The IRS has opened the door a crack for real estate investment trusts (REITs) to be the lessors of wind projects.
To qualify as a REIT, a corporation must satisfy a series of complicated tests that require the corporation to own certain percentages of “real estate assets” and certain percentages of its gross income to be related to certain specified real estate activities.
Regulations proposed in May create an opportunity for REITs to invest in distributed generation solar and have the solar system count as a “real estate asset” and the rents attributable to the system count as “rents from real property.” The proposed regulations are discussed in a client alert available here. The proposed regulations are available here.
The proposed regulations require that the REIT own the distributed generation solar system, the REIT own the building, the solar system provides most of its electricity to the REIT’s building, and the REIT lease the solar system and the building to a single tenant.1
At a District of Columbia Bar Association meeting, an IRS lawyer said that the principles in proposed REIT regulations for solar could be extended to wind. But she made it clear that the extension of the proposed regulations to wind was subject to the same conditions that applied to solar:2 the REIT would have to own the wind project and the building, the wind project would have to supply most of the electricity it generated to the building, and the wind project and the building would have to be leased to a single tenant.
At the meeting, the IRS was pressed to agree that a REIT could also own a utility scale wind project that was not associated with a building, so long as the REIT leased the project to an operator and the operator sold the electricity. The lease is intended to make the REIT a passive owner because REITs are not supposed to be operating businesses. The IRS attorney declined to bite at this bait. The IRS attorney’s rationale was that the REIT solar example only worked because the solar system provided electricity to the REIT’s tenant, and that would not be the case for a utility scale wind project.3
The statements from the IRS lawyer regarding wind projects create a narrow opportunity for a REIT to own distributed generation wind assets that serve the REIT’s building. However, the REIT does not need the tax credits or depreciation generated by such assets because a REIT, unlike other publicly traded corporations, receives a tax deduction for merely paying a dividend.4 Further, it does not appear that REIT could enter into a tax equity transaction to have a third party monetize the tax benefits because the proposed regulations require the REIT to “own” the project. Thus, the distributed generation wind (or solar) project would have to be economically attractive to the REIT without the benefit of the tax subsidies available to other renewable energy investors. It will be interesting to see if any REITs see the proposed regulations as creating a viable commercial opportunity for investing in distributed generation renewable energy projects.
It is important to note that statements by IRS employees at bar association or industry meetings are not binding on the IRS. However, the statements do suggest a willingness on the part of the IRS to potentially issue a private letter ruling. Further, the proposed REIT regulations are not effective until published in their final form in the Federal Register, but they also suggest a willingness on the part of the IRS to potentially issue a private letter ruling.
1 Prop. Reg. § 1.856-10(g), Ex. 9.
2 Amy Elliot, Solar REIT Real Property Guidance can be Extended to Wind, 2014 Tax Notes Today 118-3 (Jun. 19, 2014) (statements attributed to Julanne Allen, assistant to branch 3 chief, IRS Office of Associate Chief Counsel (Financial Institutions and Products)).
4 I.R.C. § 857(b)(2)(B), (3)(A)(ii).