Review of ITC for Commercial Solar
GUIDE TO THE FEDERAL INVESTMENT TAX CREDIT FOR COMMERCIAL SOLAR PHOTOVOLTAICS
A REPRINT OF A U.S. DOE DOCUMENT dated January 2020
DISCLAIMER: This guide provides an overview of the federal investment tax credit for those interested in commercial solar. THIS GUIDE IS NOT INTENDED AS AND DOES NOT CONSTITUTE PROFESSIONAL TAX ADVICE OR OTHER PROFESSIONAL FINANCIAL GUIDANCE. This guide should not be used as the only source of information when making purchasing decisions, investment decisions, or tax decisions, or when executing other binding agreements. Always consult with an attorney or licensed financial advisor for professional tax and investment guidance.
- The solar investment tax credit (ITC) is a tax credit that can be claimed on federal corporate income taxes for 30% of the cost of a solar photovoltaic (PV) system that is placed in service during the tax year 2019.
- To be eligible for the 30% ITC, a solar PV system must have commenced construction on or before December 31, 2019. The tax credit decreased to 26% for systems commencing construction in 2020, 22% for systems commencing construction in 2021, and 10% for systems commencing construction in 2022 or thereafter. Any PV system placed in service after 2023, regardless of when it commenced construction, can receive a maximum tax credit of 10%.
- Typically, a solar PV system that is eligible for the ITC can also use an accelerated depreciation corporate deduction.
To be eligible for the business ITC, the solar PV system must be:
- Used by a business subject to U.S. federal income taxes (i.e., it cannot be used by a tax-exempt entity like a charity).
- Located in the United States or U.S. territories (though can only be used against federal income tax obligations).
- Systems must use new and limited previously used equipment.
- Not used to generate energy for heating a swimming pool.
The eligible ITC percentage scales down over time as follows:
- 30% tax credit for projects commencing construction between January 1, 2006, and December 31, 2019, but placed in service before 2024.
- 26% tax credit for projects commencing construction between January 1, 2020, and December 31, 2020, but placed in service before 2024.
- 22% tax credit for projects commencing construction between January 1, 2021, and December 31, 2021, but placed in service before 2024.
- 10% tax credit for projects commencing construction after December 31, 2021, or placed in service after December 31, 2023.
A solar project is considered to have commenced construction if:
- At least 5% of final qualifying project costs are incurred. Expenses have to be “integral” to generating electricity, and equipment and services have to be delivered (or delivered within 3.5 months after payment).
- Or, “physical work of significant nature” is commenced on the project site or on project equipment at the factory. Physical work has to be “integral” to the project. Preliminary activities on site (e.g., clearing the site or building a fence or an access road) do not count as “integral.” The project does not require proof of continuous work if the system is placed in service within four years.
- The ITC is calculated by multiplying the applicable tax credit percentage (10%–30%) by the “tax basis,” which is the amount invested in eligible property. Eligible property includes the following:
- Solar PV panels, inverters, racking, balance-of-system equipment, and sales and use taxes on the equipment.
- Installation costs and indirect costs.
- Step-up transformers, circuit breakers, and surge arrestors.
- Energy storage devices (if charged by a renewable energy system more than 75% of the time).
Other Incentives and the ITC
For current information on incentives, including incentive-specific contact information, see the Database of State Incentives for Renewables and Efficiency (DSIRE) at www.dsireusa.org
Electric Utility and State Government Rebates
Under most circumstances, solar PV system rebates provided by a utility or state government are considered taxable income and do not affect the tax basis when calculating the ITC. For example, if the tax basis is $1,000,000 for a PV system installed at a retail business that commenced construction before December 31, 2019 and was placed in service before December 31, 2023, and the state government gives a one-time rebate of $100,000, the ITC would be calculated as follows:
0.3 * $1,000,000 = $300,000
One exception is if the rebate is provided by a utility to a customer for purchasing or installing any “energy conservation measure,” including solar PV, at a residence.9 When this is the case, the utility rebate is subtracted from the tax basis, reducing the amount of the ITC claimed; however, the rebate is not considered taxable income. For example, if the tax basis is $1,000,000 for a PV system installed at an apartment complex and the utility gave a one-time rebate of $100,000, and the project commenced construction before December 31, 2019 and was placed in service before December 31, 2023, the ITC would be calculated as follows:
0.3 * ($1,000,000 - $100,000) = $270,000
The following are some examples of incentives and policies associated with a solar PV system that typically do not reduce the tax basis related to the ITC (but some may be considered taxable income):
- Revenue from the sale of renewable energy credits or other environmental attributes associated with the electricity generated by the solar PV system.
