Solar Tax Benefits Guide

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, investing in solar energy projects has become increasingly attractive for investors — both socially and financially. 

By taking advantage of solar energy investments, any high earner can increase their take-home income by 35% or more by reducing their taxes on 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 Investments

The government offers 3 main benefits for individuals looking to invest qualified solar investments 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

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.

Income Stream

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 Investments

So, you understand the benefits from investing in solar projects, let’s now talk about the different investment 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.

Flip Partnership

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: 

1. A sponsor: responsible for developing and operating the solar energy project
2. An investor: provides funding for the project.
3. 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 solar investments 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:
  1. The revenues from the project
  2. The solar system assets (panels etc.)
  3. The developer
  4. Finally the investor’s LLC 

You can read about a real-life flip partnership case study here.

Solar Sale-Leaseback

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 from their investment 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

Priya is an engineering manager at Snowflake and in 2023, she will earn $600,000 in cash and vest $400,000 in RSUs. As a result, she has a substantial tax bill: $323,000 in federal taxes, and another $97,800 in California state taxes — a total of $420,800, or 43% of her total income.

An investment in a qualifying solar project, however, could earn Priya significant tax credits and depreciation deductions to mitigate her high tax burden. 

Imagine that she chooses to invest $240,000 in a flip partnership solar project this year. As a result of this investment, she could reduce her tax bill in 2023 from $420,800 to $96,685 and also reduce it by $73,804 more in the following 5 years.

Let’s now see the numbers:

Situation Overview

• Income: $1,000,000 in 2023
• Expected taxes without solar benefits: $420,800

Solar Impact

• Investment: $240,000
• Tax Savings: $393,120

Results

• Total tax savings. As a result of her investment, she will have a total reduction in federal and state taxes of $393,120, or 166% of the $240,000 investment.

Year-by-Year Tax Savings:

Below, you can see the year-by-year tax savings from tax credits and Federal and State depreciation. You can also play with our online calculator to customize it with your own numbers and see your potential savings here.

Total Income: Negligible. While Priya will receive some income distributions over the early years, the lion’s share of the project revenue will go to her investment partners as a result of the flip partnership structure. See our guide to solar flip partnerships for more information.

What if Priya chose not to invest in solar?

This is a pretty simple comparison as if Priya doesn’t invest the $240,000 in the solar project, she would owe more than that in taxes and be sending the $240,000 in solar investments to the IRS.

Situation Overview

• Tax bill: $420,800
• Amount not invested in solar: $240,000
• Missed Tax Savings from Solar: $393,120
• Net Loss: -$153,120

Results

If Priya chose to pay her taxes instead of investing in solar, she would owe that full tax bill of $420,800. Compare that to the additional $153,120 she would gain in tax savings from the flip partnership ($393,120 in tax savings – $240,000 in the cost of the solar investment).  

If you’d like to read more in detail about Priya’s  case, you can do so here. We also invite you to read other examples of how John and his wife reduced their AMT tax liability or how Aaron managed to significantly his taxes with solar investments. 

Important Aspects When Making Solar Investments

Benefits from solar investments are clear, but there are a couple of qualifications and limitations that investors 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 you have active or passive business income, there is no limit to your depreciation write-off. 

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 22 years.

Active investor requirement

To qualify for the tax-credit portion of the IRA’s solar program, depending on your situation,  you will have to be an “active investor”.

If you are active business income, ordinary income, AMT liability, RSUs, you will need to set up an LLC and you will also need to spend at least 100 hours annually on the project between you and your spouse. This is a bit tougher for many investors, but Valur has built streamlined workflows to help you satisfy the hours requirement as quickly and painlessly as possible 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.

Conclusion

Investing in 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.

About Valur and How We Can Help

Valur has a singular goal: to help our customers reduce their taxes. We can help them access tax planning structures that are otherwise inaccessible to them.

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. 

If you would like to learn more, please feel free to check out our Learning Center, check out your potential tax savings with our online calculator or schedule a time to chat with us!