IRS Ruling Provides Additional Advantages to Investors in C-PACE Financings

August 5, 2024

Commercial Property Assessed Clean Energy ("C-PACE") financing enables owners of commercial properties to make long-term, environmentally-focused and energy-related improvements to such properties, including ones related to renewable energy, energy efficiency and climate resiliency, by providing access to long-term, low-interest capital through private lenders or government programs operating in the capital markets. C-PACE financing is only available in cities, counties or states that have passed enabling legislation and set up active programs. Repayments on C-PACE loans programs are assessed on the commercial property's tax bill pursuant to a long-term repayment schedule (usually 20 to 30 years). Because a C-PACE loan is assessed against the property, rather than against the individual borrower, a C-PACE loan is no obstacle to the sale and assignment of the improved property to a new owner.

Traditionally, the Internal Revenue Service ("IRS") has viewed special tax assessments such as C-PACE assessments as debt, and because C-PACE assessments are secured by an interest in real property, they can be viewed as "real estate mortgages" for purposes of the taxable mortgage pool ("TMP") rules. This has made securitization of C-PACE financings a complex, cumbersome means of secondary market activity, since issuers have had to structure C-PACE securitizations in a way that avoids TMP classification and the entity-level, corporate income tax imposed under the TMP rules.

A private letter ruling recently released by the IRS has allowed for the use of alternative structures by clarifying that because the obligation to repay C-PACE assessments are secured by a lien on the entire fee ownership of the improved property, C-PACE assessments are "obligations . . . secured by an interest in real property" for purposes of the REMIC provisions of the Internal Revenue Code (the "Code"). This means that C-PACE financings and the related assessments can qualify as "qualified mortgage loans" under the Code. With this clarification, C-PACE assessments may now be permitted assets for a REMIC, that can be securitized in real estate mortgage investment conduits ("REMICs").

This private letter ruling should make C-PACE assets even more attractive to secondary market investors, make additional funds available for C-PACE investments and, it is hoped, encourage government to further develop and facilitate C-PACE programs. Unlike other securitization structures (which are subject to TMP rules), REMICs can have more versatile capital structures, which may appeal to a wider pool of investors, including investors outside the United States and special entities such as real estate investment trusts ("REITs"). In the case of an investor outside of the United States, a REMIC regular interest will ordinarily satisfy the "portfolio interest" rules which allow an investor outside the United States to receive the interest (and accrued discount) on a regular interest free of United States withholding taxes. In the case of a REIT, depending on a REMIC's underlying assets, a REIT can treat regular interests as good REIT assets that generate qualified REIT income. These advantages should make investing in C-PACE assets even more attractive to investors and encourage more origination of C-PACE assets.

While as a general matter of tax administration one taxpayer cannot rely on a private letter ruling issued to another, this private letter ruling is based on a conservate reading of the REMIC statute and in the absence of some yet undiscovered abuse, should be followed in the case of similar transactions.

Dentons continues to monitor developments in the C-PACE space related to secondary market activity and the evolution of C-PACE programs generally.