- Payments for a state performance-based incentive.
- State and local income tax credits.
- State and local property tax exemptions on the equipment.
- Taxable state or nonprofit grants.
- Loan guarantees.
- Tax-exempt and subsidized energy financing (in 2009 or after).
- Depreciation deductions (see below).
Accelerated Depreciation and the Depreciation Bonus
A taxpayer who claims the commercial ITC for a solar PV system placed in service can typically also take advantage of accelerated depreciation (Modified Accelerated Cost-Recovery System, or MACRS) to reduce the overall cost of a PV installation. To calculate the income on which federal corporate taxes are owed, a business takes the difference between its revenues and expenses, plus or minus any adjustments to income. Because depreciation is considered an expense, having a larger amount to depreciate during the tax year results in a smaller overall tax liability. Note that while the ITC is a tax credit—a dollar-for-dollar reduction in taxes owed—depreciation is a deduction, meaning it only reduces a business’s taxes by the depreciation amount multiplied by the business’s tax rate (see below for an example).
When the commercial ITC is claimed, accelerated depreciation rules allow the full tax basis minus half the ITC to be depreciated over a five-year MACRS depreciation schedule using a half-year convention (where any unused depreciation can be carried forward indefinitely). Under the rules of this depreciation schedule, taxpayers are allowed to deduct a larger portion of this amount in earlier years, giving them the benefit of a greater immediate reduction in federal tax liability.
A business with a solar PV system placed in service between January 1, 2008, and September 8, 2010, or between January 1, 2012, and December 31, 2017, can elect to claim a 50% depreciation bonus. Systems placed in service between September 9, 2010 and December 31, 2011 or between January 1, 2018 and December 31, 2022, can elect to claim a 100% bonus depreciation. Starting in 2023, the percentage of capital equipment that can be expensed immediately drops 20% per year (e.g., 80% in 2023 and 60% in 2024) until the provision drops to 0% in 2027.
Example of a Calculation
A generic example can help illustrate how each incentive could be calculated and applied at a business. Consider a business that commenced construction of a $1,000,000 solar PV system in 2021, placed it in service in 2023, and uses the calendar year as its tax year. What is the net effect of claiming the ITC, bonus depreciation, and accelerated depreciation on its 2023 tax liability?
As indicated above for a solar PV property that commenced construction in 2021 and was eligible for a 22% ITC, when the tax basis is $1,000,000, the 22% ITC reduces tax liability by $220,000.
Bonus Depreciation Calculation
Because the business is claiming the ITC, its depreciable basis for the system after applying the ITC is 89% (100% - 22%/2) of the tax basis:
0.89 * $1,000,000 = $890,000
To calculate the bonus depreciation for a solar PV property placed in service in 2023, the business multiplies the depreciable basis by 80%:
0.8 * $890,000 = $712,000
Accelerated Depreciation Calculation
In the example, the business uses accelerated depreciation to determine what amount of depreciation it will deduct in each year from 2023 to 2028. Assuming this five-year recovery period, a half-year convention, and a 200% declining balance method, IRS Publication 946 Table A-1 lists the depreciation rate as 20% for Year 1. The business calculates its accelerated depreciation deduction by taking the difference between the original depreciable basis and the amount claimed for the bonus depreciation and multiplying by the depreciation rate:
0.20 * ($890,000 - $712,000) = $35,600
Total Impact on Tax Liability
Assuming the business has a federal tax rate of 21%, the net impact of depreciation deductions is calculated as:
0.21 * ($712,000 + $35,600) = $156,996
Therefore, the total reduced tax liability for 2023 from depreciation deductions and the ITC is:
$220,000 + $156,996 = $376,996
The business will continue to claim accelerated depreciation deductions for tax years 2024, 2025, 2026, 2027, and 2028—but the specific depreciation rate will vary by year.
