Use Caution When Investing in Renewable Energy Projects

With the proliferation of solar energy projects here in Hawai‘i, there has been a growing number of offers to local investors to invest in local renewable energy projects. These projects usually involve tax credits, passive losses and other incentives with returns ranging from 10-20%. Investors should be cautious when evaluating such projects. Since the returns on a renewable energy project depend heavily on an investor’s ability to qualify and use the tax incentives, it is essential that investors make certain they qualify and can make use of all the incentives in an offering.

Investments in renewable energy projects are often referred to as tax equity investments. These investments typically require an investor to use their tax liability to offset the tax credit incentives generated by the project. These investments often carry a lower level of risk yet offer higher yields than comparable investments. Investors also enjoy the social benefits of contributing to the greening of Hawai‘i.

Potential investors should approach these investments with caution. Even though these types of projects generally carry a lower level of risk than investments with comparable yields, issues often arise with regards to the investment’s tax credits. For an investor to use the tax incentives on a renewable energy investment, it is not enough to just have tax liability. The investor must be able to qualify for what is known as a passive loss and other “at risk” rules. Generally, if an investor is unsure about the difference between passive and active income/loss they probably are not a suitable investor for these types of investments.

Locally, a number of investments have been marketed in the form of an investment group or “Hui”. This is where a number of individual investors each contribute money towards a renewable energy project (typically photovoltaic solar) and in return receive a combination of Federal and State tax credits, depreciation and a stream of income from the project. These investments promise above market returns and generally lower levels of risk. Unfortunately, these “Hui” investments are not appropriate for most individual investors. The IRS is quite clear on the applicability of such investments for individuals. In a safe harbor regarding such investments, the IRS clearly states “...generally, only entities not subject to § 469, and not individuals, will be able to offset non-project income with credits received as a passive investor in a partnership.” In other words, unless an investor has an active role and is personally involved in the operation of a project, the IRS will likely consider the investment as passive. As a passive investment, the investor is only able to use the tax credits and depreciation as an offset against taxes on income from other passive investments, and possibly just from this particular investment. Some other offerings have suggested using structures that circumvent the IRS’s passive loss restrictions. Some have even claimed to have been certified by a lawyer or accountant. Unfortunately, when the IRS performs an audit, it is the investor, not the certifying accountant or lawyer that is left holding the bag.

In general, due to IRS rules, tax based renewable energy investments are usually better suited to large corporations. Large, widely held corporations are not subject to the passive loss or at risk restrictions that effect individual investors and usually have a greater tax liability to contribute.