What Are Solar Tax Benefits?
Green energy is having its moment. Almost half of all new homes in the United States have solar panels. And the Biden Administration and Congress has decided to go all in to incentivize investment in renewable resources.
In particular, the Inflation Reduction Act (IRA) increased and extended previously available tax benefits — tax credits and depreciation — for specific renewable energy projects, including solar.
In case you haven’t read about tax credits and depreciation from our previous articles, you can do so here. In summary, tax credits are a dollar-for-dollar reduction in the amount of taxes you owe. The Government lets you deduct a certain percentage of solar purchase costs from your taxes. Depreciation, instead, refers to the amount of value that a physical asset loses over time. From a tax standpoint, depreciation is relevant because you can take a deduction for some or all of the amount of the value an asset loses over time, reducing your taxable income and saving money on your taxes
The basic tax benefits of buying qualified solar infrastructure projects are massive, you can receive up to an 130% of your investment in first year tax savings as we explain them in detail in our solar project purchase tax benefits guide.
What is a Flip Partnership?
A flip partnership is a solar structure that allows investors to receive more tax credits and depreciation with the same investment. The key mechanism is that by borrowing, the investor can increase the amount of cash in the project and, as a result, the tax credits and depreciation available. You can read more about the details in our guide to solar flip partnerships.
How do Flip Partnerships Work?
The flip partnership structure works by allocating most of the tax credits and depreciation — typically 99% of the tax benefits — to the investor partner. This can be particularly advantageous for the investor, as they can use the tax credits and depreciation created from the bank partner’s loans, thereby increasing the tax benefits they receive without increasing their personal investment. In return for these up-front tax benefits, the debt partner receives the majority of the cash flow from the project over its lifetime.
With those details out of the way, let’s take a look at a case study to illustrate how leverage can significantly increase your returns from solar investment.
Solar Project Purchase Tax Benefits: Case Study
Aaron is a married California resident with $1,000,000 in income in 2023, and, as a result, he’s looking at $503,000 in federal taxes and California taxes at the end of the year, more than a 50% haircut.
As we explained in earlier articles, however, buying a qualifying solar project could earn Aaron and his wife significant tax credits, depreciation deductions, and ongoing income to mitigate their high tax burden.
Specifically, imagine that the family chooses to put $300,00 in a flip partnership solar project this year. As a result of this investment, they could reduce their tax bill in 2023 from $503,000 to up to $192,202 and also reduce it by up to $98,417 more in the following 5 years.
Let’s now see the numbers:
- Income: $1,000,000 in 2023
- Expected taxes without solar benefits: $503,000
- Investment: $300,000
- Tax Savings: up to $409,215
Total tax savings: As a result, their total tax bill will come down from $503,000 to up to $93,785. That’s a total reduction in federal and state taxes of up to $409,215, or 136% of the $300,000 investment.
- Tax Credits: $187,110 in tax savings in the first year, or 62% of the initial investment
- Depreciation: $222,105 in tax savings, or 74% of the initial investment. (About 56% of this depreciation credit is available in year 1, and the remainder will be spread over the following 5 years, as you can see in the next table)
Year-by-Year Tax Savings:
Below, you can see the year-by-year tax savings from tax credits and Federal and State depreciation for Aaron and his wife taking into account their particular situation. You can also play with our online calculator to customize it with your own numbers and see your potential savings here
Total Income: $15,000. While the couple will receive some income distributions over the early years, the lion’s share of the project revenue will go to their investment partners as a result of the flip partnership structure. See our guide to solar flip partnerships for more information.
Phantom income tax: -$38,400. Phantom income occurs when an individual is taxed on the value of their stake in a partnership (or another equivalent agreement), even if they do not receive any cash benefits or compensation. For example, if a partnership reports $100,000 in income for a fiscal year and a partner has a 10% share in the partnership, that individual’s tax burden will be based on the $10,000 in profit reported. Even if that sum is not paid to the partner because, for example, it is rolled over into retained earnings, reinvested in the business or in the case of most solar flip partnerships being used to pay down partnership debt, the partner may still owe tax on the full $10,000. As a result, Aaron is taxed on income he never receives or “phantom income”, in this case, for a total of -$38,400
What if Aaron chose not to start a solar business?
