📝 The intention of the Inflation Reduction Act (IRA), as the name suggests, is to reduce the rate of inflation. How the IRA does this is unique: In the past, energy credits existed, think tax equity. The IRA has taken a smaller market and potentially added as much as a $1 trillion to the tax credits that are available for purchase.
Buying tax credits under the IRA can extend to 10 years. Credits can also be carried back three years and forward up to 22 years.
⚡ Here are the “eligible credits” and code section: Alternative fuel vehicle refueling property (§ 30C), renewable electricity production credit (§ 45), carbon oxide sequestration credit (§ 45Q), zero-emission nuclear power production credit (§ 45U), clean hydrogen production credit (§ 45V), advanced manufacturing production credit (§ 45X), clean electricity production credit (§ 45Y), clean fuel production credit (§ 45Z), energy credit (solar, wind, geothermal – § 48), qualifying advanced energy project credit (§ 48C), and clean electricity investment credit (§ 48E).
🛑 Below, we will answer some of the most frequently asked questions:
✅ Has the IRS provided any regulations? Yes, the IRS has issued Proposed Regulations (regulatory sections 1.6418-1 through 1.6418-5 and temporary regulation section 1.6418-4T). Also, sellers of tax credits under the IRA must register with the IRS. That portal first opened December 22, 2023.
✅ Who can buy tax credits? Corporations, S-corporations, partnerships, trusts, and individuals. However, regular corporations have the greatest advantage. There are possible tax strategies as a result.
✅ Will I get a K-1? No. You are not buying part of a business. You are buying only the credit. Unlike many real estate partnerships that issue a K-1, buying tax credits is a legal contract. You know the exact value of the credits you are buying.
If you buy $10,000 of credits, you get $10,000 of credits on the current tax return. Unless you buy additional tax credits, you get no additional advantage on future tax returns, with the exception of carryforwards.
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✅ How will buying tax credits affect my tax return? Buyers purchase tax credits at a discount. Example: You might pay $8,500 for $10,000 of credits. The discount is not included in gross income.There is a three-year carryback and 22-year carryforward on unused credits.
Credits can be used to pay estimated income taxes. Tax credits are passive. Therefore, the passive activity limitations apply to tax credit purchased.
✅ Is the purchase amount for the credits deductible? No.
✅ Are there any risks? There are always risks and buying tax credits carries a unique set of risks:
- First, due diligence is always necessary. Each project selling credits must follow certain rules for the credits to be valid. You need to determine these rules have been followed.
- Second, the buyer is liable for any recapture credits should the IRS later deny the credits. If the seller is later to be found selling nonqualified credits, the buyer is liable to pay the credits claimed back to the IRS. There is also a 20 percent penalty if some or all of a credit is disallowed.
- Partners and S-corporation shareholders selling some or all of their position could trigger recapture for that specific individual.
- Third, tax credit insurance can help reduce risk, but at a cost. You still need to conduct due diligence. The insurance company will also conduct its own due diligence.
- There are likely more undisclosed risks that will evolve or become apparent as IRA tax credits evolve and regulations clarify.
✅ Why do companies want to sell their tax credits at a discount? Many businesses were formed to take advantage of the landscape for energy credits. These new businesses frequently do not have a tax liability in the early years of their existence but need financing. By converting tax credits into cash, they can acquire the financing they need to fund future projects and maintain current projects.
Selling credits can also service loans. Selling tax credits, in short, frees up capital where a tax credit does not provide current value for the seller.
✅ How do passive activity rules affect tax credit buyers? Regular corporations, with the exception of personal service corporations, generally do not have passive activity issues. That is what makes the C-corporation a prime candidate for buying tax credits.
- IRC Section 469 (passive activity rules) apply to noncorporate taxpayers, closely held C-corporations, and personal service corporations.
- A corporation is closely held if five or fewer individuals (directly or indirectly) hold more than 50 percent of the value of outstanding stock during the last half of the tax year. A closely held corporation can offset passive losses against active income, but not against portfolio income.
- Other candidates for buying tax credits are investors with large amounts of passive income from passthrough entities. Income property owners also might benefit from buying tax credits as long as they are not a real estate professional.
✅ What is the issue with real estate professionals? Real estate professionals must treat rental real estate activities they materially participate in as nonpassive activities. Buying tax credits will not help in such situations.
✅ Can I use the $25,000 Special Allowance for rental real estate if my income is low enough? No. While real estate is usually a passive activity, the special allowance is for real estate only. The IRA tax credits are not real estate related.
✅ What about the alternative minimum tax (AMT)? The IRA created a new 15 percent corporate alternative minimum tax (CAMT).
The good news is that the CAMT does not apply to corporations with $1 billion or less in annual adjusted financial statement income over the three-year period, starting with the current year. Loss carryovers do not apply for this calculation.
Only the largest of corporations will face the CAMT. The Joint Committee on Taxation estimates that only ~150 corporations will be subject to the CAMT.
✅ What do tax credits cost? The seller and buyer agree to the transaction amount. Some brokers use an auction process, while others set a fixed rate, 85 percent or 90 percent to be a common rate. This means buying $10,000 of tax credits will cost you $8,500 if the discount is 15 percent.
You do not add the discount into income, and the credit reduces your federal income taxes dollar-for-dollar against passive income.
✅ Is there a minimum or maximum amount of tax credits I can buy? No. For practical purposes, you don’t want to buy more than you can use currently. Any minimum restriction would come from the firm brokering the transaction. The Tax Code does not place purchased tax credits in a band.
✅ Can self-rental profits be offset by IRA tax credits? Real estate is generally passive income, but if an individual rents real estate to a trade or business he materially participates in, the net rental income is treated as nonpassive.
🛑 To consider: Tax credits offer a new opportunity for some taxpayers to seriously reduce their tax liability after including the cost of purchasing credits.
💥 If you would like an advice to get strategies to maximize your tax efficiency, we can help you at Wave Tax. Contact us at info@wavetax.us