(Pre-emptive disclaimer: I am neither a lawyer nor an accountant, and the following is general information, not tax advice. You should consult a qualified professional to analyze your individual tax situation.)
Tax Incentives for Solar Power
In a previous article, I discussed how solar power is profitable — but only because of the associated tax advantages:
Under standard tax treatment, a 1MW solar plant that costs $2.5 million would generate about $100,000 of profit (after tax) in its first year. Over the 30-year lifespan, this works out to a paltry 2.5% return on investment for project sponsors.
Fortunately, the U.S. government provides some significant tax incentives to spur the industry.
There are two tax incentives: a credit for 30% of the project cost, and deductions for 85% of the project cost over 6 years (including 50% in the first year) via depreciation.
Solar developers themselves are unable to take advantage of these tax incentives. For any given project, the federal tax on a developer’s profit is going to be just a fraction of the value of the tax credit. They need an investment partner that pays a lot of tax, and can absorb the full tax credit and deduct the full depreciation. These are called tax equity investors.
Tax Equity Investing
Billions of dollars are invested as tax equity each year for solar projects. Most of this money comes from large companies and banks like Berkshire Hathaway, Goldman Sachs, Bank of America, etc. Google is another big player. These businesses pay a lot of tax, so they are able to take full advantage of the solar tax incentives.
These tax equity deals are structured so that the majority of the investment returns come from tax benefits. The initial investment gets recouped within the first year, and additional profit comes from a combination of ongoing depreciation, a small share of returns from the solar power, and a buyout after 5-10 years. (The solar tax credit has a 5-year vesting period, so investors cannot plan to sell their equity before then.)
Tax Incentives and Crowdfunding
Suppose you got a group of people together and formed a company - could you do tax equity investing that way? For partners in a Limited Liability Company (LLC), all gains, losses, and tax credits are passed directly to the individual tax returns of the partners. However, it will be considered “passive activity” for tax purposes.
For individual taxpayers, losses and tax credits from passive activities get special treatment from the IRS. Passive losses can only be deducted from passive gains (i.e. not the income from your job). Similarly, passive tax credits can only be used to offset tax paid on passive gains. And the definition of “passive” is very narrow when it comes to tax law:
- Rental income, for those who are not real estate professionals; or
- Gains from limited partnership in a business, for those who do not actively work on behalf of that business.
Fortunately, individuals that cannot use their passive tax credits and losses can carry them forward to their taxes the following year. But having to stretch the tax benefits over 10-20 years makes them much less valuable.
(Corporations are not subject to restrictions for passive tax credits and losses. This is why they can do tax equity investing.)
Wrapping it Up
Taking advantage of solar’s tax benefits is crucial to making it profitable. At U.S. Clean Energy Fund, we are working on ways to make this possible for everybody.
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