Transferable tax credits: Definition and benefits

Transferable tax credits allow the taxpayer who earns the tax credit to sell it to another taxpayer. In the United States, transferable tax credits exist at both the state and federal levels. 

What is a tax credit?

A tax credit allows an individual or business to apply the amount of the credit they earn to their tax bill, to reduce their tax liability—in other words, it allows a taxpayer to subtract the amount of the credit from the total amount they owe to a government tax agency. Tax credits are a mechanism that policymakers use to incentivize certain investments and behaviors. 

Transferable tax credits

For most tax credits, the individual or entity who qualifies for the credit is the one who claims it on their tax return. Transferable tax credits are different: Taxpayers who earn transferable credits can sell them to another taxpayer who wishes to reduce their tax liability. 

Typically, a buyer purchases tax credits at a discount. For example, a buyer of $100,000 in transferable tax credits may agree to purchase the credits for 80 cents on the dollar. This means they pay $80,000 for credits that allow them to reduce the taxes they owe by $100,000, resulting in a gross profit of $20,000 on the transaction, not including any related transaction costs. 

Why are certain tax credits transferable? 

Policymakers make certain tax credits transferable to enhance the effectiveness of the credit as a government subsidy for a desired investment. With a nontransferable tax credit, the utility of the credit as an incentive is limited by the tax liability of the taxpayer earning it. Making the tax credit transferable removes that limitation. 

For example, under Section 48E of the Internal Revenue Code, a business may claim a standard Investment Tax Credit usually worth 30% of the qualifying costs of building a clean energy asset, such as rooftop solar or battery storage. But given the high up-front cost of making these building upgrades, the full tax credit may be much larger than the owner’s tax bill. In this case, the taxpayer may instead choose to sell their tax credit to an investor.   

Examples of transferable tax credits

Across the U.S., transferable tax credits incentivize a wide array of activities, including:

• Low-income housing development
• Historic property rehabilitation
• Alternative and clean energy production
• Capital investment
• Research and development

At the federal level, transferable tax credits largely pertain to clean energy production and storage. 

Transferability and clean energy tax credits

The Inflation Reduction Act (IRA) of 2022 introduced a number of new transferable tax credits aimed at increasing the production of clean energy and manufacture of renewable energy equipment in the U.S. Some of these tax credits are entirely new, while others are tax credits that already existed in the tax code, but that were modified to be made transferable for the first time.

Among these tax credits are several related to clean energy production, including:

Considerations surrounding transferability

Tax-credit transfers are subject to IRS rules, filing requirements, and restrictions:

• Credit registration: The IRS requires sellers to identify their clean energy projects through a formal registration process
• Eligible sellers: For-profit business entities may sell all or some of the clean energy tax credits they earn.
• Eligible buyers: IRS restricts the application of purchased clean energy tax credits to the buyer’s passive income.
• One-time transfer: Clean energy tax credits may only be transferred once.
• Tax filings: Certain required tax filings formalize the tax-credit transfer
• Tax treatment on sales: Payment received for tax credits is not considered taxable income
• Carryback and carryforward provisions: Purchased tTax credits can be carried backward for three tax years and forward for 20 years, subject to additional rules. 
• Required diligence: The IRS requires buyers of tax credits to conduct due diligence on sellers and their projects.

Learn more about buying and selling transferable tax credits

Evergrow helps clean-energy project developers, REITs, and investors buy and sell Section 48 and Section 48E investment tax credits. 

To learn more about tax-credit transfers, click the Get Started button above to get in touch with a member of our team.