Commercial Solar Incentives
The Commercial Solar Investment Tax Credit (Solar ITC) is an attractive option as a tax minimization strategy for eligible taxpayers. While the ITC has been in existence for many years under Section 48 of the Internal Revenue Code, the Tax Cuts and Job Act (“TCJA”) of 2017 and the Coronavirus Aid, Relief, and Economic Security (CARES) Act of 2020 both contain provisions that further enhance the potential tax benefits of the Solar ITC.
The purpose of the tax credit is to promote the adoption of energy-efficient commercial solar photovoltaic (PV) systems in the U.S. To be eligible for the 30% credit, a taxpayer must have commenced construction of a solar PV system on or before December 31, 2019. The credit decreases to 26% for systems commencing construction in 2020; 22% for systems commencing construction in 2021; and 10% for systems commencing construction thereafter. (Current legislative proposals seek to keep the solar credit at the 30% or 26% level to further incentivize the use of energy-efficient solar PV systems.)
A solar project is considered to have commenced construction if:
- At least 5% of the qualifying project costs are incurred, or
- Physical work on the project, of a significant nature, or fabrication of project components has commenced.
The Solar ITC is calculated by multiplying the applicable tax credit percentage by the cost of the eligible property. Eligible property includes:
- Solar PV panels, inverters, racking, balance of system equipment, and sales taxes on the equipment.
- Installation costs.
- Transformers, circuit breakers and surge arrestors.
- Energy storage devices.
For example, a qualifying commercial solar PV system with a cost of $1,000,000 which commenced construction in 2019 and was placed in service in 2020 would generate a federal ITC credit of $300,000 ($1,000,000 x 30% ITC Rate = $300,000.)
A taxpayer that claims the commercial ITC for a solar PV system placed into service can also take advantage of accelerated depreciation to reduce the overall costs of the system. Because depreciation is an expense, it can be used to offset the taxable income of the taxpayer, in addition to the tax credits that are generated from the solar investment. A taxpayer can receive
both a tax credit and a large depreciation deduction in the year the system is placed in service.
TCJA and Bonus Depreciation
One of the key highlights of the Tax Cut & Jobs Act (“TCJA”) of 2017 was the increase in the bonus depreciation thresholds to 100% of the qualifying costs in the year an asset is placed into service through December 31, 2022. (After 2022, the bonus depreciation benefits are scheduled to decrease 20% per year through December 31, 2026.) Under the bonus depreciation rules for solar PV systems, the basis in the PV system must be reduced by 50% of the ITC to arrive at the depreciable basis for bonus purposes. For example, a $1,000,000 PV system with a 30% ITC would have $850,000 available as a bonus depreciation deduction ($1,000,000 – ($300,000 x 50%) = $850,000).
In addition to the bonus depreciation, the taxpayer is eligible to depreciate the 15% remaining basis using a 5-year MACRS life. In this example, the taxpayer would generate another $30,000 in depreciation deductions ($1,000,000 – $850,000 x 20% Yr 1 MACRS Depreciation Rate =$30,000). The taxpayer will continue to claim future depreciation deductions using the MACRS 5-year property percentages.
|Solar PV System Cost||$1,000,000|
|Federal Tax Credit (30%)||$(300,000)|
|Tax-Effected Bonus Depreciation (37%)||$(314,500)|
|Tax-Effected MACRS Depreciation||$(30,000)|
|Tax-Effected State Depreciation (8%)||$(16,000)|
|TOTAL YEAR 1 TAX BENEFITS||$660,500|
Using Tax Credits and Depreciation
Any unused ITC can be carried back one tax year and carried forward for 20 years to offset future taxable income. Prior to the (CARES) Act, a taxpayer generating a loss from a flow-through entity was only entitled to deduct $500,000 in any one tax year ($250,000 for single filers.) However, under the recently enacted CARES Act legislation, the “loss netting” provisions under the TCJA have been removed, thus allowing the full bonus depreciation deductions to be claimed. Furthermore, if the bonus depreciation puts the taxpayer in an overall loss position, the taxpayer can carryback the losses five years or elect to carry the losses forward.
Active or Passive
The above-mentioned tax benefits can be used to offset passive income by investors. Additionally, for taxpayers with five or fewer members, active participation can be achieved by spending 100 hours relating to the solar entity and its formation, including reviewing investment options, travel time to inspect the project, time spent with CPAs and attorneys on documentation, and time spent with the developer to satisfy the requirements. With active participation, the tax benefits can be used to offset ordinary income from an operating business.
Tax Equity Investor
When a developer or contractor is constructing large commercial solar projects (>$1M) and does not have a large enough tax liability to utilize the credits and depreciation, a tax equity investor may be an option. Many tax-exempt entities use tax equity Investors to fund solar projects for churches, school districts, and local governments. These entities collaborate with a tax equity investor who has a large tax liability who can fully utilize the tax benefits. In the marketplace, we see four types of structures used in tax equity financing:
- Sale-Leasebacks: The developer or sponsor sells the solar PV system to a tax equity investor who then leases the system back to the developer or sponsor.
- Partnership Flips – The developer/sponsor forms a partnership, and the economic returns “flip” from the investor to the developer/sponsor after the investor makes use of the tax benefits and holding periods in order to avoid recapture.
- Inverted Lease – The developer/sponsor leases the system to the investor, structuring the agreement in a way that allows the investor to use the tax benefits.
Third Party Ownership (“TPO”) – Under a TPO Agreement, the sponsor will enter into a Purchase Power Agreement with the investor for usually 25 years. The investor will claim the tax credits and depreciation. The investor gets the cash flows from the sponsor from the sale of the electricity.