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Exploring Solar Investments: Tax Benefits, Requirements & How They Work in 2023

On August 16, 2022, President Biden signed the Inflation Reduction Act (IRA) into law. As a result of the new statute, the federal government will makes the single largest investment in climate and energy in American history provide up to $369 billion in tax incentives to shift America towards using renewable energy. For Americans with large tax bills, this provides an incredible opportunity to invest in clim-altering renewable energy projects and to grow their wealth at the same time.

What did the Inflation Reduction Act do with regard to Solar Investment tax benefits)?

The Inflation Reduction Act expanded a previously available tax credit that incentivizes investment in renewable energy projects. More specifically, it extended and increased the Investment Tax Credit (ITC) for solar, wind, geothermal, biogas, combined heat and power facilities, and microgrid projects. You may be wondering what are Investment Tax Credits and why you should care about them?

What are Investment Tax Credits?

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.

Investment tax credits are a federal tax incentive for business investment. They let individuals or businesses deduct a certain percentage of investment costs from their taxes. These credits are in addition to the tax write-off they get for depreciation. Investment tax credits differ from depreciation in that they offer a percentage deduction at the time an asset is purchased.

Today, credits are deployed in areas of pollution control, energy conservation, green technology, and other technologies that support environmentally conscious economic development.

What solar tax benefits does the IRA provide?

The Inflation Reduction Act offers a couple of specific tax benefits for qualified solar investments (Valur works with accounting and legal partners to qualify these investments).

Tax credits

The IRA provides for significant dollar-for-dollar tax credits in return for investment in certain specific solar programs. The credit begins at 30%, and you can receive additional tax credits that depend on the features of the project and could take investment tax credits on some projects as high as 70%.

  • 10% for projects that meet wage and apprenticeship requirements (essentially projects that pay the workers above a living wage or use union labor).
  • 10% for utilizing domestic content on projects. In practice, this means that all iron and steel and at least 40% (increasing over time to 55%) of the cost of the manufactured solar projects have to be produced in the United States.
  • 10% for basing the project in “energy communities,” “mine scarred land,” or disadvantaged areas that have historically been tied to coal, oil, or natural gas — that is, areas with at least 0.17% direct employment or at least 25% local tax collections tied to extraction, processing, transport, or storage of coal, oil, or natural gas and that have above average unemployment numbers. The government wants to help areas whose economy has depended on carbon energy to transition to renewable energy and is using these bonus tax credits to incentivize the transition for these areas.
  • Projects may also be eligible for 10% or 20% in additional tax credits for building in certain low-income areas.

Importantly, these bonus credits apply only to projects that start construction in 2023 or later, so make sure you know the features of the project you are investing in.

Depreciation

The concept of depreciation allows investors in physical assets — infrastructure or real estate, for example — to claim a tax deduction on 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 under the IRA depends on how much of a tax credit you claim. Let’s say you have a $2 million income and would owe $750,000 in federal taxes. (We’ll ignore state taxes here, since state-level depreciation is extra complicated.) If you had $800,000 in depreciation, you would be able to use that depreciation to write off $800,000, leaving you at $1.2 million of taxable income. As a result, you would owe only ~$440k in federal taxes, a savings of $330,000, not including potential state tax savings (and federal and state tax credits)!

Income Stream

Solar projects that qualify for advantaged tax treatment under the IRA typically include 15-20 year income streams tied to the energy produced by the project. These returns depend on the location of the project and local energy rates among other factors but typically will generate between 5-10% income annually on your investment.

Potential asset appreciation

Depending on the characteristics of the solar project, that income stream may continue beyond 20 years. In addition, after year 6, you may be eligible to sell your ongoing income interest in the project or move the income stream to tax exempt structures. For this reason, as you calculate the returns from IRA-eligible solar projects, you should consider the potential additional (or front-loaded) income the project could provide.

Qualifications & constraints on income tax write-off

Credit and depreciation cap

Depreciation will be capped for most investors at $289,000 per individual per tax year, or $578,000 per couple per tax year, if you are an active investor (more on this below). This means if you want your investment to return the maximum depreciation you can write-off annually you would invest $361,250 per person/year, or $722,250 per couple/year. Critically, though, there is no limit to the amount of tax credits you can apply in a given year and if you have excess depreciation 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 20 years.

Active investor requirement

To qualify for the tax-credit portion of the IRA’s solar program, you will have to be an “active investor.” What this means in practice is that you will need to set up an LLC solely focused on solar projects (relatively easy) and spend 100 hours or more on your solar LLC’s activities during each calendar year. This is a bit tougher for many investors, but a couple of features make the requirement less onerous. First, activities like viewing site work (even if you are not an expert) and attending relevant conferences and educational seminars qualify for this hours requirement. Second, participation by either spouse is counted toward satisfying the annual hours, so it is actually more like 50 hours per person for married couples. And third, Valur and our solar fund partners have built streamlined workflows to help you satisfy the hours requirement as quickly and painlessly as possible.

How to invest in qualifying solar projects

Speaking of which, how can you go about investing in 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.