For the past decade, solar power has transitioned from a futuristic vision to the lowest cost source of new electricity worldwide.
Solar photovoltaic (PV) systems have become a smart financial choice and a good investment for governments, businesses, and homeowners thanks to technologic improvements, more efficient manufacturing, solar financing tools, and both utility and tax incentives.
Unfortunately, navigating the rules and regulations to qualify for these financial incentives can be challenging to say the least.
This is the first in a three-part article series outlining some of the most important incentives available to those interested in solar energy. In the first article, we’ll cover the solar income tax credit and how it can help make installing and maintaining a solar power generating system more financially viable.
What is the Federal Solar Investment Tax Credit?
The two most significant tax incentives available to support solar development are the federal solar investment tax credit for both residential and commercial solar projects and the depreciation expense deduction for commercial solar projects.
I’m interested in installing solar on my residential property. How does the Solar Investment Tax Credit help me?
Residential homeowners can claim a credit on their own federal income taxes equal to 26% of the cost of installing a solar power system (claimed under Section 25D of the Internal Revenue Code). This tax credit is not refundable, so if the credit amount is more than your tax liability for that year, you can carry forward any remainder of the credit amount to reduce taxes owed for the following year, under Section 25D(c).
As a commercial property owner, what does the Solar Investment Tax Credit mean for me?
For commercial property owners, you can also claim a 26% federal solar Investment Tax Credit (ITC), as long as the solar project is installed on commercial property you own (claimed under Section 48 of the Internal Revenue Code), or if you own a solar project installed on someone else’s property and receive either solar lease payments or solar Power Purchase Agreement (PPA) payments. For example, a $100,000 commercial solar project is eligible for a $26,000 ITC, claimed by the installation’s owner.
In addition to the 26% ITC, commercial solar projects are eligible for depreciation expense deductions that reduce the owner’s federal and state taxable income. Note that residential projects are not able to claim this depreciation deduction. For commercial solar projects, the value of the deprecation deduction can be higher than the value of the ITC itself, depending on the solar owner’s overall effective tax rate. As a bonus, federal law allows property owners to take 100% of the depreciation value during the first year, which can often cover up to 50% of the cost to install the system.
For example, after reducing the basis by half of the value of the ITC, the $100,000 example commercial solar project will be eligible for an $87,000 reduction in the owner’s federal taxes – and Section 179 of the Internal Revenue Code allows taxpayers to claim the entire $87,000 deduction in the year the solar project is placed in service. For a solar owner with a 30% effective tax rate, the depreciation expense deduction will be worth $26,100 in the first year.
Even better news for commercial property owners is that the ITC can be applied to the tax year immediately before the year that the project was placed into service. This “one year lookback” can mean that property owners might even see a check from the IRS as a refund when filing an amendment to your previous year’s taxes when the project is energized and is put to use. The deduction expense does not have a “one year lookback,” but both the depreciation and the tax credits can be carried forward as many as 20 years.
Note that the depreciation expense is governed by Section 30 of the Internal Revenue Code, covering general business deductions. For state depreciation deductions, the solar installations are considered a 5-year asset under MACRS, resulting in an additional tax benefit to commercial property owners.
What if I’m interested in becoming a Tax Equity Investor?
Critically, both the Section 25D residential and Section 48 commercial solar tax credits are non-refundable and non-transferrable. These credits cannot just be sold to an investor separate from the ownership of the system. If you are interested in solar investment specifically to secure the tax credits, please refer to the final article in this three-part series: “How to Better Understand and Benefit from Solar Tax Incentives: Investing in Solar Tax Credits,” for more specifics on serving as a solar tax equity investor. Tax equity investors must be eligible taxpayers and be able to monetize the ITC and depreciation benefits. Investors must have the properly classified federal taxable income and a sufficient federal tax liability, particularly when the solar projects are installed on someone else’s property.
If you’re interested in adding a solar development to your residential or commercial property and would like additional information about the incentives available to you, please contact Jeremy Kalin and he or another member of the Avisen Legal team will be in touch with more information. For additional information on solar options for small business owners and non-profits, make sure you read the next article in this series, “How to Better Understand and Benefit from Solar Tax Incentives: The Power of Power Purchase Agreements for Small Businesses, Non-Profits, and Religious Institutions.”