# Tax equity s704b capital account – Video

### Video

##### This is an extract from  our tax equity modeling course.

Video Transcript

We’ll use our sample project to demonstrate 704b tax capital accounts with disproportionate allocations of tax attributes and cash distributions. The tax and cash allocations for our wind project are just like we mentioned earlier. The tax equity partner will receive 99% of the tax attributes and 20% of the cash distributions for the first 10 years. After that 10 years, the allocations will flip, and the tax equity partner will receive 5% of both the tax attributes and the cash distributions. The sponsor partner is just going to receive the inverse of those benefits. The total partnership taxable income or loss and the cash distributions for the partnership that we calculated earlier are also shown right here on the screen with a total income of \$40 million over the life and distributions of 140 million over the life. We need to allocate these losses and distributions into capital accounts in order to prove that one partner doesn’t take out more from the partnership than they’re permitted to take out. So let’s model out the 704b capital account for the tax equity partner. Their account starts with an opening balance of zero, and we’ll assume for now that they invest 60% of the cost of that project or \$60 million of the total 100 million capital cost in year one. Allocated to them will be 99% of the taxable income or losses which is 99% times the \$16 million in partnership loss equaling 15.84 million. Then, they’ll take 20% of the cash distributions which will reduce their capital account balance leaving the closing balance at 43.36 million at the end of year one. In year two, again, they’re going to be allocated 99% of the \$28 million in losses from the partnership, and that will reduce their capital account by 27.72 million, and they will also be allocated 20% of the \$4 million of cash distributions, or 0.8 million, so they will end with a closing balance in their capital account of 14.84 million. Year three we’ll bring down, again, 99% of the losses of 15.05 million and 20% of the cash distributions, or 0.8 million, such that their capital account is now negative to the tune of \$1.01 million. What does this really mean? Due to the disproportionate sharing of tax and cash, the tax equity partner is taking losses or they are writing off more than they invested which is precisely what David said we can’t do. And stepping back, this makes sense. Losses are the most influential line in the total partnership account. By the end of year three, losses have totaled \$59.2 million of which the tax equity partner has taken 99%, or 58.61 million, and distributions have totaled \$12 million in this same time period, and the tax equity took out 20% of this, or 2.4 million. So the tax equity investor put 60% of the capital in and took out 99% of the largest benefit, so of course, their account is going to go negative. In year four, we start with a balance of 1.01 million, and we are allocated losses of 99% of the 7.52 million which equals 7.44 million, and again, 20% of the cash distributions, or 0.8 million, which takes our closing balance to negative 9.25 million. And this continues in year five and year six just increasing the value of the negative balance to the tune of 20.04 million by the end of year six. However, once we get to year seven, the project has positive taxable income of \$4 million because the depreciation period ended in year six. So the tax equity partner will earn 99% of this income, or 3.96 million, and the balance in their capital account will increase from negative 20.04 million to negative 16.88 million, and this trend will continue through to year 10 with the balance gradually increasing over time. The flip occurs in year 11 which reduces the tax equity’s allocation of taxable income and cash benefits. So with an opening capital account balance of 7.4 million, the tax equity partner will receive 5% of the \$4 million of taxable income and 5% of the \$4 million in cash distributions, and as taxable income and cash distributions are equal, the capital accounts doesn’t change. It’s just going to remain at that negative \$7.4 million until the end of the project life. As a reminder, the line item with the single greatest responsibility for the 704b tax capital account going negative is tax losses. In the first six years, the losses were equal to 75.24 million before going positive to a total of 54.4 million. So tax losses are the single biggest driver of the negative balance of the tax capital account. Thank you for sticking with us. We hope you enjoyed the video. If you’d like to receive more free content, please subscribe below.

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