The IRS recently concluded that certain commercial property assessed clean energy ("CPACE") assets are "obligations . . . secured by an interest in real property" under Code Section 860G(a)(3) in a private letter ruling ("PLR").
This PLR is the first time the IRS has specifically ruled on the eligibility of CPACE assets in real estate mortgage investment conduit ("REMIC") transactions, signaling their potential use in the market notwithstanding the fact that PLRs are limited to the particular set of facts of each case and cannot be relied upon by the general public.
CPACE programs are typically administered by local property tax authorities to provide funding to property owners for improvements aimed at promoting environmental sustainability, including installing energy-efficient windows and insulation or upgrading a building's HVAC system. These improvements typically reflect a property owner's efforts to reduce energy and water consumption or to promote renewable energy.
In exchange for the initial funding, the property owner agrees to repay such funding plus interest over time, and the tax authority places a lien on the entirety of the property in the form of a voluntary tax assessment that is senior to any mortgage. The lien remains outstanding until the tax assessment is fully paid off. If the property owner fails to make payments on the tax assessment, the tax authority may foreclose on the property.
CPACE programs vary depending on the jurisdiction, although the PLR describes a typical program in which a private company provides the initial funding to the property owner while the tax authority administers the tax assessment. The property owner makes payments to the tax authority—which has the ability to foreclose on the property if the property owner stops making payments—and the tax authority forwards the payments to the private company. In this scenario, the IRS ruled that the repayment of the CPACE assessment coupled with the enforcement rights was analogous to the terms of a mortgage and therefore constituted an "obligation" under the REMIC rules.
The PLR is a step in the right direction for CPACE lenders and asset managers wishing to securitize CPACE assets with traditional sequential pay features. Absent a REMIC election, the tax law would treat a sequential pay securitization of mortgage assets as a "taxable mortgage pool" subject to a corporate-level tax. Without any direct authority regarding the eligibility of CPACE assets for REMIC transactions, market participants have typically avoided structuring CPACE securitizations with sequential pay features.
Because the taxpayer who obtained the PLR requested guidance for a REMIC transaction, the PLR does not address whether CPACE assets are suitable for real estate investment trusts ("REITs") despite the similarity between the rules for REITs and the rules for REMICs. REITs would benefit from similar IRS guidance concluding that CPACE assets are qualifying real estate assets for purposes of the REIT asset and income tests. Such guidance could also open the door for securitizations by REITs in commercial real estate collateralized loan obligation ("CRE CLO") transactions.
It would certainly be helpful if the IRS would issue formal, precedential guidance on both REMIC and REIT eligibility of CPACE loans, considering their desired use in mortgage securitizations.
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