Analyzing the tax implications of grants received for investment tax credit-eligible property.

• Author: Bakale, Anthony S.

The recent availability of grants in lieu of the production tax credit (Sec. 45) and the investment tax credit (Sec. 48) has become a well-documented source of funding for the installation of certain energy property. When structuring the financing for non-utility scale projects, taxpayers often claim the investment tax credit under Sec. 48 as well as additional grants from other federal and state programs, such as the USDA Rural Energy for America Program. The combination of tax credits, grants, and accelerated depreciation reduces out-of-pocket costs for such property and creates very attractive payback periods.

Taxability of Grants

Two recent items in The Tax Adviser discuss issues that arise in structuring the financing of such projects. Holets and Strong, "Treatment of Grants as Non-shareholder Contributions to Capital" (September 2009), p. 575, discuss the taxability of grants. Valentine, "Grants in Lieu of Business Energy Credits" (December 2009), p. 809, outlines the availability of grants in lieu of tax credits under Section 1603 of the American Recovery and Reinvestment Act of 2009, PL. 111-5 (ARRA). These grants mirror the eligibility rules for the production tax credit and the investment tax credit, with some exceptions. For the purposes of this commentary, note that the use of the Sec. 48 investment tax credit will be addressed because, as of the writing of this item, ARRA Section 1603 grants have not been extended for projects commencing after 2010, and the ARRA Section 1603 grant rules were intended to follow the investment tax credit rules of Sec. 48.

When structuring the financing of renewable energy projects, practitioners are often faced with the question of whether federal and state grants must be recognized as taxable income. When a taxpayer receives a grant under ARRA Section 1603, Sec. 48(d)(3)(a) explicitly states that such grants are excluded from gross income. The only adjustment that the taxpayer must make is to reduce the depreciable basis of eligible property by one-half of the ARRA Section 1603 grant received. The same rule applies to the basis of property when the investment tax credit is received (Sec. 50(c)(3)(A)).

To determine whether grants received from other federal and state authorities are taxable, practitioners are left to the mechanics of Sec. 118, Regs. Sec. 1.118-1, and case law such as Chicago, Burlington & Quincy R.R. Co., 412 U.S. 401 (1973) (CB&Q). Most practitioners will likely try to fall...