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By Bruce J. Wein, Esq., and Drew M. Young, Esq.
DLA Piper, New York, NY
The Internal Revenue Service recently released PLR 201203003 (Letter Ruling) that may have significant implications for developers of renewable energy facilities, subject to a "facility-specific" power purchase agreement (PPA), particularly those facilities that qualify for the energy investment tax credit and the cash grant provided for under Section 1603 of the American Recovery and Reinvestment Act.
In the Letter Ruling, the IRS concluded that a taxpayer, who purchased a wind energy facility subject to a facility-specific PPA, was not required to treat the PPA as a separate asset. Accordingly, the portion of the purchase price attributable to the value of the PPA would be taken into account in determining the basis of the wind energy facility for purposes of calculating depreciation. Thus, the cost of acquiring the facility, including the PPA, could be recovered over the class lives of the facility's depreciable property and no costs would be allocated to the PPA.
The Letter Ruling was issued to an electric company that purchased multiple wind energy facilities. With respect to each of these facilities, the seller had entered into a separate facility-specific PPA that obligated the producer of the electricity generated at a specific wind facility to sell, and the buyer to purchase, a specified amount of the output of that specific wind facility. Pursuant to each PPA, the producer could not fulfill its obligations under the PPA from any source other than the specified wind facility.
In its analysis, the IRS adopted an income approach to valuation and looked to the rules that apply for purposes of determining the depreciation deduction that is available to a purchaser that acquires property that is subject to a lease. When determining the amount of depreciation available for such property, these rules provide that the entire basis is allocated to the property subject to the lease and no basis is allocated to the leasehold.
Potential implications and considerations
Although as a technical matter private letter rulings cannot be relied upon as precedent, developers who place renewable energy facilities in service should also presumably benefit from an increased energy investment tax credit or Section 1603 Grant, since the award is based upon the depreciable cost basis of the facility and the theory of the Letter Ruling is that no basis must be allocated to a "facility-specific" PPA. It should be noted, however, that the Treasury Department's Office of the Fiscal Assistant, which administers the Section 1603 Grant program, has previously indicated that if the income approach is used to support the price paid for a facility and the value determined under this approach exceeds the cost to build the facility by a significant margin, a question is raised as to whether a portion of the claimed value of the facility should be allocated to ineligible assets, such as a PPA (though this issue was raised in the context of a non-arm's length transaction).
In addition to considering the implications of this ruling for purposes of calculating depreciation and the amount of the energy investment tax credit or Section 1603 Grant, developers who will place facilities in service this year should consider whether the portion of their qualifying property's basis that is attributable to a facility-specific PPA is eligible for bonus depreciation. Developers who have claimed tax benefits for facilities that are subject to facility-specific PPAs and were placed in service during prior tax years should consider whether their income tax returns should be amended to claim greater energy investment tax credits and/or depreciation deductions for the facility.
Developers who currently have Section 1603 Grant applications pending with Treasury should consider whether they should amend their grant applications to claim a greater Section 1603 Grant. Further, in the event that a Section 1603 Grant has previously been approved, but not yet funded, consideration should be given to requesting an amendment of the grant.
For more information, in the Tax Management Portfolios, see Maule, 512 T.M., Tax Incentives for Production and Conservation of Energy and Natural Resources.
© 2012 DLA Piper
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