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Case Study: Financial Benefits of Solar Investments (2023)

What did the Inflation Reduction Act do to tax benefits for Solar investments?

The Inflation Reduction Act is the single largest investment in climate and energy in American history provide up to $369 billion in tax incentives. More specifically it increased and extended previously available the Investment Tax Credits (ITC) and depreciation for specific renewable energy projects like Solar investments. Before we get too deep into the value of these tax benefits, lets start with the basics of what they are.

What are Investment Tax Credits?

A tax credit is a dollar-for-dollar reduction in the amount of taxes you owe. For example, if you owe $1,000 in taxes and you have a $500 tax credit, your tax liability would be reduced to $500. Tax credits are different from deductions, which only reduce the amount of income that is subject to taxes. Tax credits directly reduce the amount of taxes you owe and in some sense are similar to coupons you can use to reduce your tax bill. Read more about tax credits here.

What is depreciation?

The concept of depreciation allows investors in physical assets — infrastructure or real estate, for example — to claim a tax deduction against their income from their investment to reflect wear and tear on those assets over time. The IRA’s solar provisions allow for aggressive deductions for depreciation. How much depreciation you are able to claim depends on how much of a tax credit you claim. Read more about depreciation here.

Solar investment tax benefits: Case study

Aaron is a married California resident with $2,300,000 in income in 2023, and, as a result, he’s looking at $870,000 in federal taxes and $265,000 in California taxes at the end of the year. After paying $1,135,000 in total taxes, that would leave him and his wife with $1,165,00 — an almost 50% haircut.

As we explained in earlier articles, however, an investment in a qualifying solar project could earn the family significant tax credits, depreciation deductions, and ongoing income that mitigate their high tax burden.

Specifically, if the family chooses to invest $500,000 in solar projects this year (and set up their solar LLC and spend 100 hours in the business), they can reduce that tax bill by more than $414,000 and earn almost $500,000 in income over time. Read more about these mechanics and then read on for the numbers.

Situation Overview:

  • Income: $2.3M
  • Expected Taxes (w/o Solar benefits): $1.135M
  • Post-tax cash: $1.165M
  • Solar Investment: $500k

Results:

  • Total tax savings: Reduce federal and state taxes by $414,500 (83% of the investment). This is money the family otherwise would have lost to taxes.
    • Tax Credits: $200k in tax savings in the first year, or 40% of the initial investment
    • Depreciation: $214,500 in tax savings, or 43% of the initial investment over the first six years with $137,620 of those tax savings coming in year one.
  • Total Income: $500,000 (5% of initial investment per year for 20 years)
Solar Investment Tax Savings and Income over 20 Years

Timeline breakdown

  • Year 1:
    • Tax savings, including credits and depreciation: Reduce federal and state taxes by $337,620 (68% of initial investment)
      • Critically this is money the family would otherwise have lost to taxes. Instead, they can reinvest these savings and grow the difference substantially over time.
    • Income: $25,000 (5% of initial investment)
  • Year 2-6:
    • Tax savings: Reduce federal and state taxes by $77,880 (15.4% of initial investment)
    • Income: $125,000 (5% of initial investment per year)
  • Year 7-20: Receive 5% of the initial investment per year, or another $350,000.
  • Total: These tax credits and revenue distributions add up to $955,250, none of which the family would have received without their solar investment.

How does this compare to not investing in the Solar Project?

A common question is how these returns would compare if Aaron and his wife were to invest the money without any tax benefits instead. We’re including a comparison below to compare the results to see how much Aaron and his wife would have after taxes in 20 years, and assume that investment plus all of the tax savings and income from the solar project will be reinvested in the year they receive it and earn 6% annually.

Situation Overview

  • Solar Investment: $500k
  • Investment growth: 5%

Results

Additional 34.2% return after taxes: Over the 20 years Aaron and his wife are able to earn an additional 34.2% or $170,000. Let’s break down how the solar investment enables this.

Not using Solar tax credits

We’ll compare if Aaron and his wife instead choose to pay their taxes on $500,000 of income ($250K) and invest the remaining $250,000. After investing the $250,000 for 19 years at a 5% growth, Aaron and his wife would have $631,738. If they sold those assets and paid taxes they would have around $498,129.

Using the Solar Tax Credits

If they invest in the Solar investment, Aaron and his wife would create income from two key areas, tax benefits (tax credits and depreciation) and income from the project (as well as reinvesting their tax savings and solar income). Respectively after taxes in 20 years they are able to earn $312,800 from the tax benefits and $356,161 from the investment income from their original investment for a total of $668,241 after taxes.

Tax benefits: After investing in the project they would receive $414,500 of tax savings from the tax credits and depreciation over the first 6 years. We assumed those savings, minus the $250K they have to pay in taxes in the first year would start being reinvested the year after they are received at a 5% growth rate. After 20 years that would be worth $391,547 or $312,080 or after taxes.

Investment Income: The solar project will also generate 5% of the original investment amount per year (or $25,000). Unfortunately this will be taxed at ordinary income tax rates so we applied a 50% tax rate to this income and assumed the remaining $12,500 would be reinvested each year at a 6% growth rate. After 20 years this would be worth $413,324 or after taxes $356,161.

How to invest in qualifying solar projects

Speaking of which, how can you go about investing in IRA-qualified projects? It’s relatively simple: Valur has partnered with nationally recognized accounting and investment firms to facilitate investments into solar projects. We will help you identify the opportunity, visualize the potential benefits, and calculate how much you need to invest to capture the right sized tax credits. From there, we and our partners will help you seamlessly finalize your investment and keep track of the relevant data for ongoing tax purposes.