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Common CPA FAQs: Solar Tax Investing (With IRS regulations)
Solar has become one of the hottest tax advantaged investments over the past year due to the tax incentives created in the Inflation Reduction Act. One year after the bill has passed, Goldman Sachs estimates the cost of renewable energy tax benefits will 3x the 2022 government estimated cost, increasing the cost from $369 billion to $1.2 trillion. Now as individuals and their accountants look to take advantage of the opportunity large financial firms and corporations have been diving into they have a number of questions. While we can’t answer every question, we have put together an overview of the most common technical accounting questions accountants have for us!
Q: Is this a syndication investment or can you structure this as a syndicate?
A: No. All of our solar projects are structured with a single owner — your LLC. If this were a syndication, every investor would need to spend more than 500 hours to become active in the business or have passive business income they were looking to offset. Since it’s not structured as a syndication it means you can qualify for material participation with a lower threshold of 100 hours.
Material Participation Tests
For any tax year, a taxpayer, or their spouse, qualifies as materially participating in a venture if they satisfy any one of the IRS’s seven material participation tests. For reference, here are those tests, with the most commonly and most easily satisfied tests in bold:
- Test one: Participation for more than 500 hours.
- Test two: Activity that constituted all participation substantially.
- Test three: Involvement for more than 100 hours and no less than the participation of any other individual.
- Test four: Which is a significant participation activity, combined with all significant participation activities, for more than 500 hours. A significant participation activity is a business in which the taxpayer participates, without qualifying for any of the other six tests, for more than 100 hours.
- Test five: Participation during any five of the preceding ten taxable years.
- Test six: Which is a personal service activity for any three prior taxable years. Personal service activities are activities in which capital is not a material income-producing factor, such as health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting.
- Test seven: Partaking for more than 100 hours and based on all the facts and circumstances, on a regular, continuous, and substantial basis.
Source: https://www.irs.gov/pub/irs-pdf/p925.pdf
Q: Where are the tax credits (and their limitations) described in the Internal Revenue Code?
A: The Investment Tax Credits (ITCs) for renewable energy, which are outlined in §48, are general business credits, governed by §38 of the Internal Revenue Code. General business credits are a type of tax credit. These credits can be applied to offset a an individual or company’s tax liability, and any unused credits can be carried forward to future years. However, there are limitations on the amount of credit that can be claimed in any given year, with a cap of 75% of the taxpayer’s total federal tax liability after depreciation and deductions are applied. For example, if you have a federal tax liability of $100,000 and are eligible for $80,000 in ITCs, you can only claim up to $75,000 in credits for this year, with the remaining $5,000 carried forward to future years or applied back to the past 3 years.
The specific tax credit levels and their requirements for renewable energy projects are identified in Internal Revenue Code § 48E. The key language is in 48E, which sets the base rate for qualifying projects under 1 mW (which all Valur projects are) at 30% and identifies add-on credits for which projects can be eligible. Many of the projects we have on the market right now qualify for an additional 10% “domestic content” credit, and we expect additional kickers to apply on projects that come online next year.
Q: Why is most of the federal depreciation applied in year 1?
Most of the federal depreciation for solar assets is applied in year 1 because of bonus depreciation. Bonus depreciation is a tax incentive that allows businesses to immediately deduct a percentage of the cost of eligible assets in the year they are placed in service, rather than having to depreciate the cost over several years. In 2023, the bonus depreciation rate for solar assets is 80%, which means that up to 80% of the project value can be deducted from your income in that first year.
The rest of the depreciation is applied according to the The Modified Accelerated Cost Recovery System (MACRS) depreciation schedule. MACRS is a tax depreciation system used in the United States for assets placed in service after 1986. It allows businesses to recover the cost of an asset over a specified period of time through annual deductions. The MACRS depreciation schedule, copied below, outlines the non-bonus depreciation deductions for different types of assets over their respective recovery periods.
| Year | Percentage |
|---|---|
| 1 | 20% |
| 2 | 32% |
| 3 | 19.20% |
| 4 | 11.52% |
| 5 | 11.52% |
| 6 | 5.76% |
Q: Where is the depreciation described in Code?
A: One of the main benefits of solar investing is the significant bonus depreciation available in the first five years. That bonus depreciation schedule is captured in IRC § 168(e)(3)(b), on page 724 of the linked PDF.
Q: What are the depreciation limitations?
A: For earned income i.e. non-business income, the depreciation losses are limited to $289,000/person/year. This is based on the excess business loss rules from the the Tax Cuts & Jobs Act, which in 2018 set the excess business losses as your business income for the year as $250,000 plus inflation which in 2023 is $289,000 per individual (or $578,000 per couple/year).
Let’s walk through this with an example:
For 2023, Kyle, a single taxpayer, has $1 million of gross income and $1.4 million of deductions from a retail business that is an active business activity. His excess business loss is $111,000, ($1,400,000 – ($1,000,000 + $289,000)), which would carry over to 2024.
Source: https://www.law.cornell.edu/uscode/text/26/461
Q: When does someone have to invest to benefit from the tax credits?
A: To be eligible for the program’s tax credits and depreciation, you have to buy the project and place your investment at risk before it is materially complete. “Material completion” in solar projects refers to the point at which the solar project is complete and operational. So, in other words, you have to sign the project paperwork and cut your check before the project has been brought online.
The requirement to invest in a solar project before it is materially complete to be eligible for tax credits is outlined in the Internal Revenue Code Section 48(a)(5), which states that the credit is only available for property that is “new” and is placed in service by the taxpayer during the taxable year. The term “placed in service” refers to the point at which the property is in a condition of readiness and availability for its specified use.
The IRS also provides additional guidance on this requirement through various publications, including Publication 946, which provides instructions for claiming depreciation on property, and Publication 541, which outlines the tax rules for partnerships.
Q: When do the tax credits apply?
The Investment Tax Credits from solar projects apply during the taxable year when the solar project is placed in service by the taxpayer. The term “placed in service” refers to the point at which the property is in a condition of readiness and availability for its specified use not necessarily when it goes online as it may require approvals before being turned on.
Q: How do these projects generate income?
All of our projects start generating income once they are turned on. They generate income by selling electricity generated by the solar panels to the offtakers (the business that will use the electricity). For all our projects, the offtakers are commercial entity’s where the solar panels are located or a utility provider.
You may wonder why are these businesses buying the solar electricity. It’s simple, cost. The solar electricity is significantly cheaper than the cost the business would pay their utility provider for electricity. This income is also important from a tax perspective as it means that the depreciation from the business doesn’t create hobby loss issues.
About Valur and How We Can Help
So, how can you go about investing in qualified solar projects? It’s relatively simple: Valur has partnered with nationally recognized accounting and investment firms to facilitate these investments. We will help you identify the opportunity and choose between different types, visualize the potential benefits, and calculate how much you need to invest to capture the right sized tax benefits. From there, we and our partners will help you seamlessly finalize your investment and keep track of the relevant data for ongoing tax purposes.
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!
