While helpful, California’s Board of Equalization has not exactly taken the most pro-renewable energy position in their new guidance on the effect of the installation of a solar power system on tax-exempt property. In what appears to be a fairly common acquisition structure, for example, a solar power company installs a solar power system that it retains ownership of, and the nonprofit provides the space for installation and then leases the system from the solar company. The nonprofit expects to save more on its energy bills than it pays on the lease. The solar power company, in many cases, can sell or otherwise utilize excess capacity generated by the system, often during nonpeak use hours or on weekends.

The guidance provides that a nonprofit organization may install a solar energy system that it does not own or operate (to produce electricity for the nonprofit organization), without disqualifying any portion of the property’s exemption, including the system’s location.

Unfortunately, the new guidance also appears to indicate that if any of the power generated can be utilized by the for-profit, the entire portion of the property on which the solar power system lies loses its property tax exemption. A better position could involve the revocation of a property tax exemption only to the extent that the power is utilized or is expected to be utilized by the solar power company, rather than the nonprofit. While this may make the calculation of the partial revocation more difficult, the calculation may already be far from straightforward.

Under the new guidance, in many cases it may be unclear how such a partial exemption disqualification will be assessed. With a ground-based solar system, the local county assessor could calculate the square footage utilized and limit the tax exemption accordingly. A rooftop installation, or even a system with panels installed above an open parking lot, presumably will necessitate more subjective calculations.

Not knowing the extent to which its property’s tax-exempt status will be lost, it may be difficult for a nonprofit to calculate the overall benefit that the installation of a solar power system will provide. In addition, the loss of even a portion of a nonprofit’s property tax exemption could lead to the loss of the tax-exempt status of bonds issued for the benefit of the organization or the violation of bond covenants.

In sum, the new guidance provides that if a nonprofit leases a portion of its property to a for-profit for the installation of a solar power system and the power is used by both the nonprofit and the for-profit entity, the portion of the property leased to the solar power system owner/operator would be disqualified, although it can be unclear how the partial revocation will be measured. The exempt status of the remaining portion of the property would not be revoked.

The Board of Equalization’s legitimate concern is whether such property is still considered "used exclusively" for exempt purposes, as required to maintain the property tax exemption. 

Background 

Under what is commonly known as the "welfare exemption," property used exclusively for religious, hospital, scientific or charitable purposes, and owned and operated by nonprofits organized and operated for such purposes, generally is exempt from California property tax. Separate nonprofit exemptions are provided under the "church exemption" and the "religious exemption."

The Board of Equalization has indicated that nonprofits may continue to qualify for the property tax exemption if they enter into an agreement with a for-profit entity to install and operate a solar energy system on their property, so long as the solar energy system is used to produce electricity for the nonprofit’s own use.

While "used exclusively" is not statutorily defined, the California Supreme Court in Cedars of Lebanon Hospital v. Los Angeles County did not define it literally, indicating that "the phrase ‘property used exclusively for ... hospital ... purposes’ should be held to include any property which is used exclusively for any facility which is incidental to and reasonably necessary for the accomplishment of hospital purposes; or, in other words, for any facility which is reasonably necessary for the fulfillment of a genrally recognized function of a complete modern hospital." New Guidance 

The county assessor will be responsible for determining, on a case-by-case basis, if the solar system is incidental to and reasonably necessary to the accomplishment of exempt purposes. If so, the installation should not disqualify any portion of the property’s tax exemption. The assessor may need to review the nonprofit’s contract with the solar provider to make the determination.

The letter to the assessors provides three examples of solar energy systems installations, whereby either the nonprofit or the for-profit entity, or both, are able to use the power generated from the solar energy system.

In the first example, a nonprofit leases a portion of its property to a for-profit entity, where a solar power system is installed and the for-profit utilizes the power generated. The resulting disqualification of the exemption for that portion of the property will not alone jeopardize the exemption on the remaining portion of the property.

In the second example, the nonprofit leases a portion of its property to a for-profit for the installation of a solar power system and the nonprofit uses the power generated. In this situation, the solar system does not serve to disqualify any portion of the property’s tax exemption, including the portion specifically used for the placement of the system. 

In the third example, the nonprofit leases a portion of its property to a for-profit for the installation of a solar power system and the power is used by both the nonprofit and the for-profit entity. Presumably, this could be the case where the capacity of the solar energy system at times exceeds the nonprofit’s usage, and the excess energy can then be utilized or sold by the for-profit. The portion of the property leased to the solar power system owner/operator would be disqualified, but the exempt status of the remaining portion of the property would not be revoked for that reason. 

Conclusion

Sensibly, California’s Board of Equalization has indicated that a nonprofit organization may install a solar system that it does not own or operate to produce electricity, for use by the nonprofit, without disqualifying any portion of the property’s tax exemption. If the for-profit owner/operator of the system can benefit from all or some of the power generated, however, the entire portion of the property on which the system is installed may lose its tax exemption. Further, the method of calculating such a partial revocation may be unclear, especially when the solar power system is installed on a rooftop or above an open parking lot. Hopefully, additional guidance on these issues will be forthcoming, permitting nonprofits to effectively weigh the potential economic and other benefits of installing a solar power system.

Ofer Lion is of counsel in Hunton & Williams' Los Angeles office. He served as an adjunct professor at the University of California Los Angeles School of Law where he taught a course in tax-exempt organizations.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.