In October 2024, a monumental milestone occurred on Navajo and Hopi lands in the southwestern United States. Navajo Power Home, a local solar energy provider for off-grid homes in 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. Unremarkable and unknown to many, this sale of tax credits serves as evidence of the democratization and progressive nature of the new tax portability scheme. A standalone deal of this magnitude would not previously have been possible with traditional tax equity, but importantly, the benefits of clean, affordable energy would not have been realized for this often overlooked and marginalized community if it were not for tax portability .
Traditional tax share structure
Credit: Nextracker
The traditional tax structure has been introduced since 2007, when the IRS released Revenue Procedure 2007-65. While there have been many adjustments of this tax equity partnership over the years, the mechanisms remain largely the same. The sponsor, who often does not have sufficient tax capacity to take full advantage of these tax credits, receives capital upfront and avoids the need to seek additional debt or equity financing. The investor reduces its tax liability through the project’s tax credits and accelerated depreciation deductions, while meeting increased public demand for clean energy credits for ESG objectives.
Tax equity is at the heart of the financing strategy for most developers Typically covers about 40% of the cost of a solar project. With legal fees, accountants, engineers and compliance and due diligence of contracts and data rooms, the The initial costs for setting up a tax equity partnership start at $100,000 and can easily escalate to millions. These costs and complexities would make any financing arrangement for smaller projects and developers financially unfeasible. The result is a limited space in which only established major developers and companies can participate. Before 2023, the the average tax share deal was about $100 million and the The tax equity market was approximately $23 billionwhere domestic banks are represented more than 80% of investors. The two largest investors, JP Morgan Chase and Bank of America, report for more than 50% of the entire tax equity market. The lack of accessibility on both the supply and demand sides of tax justice is a problem that tax portability hopes to solve.
Democratization through portability and solar energy
The new tax portability provision (Section 6418) in the IRA has dramatically increased the ease for smaller developers to generate income and for smaller investors to purchase these tax credits. This direct sale or “transfer” of tax credits on an open market allows buyers to purchase these tax credits from about 10% discount, while allowing the seller to receive the necessary capital up front and avoid the complexity and costs of a tax equity partnership. Compared to the typical $100 million tax equity transaction, more than 80% of transferability agreements amounted to less than $50 million in 2023. Tax portability has given smaller players the opportunity to monetize tax credits for projects that were not financially viable in the past.
Tax portability applies to many clean energy investments, but is especially relevant for solar energy given its scalable nature. Wind energy, the largest source of renewable energy in the United Stateshas an increasing efficiency as the rotor diameter increases. Solar energy, on the other hand, does not require such high investments to develop and the technological fundamentals are largely the same whether it is a small behind-the-meter installation or a large utility-scale installation. This has led to the solar space being more suitable for diversity in terms of developer and project size. The biggest hurdle for smaller solar developers historically has been access to capital. Tax portability gives these small developers the financial tools that were once available only to the big and the few.
Portability and solar energy
Since the U.S. Treasury Department issued guidance on tax portability in June 2023, the tax portability market has emerged as an important capital pool with great depth and liquidity. The size of the emerging tax portability market now rivals that of the established tax equity market It is estimated that between $22 and $25 billion in tax credit transactions will occur by 2024. The tax stock market for the same year will be between 21 and 23 billion dollars. This dramatic increase in the use of portability over tax share is predicted to continue as the tax portability market is forecast $60 billion compared to $33 billion for the tax equity market in 2030.
According to the US Energy Information Administration (EIA), solar and battery storage projects are expected to take this into account 81% of new electricity generation capacity in 2024 with an estimated 30 GW of new solar capacity expected to come online. Already, solar ITCs represent 35-40% of the total tax credit market; by far the largest market share. As more solar sponsors become familiar with and take advantage of tax portability, solar growth will only accelerate with more representation from smaller developers. The future of solar energy looks bright, and now that the loads are transferable, it’s shining bright enough even for the little guys.
Gary Lee works on the project finance team for Trajectory Energy Partners, an Illinois-based solar developer focused on Community Solar. Previously, Gary has worked in the finance team for a variety 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 BS in Environmental Science and his BA in International Relations. In his spare time, Gary volunteers for Dive Against Debris, an organization that combines his passion for diving with marine conservation.
Disclaimer: The opinions expressed are those of the author and do not necessarily represent those of Trajectory Energy Partners.