This is, of course, a common question: How would Aaron do if he simply paid his taxes and invested the remaining money? This is a pretty simple comparison as if he doesn’t invest $300,000 in the solar project, he would owe more than that in taxes and be sending $300,000 in solar investments to the IRS.
- Tax bill: $503,000
- Amount not invested in solar: $300,000
- Missed Tax Savings from Solar: $409,215
- Net Loss: -$109,215
If Aaron chose to pay his taxes instead of investing in solar, he would owe that full tax bill of $503,000. Compare that to the additional $109,215 he would gain in tax savings from the flip partnership investment ($409,215 in tax savings – $300,000 in the cost of the solar investment).
(Aaron also could have earned a different type of return, focused more on ongoing income and less on up-front tax savings, via a “sale leaseback” You can read more about the various solar investment structures here).
Hopefully, the benefits from solar investments are now clear, but there are a couple of qualifications and limitations that investors should take into account and you can read more about the mechanics (including “active participation” and other regulatory requirements) here.
What Are The Depreciation And Tax Credit Constraints?
Depreciation will be capped for investors earning W-2 (i.e. salaried income) at $289,000 per individual per tax year, or $578,000 per couple per tax year if you are an active investor. However, if you have excess depreciation, you can roll it forward and apply it in future tax years. From the example and given per year results shown in the table above, depreciation in the first year would be $123,688, which is below the cap of a single individual per tax year.
In addition, you can only write-off 75% of your remaining federal tax liability with tax credits and if you have excess tax credits for the current tax year, you can apply them to your taxes from the past 3 years or roll them forward and apply them over the next 22 years. For Aaron´s example, his federal taxable income would be $711,000, , which is the net value between his $1,000,000 income and his $289,000 savings from federal depreciation (tax savings from depreciation in year 1 are $106,930 and assuming a 37% federal tax bracket, Aaron’s savings from depreciation would then be $289,000). His income would fall into the 37% federal income tax bracket, so his federal income taxes would be around $263,070. He could write-off up to $197,302 in year 1 from tax credits (75% of $263,070 for the current tax year, so in this case, they could write-off all $187,110 of his tax credits from the flip partnership and could invest more to increase his tax savings and returns!).
Hopefully, the benefits from buying solar projects are now clear, but there are a couple of qualifications and limitations that investors should take into account and you can read more about the mechanics (including “active participation” and other regulatory requirements) here.
Active Participation Requirement
To qualify for the tax-credit portion of the IRA’s solar program, you will have to have material participation in business. You will need to set up an LLC focused on running your solar business and you will also need to actively participate with annual hours in your solar business. This is a bit tougher for many investors, but a couple of features make the requirement less onerous:
- Activities like viewing site work (even if you are not an expert) and attending relevant conferences and educational seminars qualify for this hours requirement.
- Participation by either spouse is counted toward satisfying the annual hours.
- Valur streamlines your documentation process, enabling you to save relevant documents and log your participation hours directly on our platform.
You can also read our Active Participation article to understand all the requirements, regulations and activities involved.
Purchasing solar projects can help employees with high ordinary income to mitigate taxes and offset a large part of the tax he would otherwise owe. If you have any accounting questions, we have put together an overview of the most common technical doubts accountants have for us and you can read them here.
So, how can you go about buying qualified projects? It’s relatively simple: Valur has partnered with nationally recognized accounting and investment firms to facilitate the purchase of solar projects. We will help you identify the opportunity and choose between different solar project opportunities, 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.
To learn more you can schedule a call with us here.
- Exploring Solar Projects in 2023
- Case Study: Financial Benefits of Solar Project Purchases (2023)
- Solar Flip Partnership: An Advanced Renewable Energy Strategy
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