Many business owners are looking for ways to obtain off-the-grid or sustainable energy resources to mitigate the risk of shutdowns due to natural disasters, reap environmental advantages and claim economic benefits. One option is to invest in solar energy projects, and like most of the Internal Revenue Code the nuances of the solar energy property credit need to be understood to be maximized. We will begin by exploring how timing your project will affect the value of your solar energy credit.
Time is Money
The Federal solar commercial energy tax credit provides an opportunity for you to receive a tax refund of twenty-six cents for every dollar you invest in solar energy property for construction between 2020 and 2022 and placed into service before January 1, 2024. Tax savings drop to twenty-two cents for every dollar if construction begins in 2023. Tax savings will decline further to just ten cents on the dollar for construction projects starting in 2024.
It is important to understand a few definitions when discussing energy credits. “Energy property” means any property “which is equipment which uses solar energy to generate electricity, to heat or cool (or provide hot water for use in) a structure, or to provide solar process heat, excepting property used to generate energy for the purposes of heating a swimming pool.” The commercial energy property credit is claimed when qualified energy property is “placed into service.” An asset is “placed into service” when it is “in a condition or state of readiness and availability for a specifically assigned function.” Typically, solar equipment is placed into service when it can produce electricity through the use solar energy, whether or not that electricity is actually sold to or used by anyone.
Construction begins when the taxpayer meets either two tests:
- Physical Work Test; or
- Five Percent Safe Harbor Test.
The Physical Work Test looks at whether or not the taxpayer has engaged in significant physical work on the energy property. The Five Percent Safe Harbor test requires the taxpayer to pay or incur 5% or more of the total project costs. If items are on backorder or delayed, please consult your tax advisor. Furthermore, the continuous construction test must be met regardless of which of the above tests are applied and is generally satisfied when the construction work is completed within five years.
In a multi-phase project, the start date for the construction project depends on whether or not the phases are considered a single project. If the phases are a single project, then the construction date commences when the first phase begins. If not, the construction dates are separately determined. The IRS outlines factors to determine if a project is defined as a single project, including whether or not energy properties are:
- Constructed on contiguous pieces of land;
- Share a common substation; and
- Are part of a single construction contract.
Maximizing the Solar Energy Property Credit
Verify Solar Energy property qualifies
Consult with a solar energy provider to ensure the solar energy equipment you intend to purchase qualifies for the credit. Obtain a written statement of the equipment’s credit qualifications. As solar energy evolves new models may be manufactured and it may be difficult to prove older models of the equipment qualifies.
Best-laid plans can lead to an optimal credit
Work with your solar provider on creating a construction schedule to maximize the energy percentage. Critical dates are the date construction begins, the date the energy property is placed into service and payment dates. Record and revisit the timetable periodically.
Meet the five percent safe harbor test
Project out the total cost to determine how much money to put down to meet the five percent safe harbor test. Build a cushion into your projection. Once underway, project costs tend to pile up and may require you to put down more money to meet the test. If the test is not met you may receive a lower credit amount. Keep track of the solar costs and separately categorize solar related costs. Request your providers to either send separate invoices for solar related costs or to itemize the solar items. Obtain contemporaneous documentation to substantiate all payments and keep them for your records in case of an audit.
Back up planning with the physical work test
Simultaneous to collecting records to support the tests above, compile evidence to meet the physical work test requirements. This may be employed as a backup plan if the five percent safe harbor test cannot be met. Request that your providers keep a log of the solar related work. Include the date the work is completed, description of the work completed and the percentage of the work completed.
Evaluate whether multiple phase projects constitute a “single project”
Typically solar projects are performed in multiple phases. Determine if the phases may be treated as a single project or, if combined, would avail you to a larger energy percentage. Work stretched out over several years may provide a benefit should their beginning phases mark the start of construction in an earlier year. List out the relevant factors referred to above and then compile evidential support.
Distinguish between commercial and residential property
Be mindful of whether the solar property was installed in a commercial or residential rental building or a home. Tax rules differ based on the type of property. Mixed-use properties should be discussed with your tax advisor.
Maximizing the Solar Energy Credit Checklist
- Invest in solar energy projects before 2023 to receive the maximum benefit.
- Investigate which solar equipment qualifies for the solar credit prior to its acquisition.
- Plan ahead and discuss with all relevant parties the various dates and requisite tests to claim the solar energy credit.
- Consider the pros and cons of combining various phases into a single project.
- Maintain contemporaneous documentation throughout the project in the event of an audit.
Contact your Friedman LLP advisor today if you have any questions about adding solar projects to your investment portfolio.