Capital Leases vs Operating Leases To Fund Solar Investments
What is a capital lease?
Capital Leases offer Solar PV projects little incremental advantage over a conventional bank loan.
- Capital Leases address the up-front cost barrier in a similar manner to a traditional bank loan.
- Leaves Tax Benefits with the site host (lessee), which can be undesirable if the lessee cannot effectively use them (many cannot).
- Consequently most lease financing of commercial PV installations has been done through Operating Leases which offer a broader spectrum of options to tailor to the Lessee's needs.
Learn More About Capital Leasing
What is a operating lease?
Operating Leases provide a number of potential advantages over the financing structures of Capital Leases:
- Operating Leases address PV’s up-front cost barrier by efficiently allocating the project’s tax benefits to those parties best able to use them, while having no direct impact the site host’s balance sheet. (Performance risk, along with the responsibility to operate and maintain the system, stays with the lessee/site host.)
- The recent trend towards longer lease terms offers a potential for making PV projects economical in the face of stagnant system costs and declining state incentive levels.
Learn More About Operating Leasing
To qualify as an Operating Lease, the following conditions must be met (otherwise, the lease will be considered a Capital Lease):
The lessor must make (and maintain throughout the lease term) a minimum unconditional “at risk” (equity) investment equal to at least 20% (10% under FAS 13) of the cost of the leased property.
At the end of the lease term, the leased property must have a remaining life of at least 1 year or 20% (25% under FAS 13) of the originally estimated useful life, whichever is greater.
If the lessee has an option to purchase the leased property, the option must be priced at no less than the fair market value of the leased property at the time the option to purchase the asset is decided upon.
The IRS requires that operating leases be “pre-tax positive,” meaning that they generate a positive return for the lessor prior to accounting for any tax benefits.
Based on the more recent Revenue Procedure 2007-65, which found that the Section 45 production tax credit can be considered a cash-equivalent (and thus applied to positive financial return for the lessor) for such purposes with respect to wind projects, many tax investors in solar projects are now similarly assuming that the ITC can be factored into the “pre-tax positive” test on a cash-equivalent basis (Martin, 2008).
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