3 Tax and ITC Considerations for Your Solar Project

On the Solar Executive MBA Training Discussion Board…

Key Takeaways:

• Depreciation benefits tend to be far lower than the value of the solar investment tax credit (ITC)
• If an asset is deemed an “integral” part of the solar PV system then it can be included for calculation of the ITC
• Some assets are ineligable for depreciation or the ITC, like the portion of the sale price assigned to the value of land

WEEK 4 Conversation between Chris Lord & Student 1

STUDENT 1: I’ve heard guys saying they can “sell a solar tax benefit at 90 cents on the dollar.” Is this the same as “tax equity investing” such that the organization “buying” the tax benefit is actually buying equity ownership in the project, or can tax benefits actually be sold without transfer of ownership of the project?

Chris Lord: You are correct in that the tax investor is “buying an equity investment” in the project, for which a portion of the return will be tax benefits. The $.90 is the value of the ITC, or investment tax credit, discounted one year at the investor’s rate of return. Depreciation benefits, because they are spread over five or six years, tend to be much lower – say$.70 or less, depending on the discount rate.

Except in limited circumstances (e.g., low income housing tax credits), the IRS essentially bars “selling” tax benefits. In fact, the IRS’s economic substance test for transactions is about assessing the transaction economics to ensure that there was no purchase or sale of tax benefits, but rather a transaction entered by the parties for genuine and measurable economic reasons exclusive of the tax benefits. This is why we like to see if a transaction is “cash-on-cash” positive by looking at the investor’s return profile to ensure that if we exclude tax benefits the remaining cash return, relative to the cash investment, is positive. That positive cash return is the proof or justification to meet the economic substance test.

WEEK 7 Conversation between Chris Lord & Students 1 and 2

Student 1: What costs are eligible for ITC and depreciation? How much of the roofing, development fees, sales commission, pre paid maintenance agreement, CPA fees, attorney fees, Insurance, demand management, etc.?

Chris Lord: Great question! But not an easy one to answer.

Not surprisingly, its also one around which many law firms and accounting firms have built lucrative practices. So, keep in mind that in real life when you have a question about whether a property is eligible for the ITC you do well to consult a professional on the particulars of your situation. There are many surprised developers out there who learned belatedly that not all of their roof improvements qualified, or that interconnection costs were rejected. Given how thin margins are for developers such a finding late in the game can wipe out the profit very quickly.

As we discuss in Class 3 and 4, if an asset is integral part of the solar PV system then it can be included for calculation of the ITC. The problem is defining “integral”. For example, putting a new roof on a building for a DG System sounds integral especially if the roof is old and leaky. That said, more often than not such improvements, such as new asphalt and new water drains are excluded because they are not considered “integral” to the PV system. That said, if you painted a roof white to increase solar reflection onto your panels for a demonstrable boost in PV output, then that portion of the cost may be includable.

For fees you have to consider whether the expense can be capitalized or expensed on a return – if a fee is properly expensed (e.g., a five year casualty insurance for an operating PV system) then it is not properly included for ITC calculations. That would mean that a commission might be included as an acquisition cost and therefore capitalized in the asset’s basis.

One way that fees, commissions, a “reasonable” profit margin, etc. are swept into eligible basis is through the sale of a project to a third party prior to COD. The new owner’s basis in the project for depreciation and ITC calculations is that portion of the purchase price not allocated to inelligible assets, such as land acquisition.

Student 2: Kevin & Chris, please correct me if I’m wrong:

As I understand it, this is one of the primary motivations for using the inverted lease structure rather than the “simpler” partnership flip: the ITC is passed through to the lessee, but since the lessee (in theory) doesn’t have visibility into the cost breakdown of a project, they can take the ITC on the entire project cost (except ineligible assets such as land). Meanwhile in the partnership flip, the cost breakdown is known to both partners and thus some cost items may be ineligible for ITC.

Chris Lord:  Close, Student 2, but a little more complicated than that. In all structures, the sale of the project – whether in a Partnership Flip to the partners, a sale-leaseback to the lessor, or an inverted lease to the lessor – sets the tax basis at the sale price (even where the buyer is related to the seller), provided, however, that the sale price represents the equivalent of a “fair market value arrived at through arms-length negotiations between an unrelated buyer and seller”.

Assuming that is the case, the buyer and seller must allocate the sale price across the various assets to determine each asset’s basis. Some of the assets will be ineligible for the ITC. For example, that portion of the sale price reasonably assigned to the value of land (assuming title to the land passed to the buyer) would not be eligible for depreciation or the ITC. Similarly interconnection costs are also often not eligible for the ITC. The parties have a little leeway on how to allocate the purchase price, but it must always represent a reasonable approximation of the fair market value for that asset.

So in our modeling, if we know or can approximate some of the ineligible costs – e.g., land acquisition costs, interconnection, roof upgrades not directly tied to production of power, etc… – we should exclude them from the depreciation calculations and the ITC/Cash Grant calculations.

Both Chris Lord and Keith Cronin have extensive expertise at the highest levels of solar business and are committed to being hands-on leaders for students as they work through the Solar Executive MBA.

Additional Learning Resources: 

• Course: Financial Modeling for Solar PV Projects (Chris Lord)
• Free Course: How to Use Solar Leases to Grow Your Solar Business (Chris Williams)
• Free Course: Commercial Solar PPAS 101 (Chris Williams, Keith Cronin, Chris Lord, Mahesh Bhave)
• Free Course: Finance 101 for Renewable Energy Professionals (Chris Williams)
• Free Tool: Guide to Mastering Commerical Solar Finance (Chris Williams)