Genie in the Bottle: The Uncorked Transferable Renewable Energy Tax Credit Market

As the US transferable tax credit market takes off, renewable developers and policymakers should push for further refinements

Headlines about the 2022 Inflation Reduction Act (IRA) emphasized the $391 billion committed by the US government to fund and incentivize clean energy investments. Less heralded, however, were provisions that gave qualifying recipients of these incentives the ability to trade them, thereby creating a new market.

Despite initial skepticism about transferable tax credits (TTCs), sellers and buyers have shown a robust appetite. Full-year activity in 2024 has been projected to reach up to $24 billion from a potential pool of $50 billion in tax credits.

This uptake has significant implications for both policymakers and renewable energy proponents: namely, the explosive growth of the TTC market demonstrates the frictional costs associated with prior tax equity structuring requirements. Stakeholders therefore should focus on further reducing the effect of real-world frictional costs for incentive schemes, as measured against economic efficiency and political costs.

Addressing Past Frictions

The US is unusual in that it has historically relied on tax subsidies as the primary means to stimulate renewable energy projects, whereas regions such as the European Union favor grants or other direct transfers. These subsidies principally come in the form of credits against income tax for owners of qualifying projects. The value of these tax credits is substantial (representing 30 to 70 percent of the project cost). However, the US addiction to tax credits has long been a problem for the many renewable energy project developers and other project owners that do not have US tax to offset.

Prior to the IRA, project developers resorted to complex financial structuring to realize as much value of the tax incentives as they could, most commonly via partnerships with financial institutions such as US banks with reliable tax obligations. These partnerships were bespoke, requiring significant tax and legal efforts; they also, in the eyes of many developers, left a healthy portion of the project value in the pockets of the banks. Developers believed the tax partnership structure limited the volume of projects too, as a small group of banks had finite tax capacity to commit (approximately $18 to $20 billion) and used this limited resource to their benefit.

As a result, tax-poor developers have lobbied for—and occasionally secured—a low-friction approach: a direct refund of renewable energy tax credits by the federal government, such as the Section 1603 tax grant in lieu of credit during the global financial crisis. The direct pay or refundable solution is less popular among policymakers. Legislators suffer higher-budget cost scoring from the Congressional Budget Office that increases the fiscal deficit. The US Treasury also dislikes sending checks directly to developers, as government officials are then directly responsible for assessing recipients’ eligibility for these payments.[1]

In the absence of refundable credits, the IRA allows businesses to sell tax credits for cash without the baggage of tax equity partnerships.

 

 

Despite Challenges, TTC Uptake Exceeds Expectations

Initially, market observers expected the TTC market to develop cautiously. Final IRS guidance on TTCs was not issued until April 2024, creating uncertainty around the IRA’s interpretation. Congress added a 20 percent penalty on overclaimed amounts for IRA tax credits (in addition to any disallowed credit) to discourage aggressive claims.

The IRS also holds the TTC buyer “at risk,” so buyers seek indemnities from sellers for the risk of credit recapture. As a result, sellers (or their parent guarantors) need to be either sufficiently creditworthy to provide a “bankable” indemnity or must purchase acceptable insurance against recapture risks. What’s more, TTCs do not directly tap into other significant tax benefits monetized through tax equity partnerships, such as a “step-up” in the basis of the project to its fair market value (when a project goes into a tax equity partnership) and the time value of accelerated depreciation.

None of these concerns has slowed TTC market growth. Even before the IRS issued its final guidance, buyers and sellers had already inked $7 to $9 billion of TTC transactions in 2023. In addition to numerous smaller developers taking advantage of the burgeoning TTC market, big players have entered the fray: First Solar sold $700 million in solar manufacturing tax credits, and NextEra announced $1 billion in transfers for 2024. New market participants, including both financial and corporate investors, have moved into the buyer column, expanding renewable energy tax investors beyond the traditional bank providers.

Further, the availability of tax credit insurance appears to be sufficient, with some TTC sellers seeking flexibility from buyers in their insurance coverage requirements. Transaction terms and legal documents have become reasonably standardized, reducing the time needed to close.

And, perhaps ironically, the tax equity partnership, despite all of its attendant complications, has not gone away for TTC transactions. The partnership structure can still play a role as a vehicle to retain the added tax value of the step-up in basis for investment tax credit deals. The step-up would include the full tax attributes of the project (including depreciation) as part of the fair market value assessment when a project is transferred to a partnership. The partnership can then become the seller of the tax credits to TTC buyers.

A Good Model to Build Upon

The rapid market adoption of TTCs supports renewable project developers’ claims that the pretzel-like contortions required to unlock federal tax incentives—in which the portion of the sector most involved in bringing such projects into fruition was the least able to enjoy benefit from these incentives—inhibited US clean energy growth.

Barring an unwanted financial crisis, the oft-wished-for, low-friction direct-pay/refundable option for for-profit developers is unlikely. More economically efficient approaches, such as carbon taxes/pricing, appear to be too transparent and thus high in political costs. The next general election in Canada (no later than October 2025) has been described as a carbon tax referendum by both major political parties there and may quantify those political costs to the United States’ northern neighbor.

Therefore, developers, market providers, and policymakers should focus on making further refinements of TTCs in future legislation or rulings, including those that might unlock the value of “step-up” and depreciation benefits.

 

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[1] Although refundable tax credits were not provided for most of the for-profit renewable energy sector in the IRA, they were made available to state, local, and Tribal governments; nonprofit organizations; other tax-exempt entities such as rural electric cooperatives; and for-profit entities for specific categories of tax credits.