On April 25, 2024, the US Department of the Treasury (“Treasury”) and the Internal Revenue Service (“IRS”) issued final regulations (T.D. 9993) (the “final regulations”) concerning the election to transfer certain tax credits under section 6418 of the Internal Revenue Code (the “Code”).1 The final regulations are of interest to public and private real estate investment trusts (“REITs”) that currently have, or are contemplating the implementation of, clean energy programs. (See our recent update: Final Regulations Issued on Direct-Pay Elections and Transfer of Tax Credits.)
The final regulations largely concern the transfer of certain clean energy tax credits under section 6418, which allows eligible taxpayers to choose to transfer all or a portion of eligible credits to unrelated taxpayers in exchange for cash payments beginning after December 31, 2022. The transferees are then allowed to claim the transferred credits on their tax returns. The cash payments are not included in gross income of the eligible taxpayers and are not deductible by the unrelated taxpayers.
The final regulations generally adopt the regulations proposed under section 6418 (REG-101610-23) (the “proposed regulations”), with some modifications, and address the treatment of the relevant tax credits both in the hands of REITs and when transferred by REITs to other taxpayers.
TRANSFER OF TAX CREDITS AND PROHIBITED TRANSACTIONS
The preamble to the proposed regulations stated that cash received by a REIT as consideration for the transfer of an eligible credit is not included in gross income, and, therefore, the credit transfer is not itself a prohibited transaction. If a REIT engages in a “prohibited transaction,” 100% of the gain from the transaction is subject to tax. Commentators had requested that the final regulations clarify how tax credit transfers are treated for purposes of the REIT prohibited transactions safe harbor.
FINAL REGULATIONS
Treasury Regulations section 1.6418-5(i)(2) states that the transfer of a specified credit portion pursuant to a valid section 6418 election is not a sale of property for purposes of section 857(b)(6)(C)(iii) and section 857(b)(6)(D)(iv). These provisions provide a safe harbor for REITs pursuant to which a REIT will not be treated as having engaged in a prohibited transaction if the REIT makes fewer than seven sales over the course of a taxable year and certain other requirements are satisfied. The final regulations clarify that a tax credit transfer does not count towards this seven-sale limit. This clarification should be well-received by the industry, particularly for REITs engaging in the installation of renewable energy systems at multiple properties and REITs engaging in multiple transfers of credits to separate buyers in different transactions.
THE REIT ASSET TEST
Some commentators were also concerned with whether any credits that a REIT has not yet transferred by the end of a calendar quarter would be taken into account or treated as a nonqualifying asset for purposes of the REIT asset test in section 856(c)(4), which requires 75% of a REIT’s assets to be real estate assets, cash, cash items, and government securities.
FINAL REGULATIONS
Treasury Regulations section 1.6418-5(i)(1) addresses this issue by stating that the value of any such credits is disregarded for the purposes of the asset test under section 856(c)(4). Accordingly, the value of the credits is not included in either the numerator or the denominator in determining the value of the REIT’s total assets in section 856(c)(4).
REIT INCOME TEST CONCERNS
Commenters requested clarification that receiving eligible credits does not constitute income to a REIT.
FINAL REGULATIONS
The preamble to the final regulations states that it is a general principle of tax law that being eligible to claim a tax credit is not treated as receiving gross income, and Treasury and the IRS do not see any reason for a different treatment in this context. In light of the foregoing, the final regulations do not specifically confirm that receipt of (or the right to receive) an eligible credit does not result in gross income to a REIT.
REIT DEALER CONCERNS
Commenters also requested confirmation that the sale of energy under the production tax credit provisions is not a dealer sale under the REIT prohibited transaction rules of section 857(b)(6).
FINAL REGULATIONS
The preamble to the final regulations makes clear this matter “is outside the scope of these final regulations[.]” However, the preamble goes on to cite the preamble from T.D. 9784, which stated that, pending further guidance, if a REIT purchases more electricity than it transfers to a utility company during a taxable year, the IRS will not treat net income as a result of those transfers as net income derived from prohibited transactions under section 857(b)(6). The preamble to the final regulations notes that any sale of electricity that is not within the scope of the foregoing preamble should be analyzed on a facts and circumstances basis to determine whether the sale is subject to the prohibited transaction rules.
FINAL THOUGHTS
The final regulations under section 6418 provide much-needed guidance on the transfer election options for REITs with respect to clean energy tax credits under the Inflation Reduction Act (“IRA”). The regulations clarify and extend the applicability of these credits in ways that facilitate more involvement by REITs in the renewable energy space, which has become increasingly common as public and private REITs seek ways to implement green initiatives and monetize the associated federal tax benefits. Although some comments were not adopted, the final regulations represent a significant step forward in implementation of the IRA and allowing REITs to participate in what is evolving to be a robust tax-credit market.
1 Unless otherwise specified, all “section” or “§” references are to the Internal Revenue Code of 1986, as amended, or the Income Tax Regulations (26 CFR part 1).
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