Leveraging Clean Energy for Section 1031 Tax-Deferred Exchanges

by Maura Snabes, Esq., CES, NTP

May 2024

Today’s investors are looking not only to profit from their real estate ventures, but also for ways to “go green” and to make a positive impact on the environment. There has been a significant shift toward sustainable energy sources, with wind and solar farms at the forefront of this. Apart from their environmental benefits, these renewable energy projects also offer unique opportunities for investors seeking to defer capital gains taxes through Section 1031 exchanges.

Understanding Section 1031: Section 1031 of the IRC provides a powerful tool for deferring capital gains taxes when exchanging certain types of real property for like-kind property. While not traditionally thought of as qualifying property under Section 1031, wind and solar farms and leases offer opportunities for tax deferment.

• Qualifying Property. To qualify for a Section 1031 exchange, wind and solar farms must meet certain criteria. While wind and solar farms may not fit neatly into traditional definitions of real property, they can be classified as such under certain circumstances.

• Productive Use in Trade or Business or for investment. Wind and solar farms are undeniably used in a trade or business—the business of generating and selling renewable energy. As long as the investor can demonstrate that the primary purpose of the farm is for income generation, it should satisfy the productive use requirement under Section 1031. Further, many investors view wind and solar farms as long-term investment vehicles, providing steady income streams over the life of the project. As such, these renewable energy projects can also meet the investment purpose criteria necessary for Section 1031 exchange eligibility.

• Like-Kind Property. The IRS has provided guidance indicating that certain renewable energy assets, including wind and solar farms, may qualify as like-kind property under Section 1031. For solar landowners, particularly farmers, the 1031 is a strong motivator that allows them to sell their solar lease or land and invest it in another piece of property.

• Leasehold Interest. The sale of a lease does not always qualify for a 1031 exchange, so it is important that taxpayer consult with an attorney or a 1031 specialist when weighing out their options. There are circumstances where taxpayers can still retain ownership of the land and just sell the lease payments up front for a lump sum/the leasehold interest. There must be 30 years remaining on a lease in order for it to qualify for 1031 treatment if the land is not sold along with the lease. An easement must be established for the production of renewable energy in order for a taxpayer to sell their lease on its own without also selling the land. The easement will convey an interest in land/real estate to the buyer, allowing the sale of the lease payments to qualify for like-kind 1031 treatment.

Potential Tax Benefits - Replacement Property. By utilizing Section 1031 exchanges to reinvest proceeds from the sale of a property into a wind or solar farm or leasehold interest, investors can defer capital gains taxes, allowing for the preservation of wealth and the potential for continued growth. Additionally, owning renewable energy projects may also offer various tax incentives, further enhancing the overall tax benefits for investors.

Conclusion: Wind and solar farms represent not only a sustainable solution for energy production but also a compelling opportunity for investors seeking to defer capital gains taxes through Section 1031 exchanges. As always, a reminder that tax laws can be complex and subject to change, so it's essential to consult with qualified tax professionals and legal advisors when considering Section 1031 exchanges and renewable energy investments. With careful planning and expert guidance, investors can navigate these opportunities to achieve both financial and environmental objectives.