How to Sell Tax Credits & What You Need to Know

Selling tax credits involves a financial transaction where a business or individual transfers excess tax credits to another taxpayer to reduce their tax liability. These credits represent a direct reduction in the amount of tax owed. Not all tax credits are transferable; some are specifically designed for it, creating a market for these financial instruments. This allows the original recipient to monetize an unused asset, providing capital, and offers buyers a way to lower their tax burden.

What Are Transferable Tax Credits?

A tax credit directly reduces a taxpayer’s final tax liability. This differs from a tax deduction, which only reduces the amount of income subject to tax, meaning its value depends on the taxpayer’s marginal tax rate. For example, a $1,000 tax credit reduces a tax bill by $1,000, whereas a $1,000 deduction for someone in a 22% tax bracket would only save $220 in taxes. Most tax credits are non-transferable, meaning only the entity that generated them can use them.

Transferable tax credits are authorized by law to be bought and sold between unrelated parties. These credits are often created by federal or state governments to incentivize specific activities, such as investments in renewable energy, historic preservation, or film production. The Inflation Reduction Act of 2022, for instance, significantly expanded the transferability of certain federal clean energy and manufacturing tax credits, including those for clean energy production, carbon capture, clean hydrogen, and advanced manufacturing.

Common examples of transferable tax credits include certain renewable energy investment and production tax credits, historic rehabilitation tax credits, and some state film production credits. Eligibility requirements vary, but transferability allows developers or businesses without sufficient tax liability to convert credits into cash. Conversely, corporations or financial institutions with significant tax obligations often buy these credits at a discount to reduce their tax burden. This market provides capital to projects that might struggle to find financing and offers buyers a cost-effective way to manage tax liabilities.

Preparing to Sell Your Tax Credits

Selling tax credits requires gathering and verifying information to ensure validity and attractiveness to buyers. Verify the credit’s legitimacy, amount, and transferability by obtaining official documentation from the issuing authority, such as a state agency or the Internal Revenue Service (IRS). This confirmation is crucial for buyer confidence.

Sellers must gather and organize documents. This includes certificates or official letters from the issuing authority confirming the credit’s approval and amount. Supporting documentation, such as project completion reports, operational records, or financial statements, is also necessary to demonstrate the underlying activity. Legal opinions or attestations confirming validity and compliance with transferability rules are often required, along with the selling entity’s organizational documents.

Understanding the credit’s characteristics is essential. This includes its vintage (year issued) and expiration date, as credits have a limited lifespan. Sellers should also determine any carryforward or carryback rules, which dictate how unused portions apply to past or future tax years. Any state or federal restrictions on transferability or usage must be understood to avoid complications.

Before engaging buyers, sellers should assess the credit’s market value. Tax credits are sold at a discount to face value; understanding this range helps set realistic expectations. This valuation helps sellers gauge financial benefit and prepare for negotiations. A detailed valuation methodology is not required at this stage, but a general understanding of market dynamics is beneficial.

The Tax Credit Sale Process

Once preparatory work is complete, the sale process begins by connecting with buyers. Sellers often use specialized tax credit brokers or intermediaries with expertise in these transactions and networks of institutional buyers, such as corporations or financial institutions. Directly approaching buyers or exploring online marketplaces designed for tax credit transactions are also options. Brokers typically earn a commission for matching buyers and sellers.

After initial contact, buyers or their advisors conduct due diligence on the tax credits. This involves reviewing the seller’s documentation to verify the credit’s validity, amount, and compliance with transferability requirements. This review encompasses legal, financial, and tax analyses to ensure the credit is legitimate and usable. Buyers often require documentation validating the eligible credit property, evidence of qualifying costs, and confirmation of any bonus credit amounts.

Key sale terms are negotiated between the seller and buyer. This includes the purchase price, typically a discounted rate of the credit’s face value, and the payment schedule. Indemnification clauses, outlining responsibilities if the credit is later disallowed or recaptured, are also part of these negotiations. The purchase price for transferable tax credits can range from $0.70 to $1.18 per dollar of credit purchased, depending on various factors.

The transaction culminates in legal agreements, primarily the Tax Credit Purchase and Sale Agreement. This agreement details seller representations and warranties regarding the credit’s validity and any conditions for closing. It also includes statements from both parties acknowledging recapture requirements. Legal and administrative transfer involves filing specific forms with tax authorities. For federal credits, sellers complete pre-filing registration with the IRS to obtain a registration number for each eligible credit property.

Both seller and buyer must attach a “transfer election statement” to their tax returns for the applicable year. This statement, not a specific IRS form, is a written document formalizing the transfer. Additionally, the seller includes a completed source credit tax form and IRS Form 3800, General Business Credit, with a schedule showing the transferred amount. The transfer election statement must be completed before filing each party’s tax return. Finally, payment is exchanged, the transaction closes, funds are transferred, and all required documents are filed with the IRS.

Important Considerations for Sellers

Understanding tax credit valuation is important for sellers, as the sale price discounts the credit’s face value. The discount rate is influenced by factors including the credit type, vintage (year of issuance), and risk profile. Market demand, transferability restrictions, and the buyer’s internal rate of return also influence the final price. Buyers purchase credits at a discount to profit and reduce their tax liability.

Sellers must also consider the tax implications of selling tax credits. While the credit reduces tax liability for the buyer, proceeds received by the seller are typically taxable income. Sellers should consult a tax advisor to understand how these proceeds are treated for income tax purposes and to plan accordingly.

A risk to be aware of is “recapture.” This occurs if conditions related to the underlying activity that generated the credit are not met after transfer. For instance, if a renewable energy project ceases operations or changes ownership within a specified period (typically five years for investment tax credits), a portion of the credit claimed by the buyer might be “recaptured,” meaning the buyer owes it back to the government. Purchase agreements typically address this risk through indemnification clauses, obligating the seller to compensate the buyer for recapture amounts. The seller may still be liable for recapture if they retain any portion of the credit.

The role of professional advisors is important throughout the process. Engaging legal counsel ensures agreements are legally sound and comply with regulations. Tax advisors guide sellers on complex tax implications and assist with reporting. Financial advisors or brokers can help with valuation, market access, and structuring the deal to mitigate risks.

While buyers perform due diligence on credits, sellers should also conduct due diligence on potential buyers or brokers. This involves verifying their legitimacy, track record, and financial reliability for a smooth and secure transaction. This reciprocal due diligence protects the seller’s interests and ensures dealing with reputable parties.