Photovoltaic Systems Share Characteristics of "Real Property"
By Bill Scanlon, NREL
June 25, 2012 | 3 Comments


Photovoltaic (PV) systems may meet many of the important criteria to be considered real property — a status that could make them eligible for easier financing — a new report by the U.S. Department of Energy's National Renewable Energy Laboratory, contends.

The NREL report, "The Technical Qualifications for Treating Photovoltaic Assets as Real Property by Real Estate Investment Trusts (REITs)," points out that PV systems aren't meant to be moved — thus arguably achieving the threshold of "permanence;" and don't involve mechanical energy — thus possibly meeting the criteria for "passiveness." Those are two of the criteria that could gain PV status as "real property," similar to houses or railroad tracks, as opposed to personal property, such as bulldozers or trains.

Currently, PV systems are not eligible for a major source of public funding: Real Estate Investment Trusts (REITs) which are popular among those seeking investments in real assets. Such investors hope to see stable, long-term returns typical of real assets.

The stakes are potentially huge....

That ineligibility leaves PV contending for loans in the private market where lack of supply and access allow investors to demand rates of return that can be three times higher than seen in public markets, said David Feldman, an NREL analyst and co-author of the report....

Context
One of the requirements for solar electricity1 to achieve broad adoption and cost competitiveness with traditional forms of energy generation in the United States is widely accessible and low cost financial capital. The Department of Energy’s SunShot goals, which would result in solar energy contributing to 14% of the nation’s total electricity production by 2030, would require approximately $250 billion of solar electric generation deployment (DOE 2012). Currently, solar electric generation projects are primarily financed by institutions deploying private capital, which often require a high return on their investment. As a result, there has been a growing interest in financial policies and structures that would help migrate financing of renewable energy projects from private sources of capital to public capital markets (Mendelsohn 2012).

One investment vehicle that has been discussed by legal and financial experts in the project finance community to accomplish this is a real estate investment trust (REIT). While REITs have historically provided capital for buildings, they have recently been used to help finance other types of property, such as cellular towers and transmission lines.2 The purpose of this study is to examine the fundamental physical, functional, and operational characteristics of a photovoltaic (PV) system in the context of the characteristics of “real” property as defined by the tax code, to help determine whether REITs can own PV systems. The solar market has treated PV as “personal” property for federal and state tax purposes. If the IRS were to classify PV as “real” property, it would likely have implications on existing market structures. This work has been reviewed and informed by real estate, tax and project finance attorneys as well as experts in PV technology and deployment, however should not be viewed as an exhaustive study of the legal and tax issues surrounding the topic.

Inherent to answering this question is whether PV systems possess three fundamental properties: permanence, passivity, and being integrated as a system. These three properties are associated with real property as follows: The Internal Revenue Service (IRS) stipulates that if a system is inherently permanent, then it is realty,3 and if it is an accessory to the operation of a business, it is not. Inherently permanent and an accessory to the operation of a business are mutually exclusive terms. Therefore, to establish whether a piece of property should be considered realty, it must be determined which term best applies based on the facts and circumstances of the particular situation. Passivity is one characteristic that helps determine whether an asset is an accessory to the operation of a business, and thus non-real property. It is also important to determine what pieces of a PV system should be characterized as real property. If a PV system is integrated, one could make an argument that all of it should be classified in the same way. Therefore, establishing whether a PV system is inherently permanent and passive will help inform whether it is real, and establishing whether it is integrated as a system will establish whether all of it should be treated in the same way. Further research should be performed to explore possible outcomes of treating PV systems as real property, and whether or not it would be practical for REITS to own them.
Introduction to REITs
The REIT structure was designed to bundle and securitize real estate assets in order to attract capital from a wide range of sources. A REIT is a tax designation status that eliminates most corporate taxes so long as the REIT distributes 90% of its taxable income to investors.4 The REIT structure has several attractive features compared to traditional sources of financing for PV. Many of these have the potential to lower the cost of capital for projects, increase the pool of potential financiers, and allow a large number of locations well cited for solar to be more easily developed.

Key Benefits
Some key benefits of REITs include:
....