the interests are "flipped," causing the partners' interests in the allocation of profits and losses of the partnership to shift.

While tax-exempt entities might take advantage of these models, there are some limitations. For instance, sale-lease back transactions generally cannot involve tax-exempt property. Likewise, state law may limit participation in partnership flips, and risks could include a revocation of tax-exempt status.

The Third-Party Alternative
Another structure gaining in popularity is the third-party ownership and management of renewable and efficiency projects through the use of power purchase agreements or performance contracts. This model may be easier to implement than those described above.

The Power Purchase Agreement (PPA) model has typically been used for solar panel systems, although it could apply to other renewable technologies. A developer installs the system on the customer's property, owns and operates the facilities, and is responsible for all maintenance. The developer then sells the energy produced by the system to the customer under the power purchase agreement, and the tax benefits are realized through a reduced price for the energy.

Similar to the PPA, the Performance Contract model is often used to implement energy efficiency projects. Here, the customer contracts with a private energy service company (referred to as an "ESCO") for retrofits and other energy-saving equipment. This might include adjusting HVAC systems, installing energy management control systems, or modifying boilers and chillers. The customer pays the ESCO to design, install and maintain the equipment. The ESCO is responsible for financing the project, and usually guarantees a level of energy savings over the term of the contract. Again, the tax credits available to the private ESCO could be reflected in the price paid for services under the performance contract.

These third-party contracting models have both benefits and potential drawbacks. On the plus side, there is no up-front cost to the customer. The developer owns the equipment, and is responsible for its operation and maintenance. However, there are still transactional and operational costs involved in these projects. There is also some risk in allowing a third party access to the premises and to on-site facilities.

No Silver Bullet
Business structures do exist to allow public institutions to realize the benefit of tax incentives though partnership with private entities. However, there is no silver bullet - any deal will have its benefits and potential downsides.

Third-party contracting arrangements are probably the easiest to implement. There are a number of issues to consider when negotiating these deals. What happens to the equipment at the end of the contract term? How do you manage the risk of providing the contractors access to your facilities? What, if any, coordination with the local utility is necessary? How do the savings compare to the cost of financing and constructing the project on your own? These, and other factors, may influence the ultimate viability of these third-party options.