Solar Case Study: Lower Your Alternative Minimum Tax (AMT) Liability

Over the past few weeks, we’ve explained how solar investments can be an especially effective method to reduce your income tax bill. In this article, we’ll demonstrate how you can use this strategy to lower your Alternative Minimum Tax (AMT).

Key Takeaways:

1. Solar investments can help you reduce or eliminate the AMT you would otherwise pay — for example, when you exercise incentive stock options — and even recover taxes you’ve paid in the past three years.
2. Solar flip partnerships allow you to earn tax credits that are greater than the amount you invest in the solar project.

What is the Alternative Minimum Tax work?

The Alternative Minimum Tax is, functionally, a separate tax system that runs parallel to the regular income tax regime. It was created to prevent high-income taxpayers from exploiting tax loopholes to capture large deductions. The AMT calculation starts with your taxable income, adds back in certain deductions, and then applies a different set of rates and exemptions. If your AMT liability is higher than your regular income tax liability, you must pay the difference as AMT.

This parallel system can be quite complex, and some taxpayers may find themselves unexpectedly subject to more tax than they expected, this often happens when exercising startup equity options. Solar investments offer an opportunity to offset the AMT and reduce your tax burden.

How can solar investment tax incentives help with the AMT?

Investing in qualified solar projects can provide you with tax credits and deductions that can be used to offset your AMT liability — critically, unlike most deductions, these benefits apply to AMT just as they do to regular income. The returns from a qualified solar investment include federal credits, federal and state depreciation deductions, and a share of income from the project you invest in. The financial benefits of qualified solar infrastructure investments are substantial, and we explain them in detail in our solar tax credits guide.

Now, let’s look at an example.

Case Study: John’s Solar Investment for AMT Relief

Background

John and his wife, both New York residents, have a combined income of $550,000. In addition, John exercised about $1 million worth of incentive stock options from his startup this year, and, as a result, they have incurred an estimated AMT liability of $360,000. To mitigate their tax burden, the family plans to invest $300,000 in a flip partnership commercial solar project that offers a 40% Investment Tax Credit (ITC), bonus depreciation, and minimal income that we’ll ignore in this example.

Tax Liability and Savings

1. AMT Liability: $360,000
2. Regular Federal and State Tax Liability: $220,000 (approximately 40% of their income).
3. Total Tax Liability: $580,000 ($360,000 AMT + $220,000 income tax)

Solar Investment Benefits

1. Investment: $300,000
2. ITC: $332,000 in tax credits (40% of $830,000 project cost)
3. Depreciation Basis: $786,000

Depreciation Calculations

Federal:

1. Adjusted Depreciation Basis: $786,000 – ($332,000 * 50%) = $620,000
2. Federal Tax Savings: $786,000 * 35% (assumed federal tax rate) = $217,000

New York State

1. Depreciation Basis: $786,000
2. Depreciation per year (Years 1-5): $786,000 / 5 = $117,400
3. State Tax Savings per year (Years 1-5): $117,400 * 6% = $7,044

Year by Year Analysis

Year 1

• Tax Liability before Solar Investment: $580,000
• ITC Savings: $332,000
• Federal Depreciation Savings: $217,000
• New York State Depreciation Savings: $7,044
• Total Tax Savings: $556,000
• Remaining Tax Liability: $24,000. (Note: If the family had more tax savings than taxes in this year, they could have applied the excess to a previous year’s tax filing or carried forward to apply to a future year.)
• Net Cash Flow: -$300,000 investment + $556,000 tax savings = $256,000 gain in year 1

Years 2-5

• New York State Depreciation Savings: $7,044
• Net Cash Flow: $7,044 (state depreciation savings)

Year 6

• Developer buys back John’s interest in the project, creating depreciation recapture. (Assumed recapture is 25% of the depreciation claimed at the federal level.)
• Federal Depreciation Recapture: ($786,000 depreciation basis – $300,000 investment) * 25% = $121,500
• Additional Federal Tax: $121,500 * 25% (assumed federal tax rate) = $30,375
• Net Cash Flow: -$30,375 (additional federal tax)

Summary

John and his family benefited significantly from investing in a flip partnership commercial solar project. The investment helped them reduce their tax liability, with a focus on their AMT taxes, while also providing long-term savings and wealth creation. In the first year alone, they saw a positive net cash flow of $256,000. Adding in the future depreciation savings and wealth creation from the investment of these savings and subtracting depreciation recapture, the family earned an additional $254,000, as compared to a world in which they did not pursue a solar investment..

Investing in a solar project proved to be a strategic financial decision, as it allowed John’s family to offset their high AMT tax burden from the current year. This strategy can be advantageous for individuals with high AMT liabilities this year or in the past three years, offering substantial tax savings and a favorable long-term financial impact. By investing in renewable energy projects, taxpayers not only reduce their tax burden but also contribute to a cleaner and more sustainable future.

How to make solar investments

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. To learn more you can schedule a call with us here.

Related Readings

• Exploring Solar Investments in 2023
• Case Study: Solar Flip Partnership
• Solar Flip Partnership: An Advanced Renewable Energy Strategy

About Valur

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