Tax credit investing for individuals: rules on passive activity

November 6, 2023

At Crux, we hear frequently from individuals interested in participating in the market for clean energy tax credits — both to seize an opportunity to invest in sustainable energy and manage federal taxes. While individuals can participate in the market, that opportunity is currently limited. As with any tax credit transaction, it is the responsibility of the buyer to ensure that their tax liability is adequate and that credits can be used to offset that liability. We encourage anyone interested in participating in this market to speak with their personal tax advisors. 

Democratizing clean energy finance

Historically, the overwhelming majority of tax equity was provided by large corporations (predominantly banks) that had sufficient tax liability and sophistication to invest in clean energy projects and access the tax credits those projects generate. In turn, the projects these companies invested in were also large — leaving out many smaller projects. 

The new provision in the Inflation Reduction Act that permits clean energy project developers and manufacturers of all sizes to easily transfer their tax credits to another unrelated taxpayer (we call this “transferability”), opens an entirely new channel for clean energy finance and investment. Many companies of all sizes, and many individuals, are eager to explore how to engage in this new marketplace.

For 2023 alone, projects of all sizes have listed their credits for sale on Crux; our smallest credits can be as little as a hundred thousand dollars and our largest are in the hundreds of millions. This market is wide open, and we are eager to encourage buyers of all sizes to get involved. 

That said, there are important rules that govern the ability of individuals, as opposed to corporations, to purchase tax credits. In practice, individuals may find this market challenging to navigate and we strongly encourage any individual to speak with their tax advisor to understand their unique circumstances.

Passive activity 

The most significant aspect of the IRS’s rules for transferability as it relates to individuals centers around the designation of the transferable tax credit as a passive credit, which can only be used to offset income from passive activities. Taken from the IRS’s draft guidance, issued in June, “[A] transferee taxpayer subject to Section 469 would be required to treat the credits making up the specified credit portion as passive activity credits.”

The IRS’s passive activity rules limit individual investors to using passive activity credits only against income from other passive activities. Passive activities include any trade or business in which the individual did not materially participate and many real estate rental activities (the IRS has thoroughly defined what constitutes material participation). While most individual taxpayers will not have passive income, there are some who will. Individuals with substantial investments in real estate, passive interests in private companies, and pass-through partnerships (like master limited partnerships) may report passive income and have the opportunity to offset it by purchasing passive clean energy tax credits. 

Passive income is not evenly distributed among individual taxpayers — many will have none, some will have some, and a few may have quite a lot. Crux is currently engaged with family offices that are actively participating in this market, and the wide and diverse array of projects on our platform allows us to serve credit buyers of all sizes.

Potential for future consideration

The guidance from the IRS limiting tax credits to passive income tax liabilities is still a draft, and the agency sought comments from the public on this issue (comments were due August 14). In the notice of proposed rulemaking, Treasury specifically sought comments on whether there are circumstances in which it would be appropriate to not apply the passive activity rules under section 469 to a transferee taxpayer or to attribute the participation of an eligible taxpayer to a transferee taxpayer. Recent reporting suggests the Treasury continues to evaluate how or whether to expand the opportunities for individuals to purchase clean energy tax credits. As the rules come together, it will continue to be important for individuals interested in purchasing tax credits and their advisors to remain updated with the market and any regulatory changes. 

Crux supports buyers, sellers, and their advisors in transactions of all sizes. Our software and suite of standardized documents streamlines the process of transacting and lowers barriers to participate in the market. Get started today.

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