Renewable energy is currently experiencing a surge in popularity and the Biden Administration and Congress have decided to go all in to incentivize these types of investments. As a result of that focus in Washington, buying solar energy projects has become increasingly attractive for investors — both socially and financially.
By taking advantage of solar energy project purchases, any high earner can increase their take-home income by 35% or more by reducing their taxes on capital gains and ordinary income like salary, RSUs, a bonus, business income and other sources.
In this guide, we’ll see how they work, when they make sense, their financial benefits and risks, a real-life example and some other aspects to take into account.
Let’s get started!
Benefits From Solar Asset Purchases
The government offers 3 main benefits for individuals looking to buy qualified solar projects and you can read a detailed article about them here.
Investment Tax Credits
A tax credit is a dollar-for-dollar reduction in the amount of taxes you owe. It is in a sense similar to a gift card or store credit you can use to reduce your tax bill. For example, if you owe $1,000 in taxes and you have a $500 tax credit, your tax liability would be reduced to $500.
The government typically offers tax credits to incentivize certain behaviors or investments. Over the last few years, tax credits have become an increasingly popular tax mitigation tool due to incentives tied to renewable energy.
Depreciation is the amount of value that a physical asset loses over time. From a tax standpoint, it is relevant because you may be able to take a deduction for this amount, reducing your taxable income and saving money on your taxes.
Let’s say you have a $2 million income and would owe $750,000 in federal taxes. (We’ll ignore state taxes here.) If you had $800,000 in depreciation, you would be able to use that depreciation to write off $800,000 of income, 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.
Solar projects typically include 15-25 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 3-7% annually of your investment amount.
Popular Solar Structures
So, you understand the benefits from buying solar projects, let’s now talk about the different structure options.
Two of the most popular structures are flip partnerships and sale-leasebacks. Below, we will explain how each structure works and their financial benefits, risks, and comparisons and you can also read our in-depth article about them here.
A flip partnership allows investors to receive a greater share of the tax credits and depreciation relative to their investment. The partnership is structured with three partners:
- A sponsor: responsible for developing and operating the solar energy project
- An investor: provides funding for the project.
- A bank: provides debt financing that increases the total investment in the project.and the tax credits and depreciation available to the investor.
These structures work by allocating typically 99% of the tax credits and depreciation to the investor partner in the early years of the project. In return, the sponsor partner receives the majority of the cash flow from the project over its lifetime.
Who is this for?
Flip partnership are a particularly good fit for individuals and businesses aiming to offset more than $500,000 in annual income.
What are the Financial Benefits?
- Tax benefits: the investor enjoys the majority of the tax credits and depreciation and can earn more in tax savings than what they invest (per dollar invested, you get somewhere between $1.5 and $1.7 in tax savings, roughly $1.3 in the first year)
- Risk sharing: the developer and investor share the project risks, reducing the exposure for each party.
What are the Risks?
- Debt (although debt partners limit the debt to what the projects can cover and solar systems revenues are fairly predictable based on historical performance)
- Liability: in case the debt can’t be covered, the risk to the investor is extremely low because the bank would previously pursue:
- The revenues from the project
- The solar system assets (panels etc.)
- The developer
- Finally the investor’s LLC
You can read about a real-life flip partnership case study here.
A sale-leaseback is a financial arrangement in which a solar project developer sells a solar system to an investor and then leases it back from the investor. This way, the investor benefits from tax incentives and a steady income stream from the project with minimal overhead, and the developer operates, maintains the system and is able to take the risk and make a profit based on the spread between the price they sell the electricity and what they pay the investor.
Who is this for?
Solar sale-leasebacks are a good fit for individuals who want cash flow and/or have smaller tax write-off needs.
What are the Financial Benefits?
- Tax incentives: the investor can claim federal tax credits accelerated depreciation, which can significantly offset the system’s investment cost
- Stable income: the developer makes regular lease payments to the investor, providing a predictable return on investment.
What are the Risks?
- Credit risk: if the developer defaults on the lease payments, the investor may have to find another operator.
Real Life Example
Lara is a tech executive living in New York and plans to put $1,000,0000 in a commercial solar project: Most commercial solar projects today have an immediate 40% tax credit. That’s $400,000 in tax credits right there, so are insanely valuable $400K less in taxes
On to the second benefit, bonus depreciation will allow her to front-load the depreciation and take more of it in Year . She can claim 80% of the value Year 1, and the rest over subsequent years. In a high income tax state like New York, she could end up with up to $100,000 + in lifetime state tax savings on the $1,000,000 project over 5 years.
The third benefit would be an income stream: she’d be paid another $50K a year for the lifetime of the project.
Bringing it all together, Lara’s $1,000,000 in the solar project gets:
- A $400,000 federal tax credit.
- ~up to $640,000 of federal depreciation in Year 1 or $300K in tax savings at top bracket.
- ~up to $800K of state depreciation or $100K+ in tax savings in NY.
- $50,000 in income every year.
Not bad results at all! And you can also play with our online calculator to customize it with your own numbers and see your potential savings here.
If you’d like to read a more detailed example, please read about Priya’s case here. We also invite you to read another example of how Aaron managed to significantly his taxes by purchasing solar projects.
Considerations When Starting A Solar Business
Benefits from solar projects are clear, but there are a couple of qualifications and limitations that people should take into account.
Depreciation and tax credit cap
Depreciation will be capped for investors earning W-2 (i.e. salaried income) at $289,000 per individual or $578,000 per couple per tax year if you are an active investor. However, if you have excess depreciation, you can apply them in future tax years. Critically, if your are a business owner – if you have active or passive business income – there is no limit at all to the amount of depreciation you can apply.
On the other hand, there is no limit to the amount of tax credits you can apply in a given year 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 apply them over the next 20 years.
Active participation requirement
To qualify for the tax-credit portion of the IRA’s solar program, depending on your situation, you will have to be active.
If you are active business income, ordinary income, RSUs, you will need to set up an LLC and you will also need actively participate in the project. This is a bit tougher for many investors, but Valur streamlines your documentation process, enabling you to save relevant documents and log your participation hours directly on our platform and you can read more about it here.
On the other hand, if you have passive business income and want to invest in a solar project, you will also need to set up an LLC focused on solar projects, but you don’t need to spend any time on it.
Purchasing solar projects such as flip partnerships and sale-leasebacks offers significant benefits for individuals looking to reduce their taxes and increase their long-term returns. The government provides incentives in the form of tax credits, depreciation, and income streams, making renewable energy investments increasingly attractive for high earners.
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.
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.