Mark Van Deusen is a principal in the Washington National Tax Group at Deloitte Tax LLP, focusing on tax issues faced by REITs and other real estate investors. He will be speaking on a panel addressing tax conundrums, during Nareit’s REITwise: 2023 Law, Accounting & Finance conference in Phoenix, Arizona on March 21-23.
Have you seen a lot of interest among your REIT clients in recently enacted energy tax incentives?
Definitely. Since the passage of the Inflation Reduction Act (IRA) we have had lots of discussions with REITs about how they can now benefit from energy tax credits in ways that weren’t possible before. IRA allows REITs to monetize energy tax credits because the credits are now transferable, meaning REITs can sell them to a buyer for cash.
Before the IRA, REITs typically had to own solar and other projects qualifying for energy tax credits through taxable REIT subsidiaries (TRSs). Those structures were a bit unwieldy, and the corporate tax paid by the TRS reduced the economic incentive to participate in the energy tax credits. IRA changed that. Now REITs can reap the economic benefit of green energy tax credits without paying corporate tax. Not surprisingly, we are seeing lots of interest in those credits.
What types of projects are your clients considering?
Many of our REIT clients are focused on solar projects. Even before IRA, many REITs had installed solar panels on their properties, but the need to own those through a TRS was not ideal.
Also, we have seen a growing number of REITs adopt ESG goals, and solar is a big part of those goals. For those REITs, the IRA provides additional incentives to engage in activities that already made sense from a business perspective. In addition, we are seeing some clients look at solar with fresh eyes given the opportunities created by IRA.
What type of guidance do you need for your clients to implement these investments?
Where to start? With a large tax bill such as IRA there are often more questions than answers. One gating issue with the energy tax credits will be whether passive activity rules apply to credits that are transferred. If they do apply to the transferee, that would effectively preclude individuals from purchasing the credits. If the government determines that passive activity rules do not apply to the transferee, that will likely increase the universe of buyers, which may favorably affect pricing of the credits.
Another important area is the five-year recapture rule that applies to some of the credits. That rule would trigger a recapture of credits that a REIT transferred to a buyer if the REIT sold the property generating the credits within five years. It will be helpful to have guidance on the mechanics of how the recapture rule will apply, especially whether there will be any exceptions to the recapture rule.
Has the interest rate environment resulted in any tax issues for your clients, and if so, how do you suggest they handle them?
The rising interest rate environment has been challenging economically for investors in real estate. At least on the borrowing side, a common way to mitigate that risk is through interest rate hedging transactions, such as interest rate swaps and caps. REITs are subject to special rules for hedging transactions. Income from what are often called “qualified liability hedges” is generally ignored for purposes of the REIT income tests (i.e., the income doesn’t help or hurt compliance with those tests).
There are some identification requirements necessary to obtain qualified liability hedge treatment, and those requirements are different from the GAAP requirements. Also, the qualified liability hedge rules, while generally pretty flexible, do have some traps for the unwary. For example, qualified liability hedge treatment will not apply if the debt the REIT wants to hedge is not in the same taxpayer that enters into the interest rate derivative. Suffice it to say, REITs looking to hedge interest rate risk need to be mindful of the tax implications.