Tax Advantages of Solar or Geothermal Energy
Daniel Gayer, Tax Senior Manager
Updated February 2014
Are you interested in green energy as a potential investor or donor to nonprofit organizations who might benefit from solar or geothermal energy to power their buildings? Are you in a high tax bracket with a large amount of income from passive investments? If so, you may wish to consider an investment in a solar or geothermal energy project as a means to reap the greatest possible tax rewards from your investment or charitable contribution.
The Energy Credit
Internal Revenue Code Section 48 allows taxpayers to claim a tax credit equal to 30% of the amount invested and attributable to the cost of qualified solar energy property. In practice, this typically consists of solar panels and equipment installed on the roof of a commercial building. The credit can be claimed in the year in which the property is placed in service, and is currently authorized to continue until January 1, 2017. A similar credit is available for investments in geothermal energy projects, although the credit in that case is limited to 10% of the amount attributable to the cost of qualified geothermal energy property.
While C corporations may claim this credit, the focus of this article is on individuals, who often obtain the credit through their ownership in partnerships, LLCs or S corporations (“flow through” entities). To claim the credit, the taxpayer must be the owner (directly or indirectly through a flow through entity) of the energy property. The taxpayer also must report net passive income, because use of the credit is based on passive income. An additional benefit of this ownership is that taxpayers with sufficient passive income can claim depreciation deductions related to their remaining basis in the property, after first reducing the basis by 50% of the credit claimed. Under 2013 rules, the taxpayer can take advantage of 50% bonus depreciation to deduct 50% of the depreciable basis in the first year, and deduct the remainder over the next five years. Effective January 1, 2014, bonus depreciation is no longer available, although Congress sometimes reinstates it retroactively. Even in its absence, taxpayers can deduct their entire depreciable basis over six years.
As an example of the tax value of a typical solar project, a taxpayer taxed at the current top federal rate of 43.4% (including the new net investment income tax) who invests $100,000 attributable to qualifying solar energy property could obtain a $30,000 credit and a depreciation deduction worth approximately $22,100 in the first year, assuming 50% bonus depreciation. With additional depreciation deductions worth $14,800 over the next five years, the total federal tax savings would reach $66,900. If the taxpayer happens to live in a state like Maine with a high state tax rate as well, the total tax savings could exceed $70,000.
Mechanics of Claiming the Credit and Depreciation Deductions
Across the country, many renewable energy companies specialize in setting up small and large scale solar and geothermal projects costing anywhere from $25,000 on the low end to several million dollars on the higher end. These projects are typically used to power commercial buildings, often buildings owned by nonprofits such as colleges or hospitals. A typical project structure involves the renewable energy company setting up a limited liability company (LLC) to own the property, investors contributing money to and thereby becoming owners of the LLC, and the LLC then purchasing solar energy equipment from the renewable energy company. The LLC pays the renewable energy company to install and maintain the equipment located on the roof of the host-organization’s building using the invested funds.
The investors are typically the majority owners of the LLC, whose members are entitled to take the credit and depreciation deductions. The owner of the host building pays the LLC for the electricity produced by the project at a negotiated rate. Once the equipment is fully depreciated for tax purposes – typically six years – the LLC can decide to continue to hold the property and receive payments for the electricity produced, generally a small amount of income, or sell the property to the owner of the underlying building at the current fair market value.
If you have substantial passive income, are in a high tax bracket, and are considering a possible investment or charitable contribution through an investment in solar energy, please contact your BNN tax professional for a detailed analysis of how these options could benefit you in light of the specific facts of your tax situation. If you are a business owner interested in using on-site solar or geothermal energy to power your business, please contact us as well, as this credit may benefit you too and help you to more quickly recover the cost of your investment.
Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.
IRS CIRCULAR 230 DISCLOSURE:
Pursuant to requirements imposed by the Internal Revenue Service, any tax advice contained in this communication (including any attachments) is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code or promoting, marketing or recommending to another person any tax-related matter. Please contact us if you wish to have formal written advice on this matter.