Attorney at Law         

Lease versus Partnership Financing Alternatives

    Prior to the 2009 Federal stimulus legislation, energy projects qualifying for production tax credits were legally precluded from utilizing lease financings.  Under the legislation, investors may avoid this prohibition by electing investment tax credits or claiming Treasury cash grants.  Although leases are more tax efficient than partnerships in various respects (e.g., no short taxable year, no sharing of tax allocations, deferred rent structures and a three-month in-service window), and have been used extensively in solar energy financings, some investors prefer the partnership structure and others say they are indifferent.

    The partnership structure provides a way for developers to acquire a significant residual interest through a flip in allocation and distribution ratios.  See Project Flip Partnerships.  The IRS essentially approved such flips in Rev. Proc. 2007-65, albeit its blessing is limited to wind energy projects.  Alternatively, developers may use fixed-price lease options to acquire the residual.  Relatively high payments are required to exercise these options and they may be challenged by the IRS.  A partnership flip also returns the investor’s capital more rapidly than lease rents, particularly if the project produces more cash flow than is assumed in fixing rental amounts.

    Since mid 2008, Mr. Cozart has advised several solar energy developers about the choice between lease and partnership financing structures.  A rigorous decision making process involves weighing competing considerations that cannot easily be reconciled, and requires complex mathematical calculations based on difficult to verify assumptions.  Among other things, structures that provide the same or similar yields for the investor can produce significantly different net present value benefits for a developer.

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