There are several risks that buyers of investment tax credits face (including opportunity cost if a buyer purchases tax credits in advance for a project never placed into service, and uncertainties given the incomplete status of IRS regulation), but two of the most important (and unique to the purchase of tax credits) are as follows:
Excessive credit transfer risk: The first type of risk is that the amount of tax credit is incorrectly determined and is reduced after IRS audit. This risk is generally dependent on events that have occurred prior to the sale. Such an excessive credit transfer can result from several sources: for example, there are detailed rules on what counts and what does not in the calculation of the investment that the IRS will provide an investment tax credit for, and to what extent “soft costs” such as developer’s fees may be included; failure to comply with these rules can result in a credit reduction. The laddered structure of credits under the Inflation Reduction Act described above also introduces the risks that credits may be reduced due to failure to comply with certain requirements, including, for example, those regarding payment of prevailing wages, usage of apprentices, usage of domestic materials, location of the project within an “energy community” or low-income census tract or Tribal lands, or provision of benefits to low to moderate income persons.
Failure to calculate a tax credit correctly may result in the buyer having to repay the excess to the IRS, if the amount of the tax credit sold exceeds the correct credit amount. In addition, if the buyer did not have reasonable cause to believe in the credit amount determined by the seller, it may face a 20% penalty on top of such repayment.
Recapture risk: The second type of risk is recapture, which is the risk that part of the credit will need to be repaid to the IRS if the project ceases to operate, is sold, or the developer fails to comply with prevailing wage requirements, within the first five years after the credit is earned. This reintroduces some project risk to a tax credit sale - to avoid recapture, the project has to remain in operation, maintain compliance with prevailing wages in any repair or alteration work, and the developer or project owner has to agree not to sell. It may also be harder to diligence this risk prior to a sale since it relates to events that occur after the transaction.
The consequences of recapture are slightly different than excessive credit transfer, and depend on what year the event described above triggering recapture occurs during the five-year window: each year, the amount of credit “recaptured” goes down 20 percent, from 100 percent during the first year following the project’s placement into service to 20 percent during the fifth year.
It should also be noted that individual buyers may face individual risks associated with their own tax or regulatory position - for example, banks may need to consider the effect of their capital requirements, and multinational corporations may need to consider the effect of the Pillar 2 treaty if and when it is adopted by the United States.