Solar Tax Incentives: Active Participation Explained

You’ve seen the numbers: Purchasing solar assets can offer massive tax savings and ongoing income. You’ve done your research: The tax credits and depreciation tax savings are firmly enshrined in the Inflation Reduction Act and associated regulations, and you’re comfortable with the track record of our developer partners. Just one question remains: Can you reasonably expect to satisfy the “material participation” requirement? In this article, we’ll outline the regulations that impose the requirement and identify the types of activities that can best set you up to succeed.

The basic requirement

The material participation requirement arises out of a general rule in the tax code: Activities and income are grouped into two categories: “passive” and “active.” Income from these activities is generally treated the same, aggregated as part of the taxpayer’s total taxable income and taxed according to the applicable tax bracket. Write-offs from these activities, however, are treated very differently: Deductions and tax credits from active activities can be used to offset all taxable income, but, critically, benefits from passive activities can offset only passive income.

What does this mean for solar? Most income is active — W-2 earnings, RSUs, personal business income, and even some capital gains all count. For that reason, most people will need their solar activities to count as active if they want to use the benefits against their ordinary income. If the client is found to be an active participant in the solar project, the credits and deductions would be active and available to offset tax on all sources of income.

The regulations

To qualify as an active participant in a solar project, you must satisfy one of seven “material participation” requirements outlined in IRS Publication 925 in each year that you want to claim tax benefits.

Here are the seven IRS material participation tests:

1. You participated in the activity for more than 500 hours.
2. Your participation was substantially all the participation in the activity of all individuals for the tax year, including the participation of individuals who didn’t own any interest in the activity.
3. You participated in the activity for more than 100 hours during the tax year, and you participated at least as much as any other individual (including individuals who didn’t own any interest in the activity) for the year.
4. The activity is a significant participation activity, and you participated in all significant participation activities for more than 500 hours. A significant participation activity is any trade or business activity in which you participated for more than 100 hours during the year and in which you didn’t materially participate under any of the material participation tests, other than this test.
5. You materially participated in the activity (other than by meeting this fifth test) for any five (whether or not consecutive) of the 10 immediately preceding tax years.
6. The activity is a personal service activity in which you materially participated for any three (whether or not consecutive) preceding tax years.
7. Based on all the facts and circumstances, you participated in the activity on a regular, continuous, and substantial basis during the year.

Source: https://www.irs.gov/pub/irs-pdf/p925.pdf

The activities

The consensus among accountants is that Test 3 is the easiest path. To satisfy that requirement, you’ll need to spend at least 100 hours on solar activities, and you’ll need to be the most active participant in the activity. Let’s break those two factors down.

The hours / married couples. Spending 100+ hours on solar activities sounds like a lot, but part of our job is to make this as approachable as possible. We talk about how you can satisfy this requirement below.

Most active participant. This requirement has a significant and often overlooked consequence: If you have to be the single most active participant in the business to qualify, that means that it really only makes sense to have one person own the project. If you had a co-investor (other than your spouse, who is exempted), then either (1) you’d both have to spend 500 hours on the project or (2) only one of you could claim the tax benefits. For that reason, all of our projects have a single owner (or married owners).

Practicalities

Back to that hours requirement. How can you reasonably expect to spend your time? Fundamentally you should think about spending your time as you would running your own business that is in the renewable energy space.

1. Diligence. Like any assets a business purchases, the hours you spend on the diligence behind major purchases counts as part of the time you spend running your business. This includes phone calls you’ll do with the Valur team, our outside accounting firm, your own CPA and financial advisor if you have them, and the solar developers. It also covers your review of legal documents, research on the solar space, and other background work. You can include work done before you finalize your investment, as well as any work you do to evaluate additional projects in the future.
2. Site visits. Site visits are typically the single most productive activity in terms of time spent — you can count time on site, with developers, customers and broader diligence.
3. Conferences and industry events. This includes attending industry conferences, which happen throughout the year in Las Vegas, Chicago, New York, and other locations, as well as other industry events.
4. Continuing education. This includes (1) our library of educational videos, (2) research reports, and (3) articles addressing the business and technical side of solar power.
5. Other. This is a catch-all category that includes ongoing tracking of project production, planning further purchases, and any other activities that aren’t covered by the other categories.

About Valur

We’ve built a platform to give everyone access to the tax and wealth building tools typically reserved for wealthy individuals with a team of accountants and lawyers. We make it simple and seamless for our customers to take advantage of these hard-to-access tax-advantaged structures so you can build your wealth more efficiently at less than half the cost of competitors. From picking the best strategy to taking care of all the setup and ongoing overhead, we make things simple. The results are real: We have helped create more than $1.1 billion in additional wealth for our customers.

If you would like to learn more, please feel free to explore our Learning Center, check out your potential tax savings with our online calculators, or schedule a time to chat with us!