From the investor’s point of view and tax benefits under OZ rules, we are fast approaching expiration the deadline of December 31, 2026 for enjoying special breaks for deferral or reduction of taxes on capital gains invested. This means that in 2027 investors will need to pay taxes on capital gains invested in 2020 and will receive only a 10% reduction in those taxes. (the additional 5% reduction disappeared unless investors made their investments in OZ projects before the end of 2019).
All this means that there should be more focus on two other important tax benefits: One is traditional under the IRS Code and the other is a special OZ benefit. The traditional benefit, not always available on real estate projects, is bonus or 100% accelerated depreciation on the investment in Year 1, if investor funds are used to purchase eligible assets. This is where renewable and clean energy projects come into play. Very often they require a large capital investment in the type of equipment --solar panels and Combined Heat and Power (CHP) and biomass or wind machinery eligible for bonus depreciation. That depreciation is a major tax benefit usually reducing the net cost of the investment by 20% or more in Year 1.
Second, there is an important OZ tax benefit: exclusion of all taxes on the investor’s gain on the sale of a project if the investor holds the assets for ten (10) years. Renewable and clean energy investments in commercial and industrial businesses can provide a positive income stream during the first ten (10) years and an exit strategy: sale or refinancing of the project in year 11. What are the benefits? The benefits can be payback of the principal amount, usually in years 5-10, and tax-free profits on their gain when the project is sold in Year 11. This type of back end benefits, when built into a project should be where the action is.
Fortunately, this interest in tax fee capital gain upon a sale coincides with increased use of OZ moneys to fund industrial projects, including those in the clean energy sector. These projects meet the social goals of job creation. They also can result in greater tax-free gain for investors, now that deferral of capital gain taxes on funds invested in Year 1 is becoming less and less important. As one OZ investor fund put it: “When a business has to fabricate thousand so of items each day, the expectation is to have the electrical power to complete that work. If there’s a power failure, production is interrupted. With backup power like solar, combined heat and power [CHP] and battery storage, production can continue if the grid fails.” Bristol at Greenwave Opportunity Fund, quoted in an interesting article: “Fund Managers are Optimistic about Renewable Energy Projects after OZ Final Regulations” April 6, 2020 navigate here: https://bit.ly/3fecbUG
Let’s take a hypothetical example. Investors place $25 million in capital gains in 2020 to buy 80% equity in a clean energy factory OZ project that has other financing and a bank loan in its capital stack of $50 million. The project also has bonus depreciation-eligible assets like robotics and machinery and can creates 75 good paying jobs for the distressed, OZ locality. This investment will allow the investor to deduct roughly $5 million in Year 1 for Bonus Depreciation. In 2027 the investor saves another 10% on capital gains taxes that have been deferred under the OZ program and now must be paid. During the 10 years of operations, if we assume the factory has sales of $25 million and from profits can return $4 million annually to the investor by the way of dividends, the investors would reach payback of their principal in Year 5 or 6. Finally, if the factory can be sold in ten years for $90 million, the investor will receive 80% of the $90 million sales price or $72 million. This represent a capital gain of $72 million less $25 million = $48 million. However, under the OZ rules, the $48 million is free of all federal income taxes. These are the types of tax savings on a good project that can make money that can attract investors to the many funds now active in the OZ space. THIS IS AN EXAMPLE ONLY AND YOU SHOULD CONSULT YOUR TAX ADVISOR BEFORE MAKING ANY ASSUMPTIONS CONCERNING ITS APPLICATION TO YOUR SPECIFIC TAX SITUATION.
To receive information about a Clean Energy (Combined Heat and Power) OZ Greenhouse Project now seeking up to a $24.75 million equity investment for its capital stack of $64 million, please click here.