Unused Tax Credits
Carryback and Carryforward Rules
Unused tax credits related to the commercial ITC may be carried back 1 year and forward 20 years. After 20 years, one- half of any unused credit can be deducted, with the remaining amount expiring.
Tax Equity Financing
When a business developing a solar project does not have a large tax liability, tax equity financing may be an option to take full advantage of federal tax benefits. The business can partner with a tax equity investor who has a relatively large tax appetite and can make use of the tax benefits. There are the following three commonly used models, although the specific arrangements can be quite complicated:
- Sale-Leasebacks: The developer sells the solar PV system to a tax equity investor who leases the system back to the developer.
- Partnership Flips: The developer and investor form a partnership, and the economic returns “flip” from the investor to the developer after the investor makes use of the tax benefits and achieves target yields.
- Inverted Leases: The developer leases the system to the investor, structuring the agreement in a way that allows the investor to use the tax benefits.
Generally, if the solar PV system is used by a tax-exempt entity such as a school, municipal utility, government agency, or charity, the ITC may not be claimed.
In some states, a tax-exempt entity can indirectly benefit from federal tax benefits related to solar by entering into a third- party ownership (TPO) arrangement. Specifically, a tax-exempt entity can agree to purchase the electricity produced by a solar PV system owned and installed by a solar company (who claims the associated federal tax benefits) for an agreed- upon number of years at a set price. This type of TPO arrangement is called a power purchase agreement (PPA). As of June 29, 2019, at least 28 states and Washington, D.C. authorize this type of TPO, 7 states prohibit them, and their legal status is unclear in the rest.16 Additionally, the ITC cannot be claimed if a tax-exempt entity simply leases the solar equipment, which is another common type of TPO arrangement used in the residential and commercial sectors; thus, in states that do not allows PPAs, tax-exempt entities cannot use the TPO arrangement to capture tax benefits.
Eligible solar PV equipment purchased through debt financing qualifies for the ITC. However, individuals (including partnerships or limited liability companies), S corporations, and closely-held C corporations financing a solar PV project by borrowing on a “nonrecourse basis” face additional rules that may delay claiming of the ITC. Borrowing on a nonrecourse basis means the borrower is not personally liable to repay the loan, and the lender primarily relies on the solar PV project as collateral. In general, the portion of the solar PV project paid through nonrecourse financing is not immediately included when calculating the ITC (although several exceptions exist); instead, in future tax years, the taxpayer can claim the ITC on the portion of the loan principal (but not the interest) as it is repaid.
Structures and Building Integrated PV
Structures holding the solar PV system may be eligible for the ITC if the solar PV system is designed with the primary goal of electricity generation and other uses of the structure are merely incidental.17 Though structural components typically do not qualify for the ITC, the IRS noted an exception for components “so specifically engineered that it is in essence part of the machinery or equipment with which it functions.”18
Claiming the ITC
To claim the ITC, a taxpayer must complete and attach IRS Form 3468 to their tax return. Instructions for completing the form are available at http://www.irs.gov/pub/irs-pdf/i3468.pdf (“Instructions for Form 3468,” IRS).
Internal Revenue Service (IRS), 1111 Constitution Avenue, N.W., Washington, D.C. 20224, (800) 829-1040.
The federal statute regarding the ITC: 26 U.S.C. § 48 at www.govinfo.gov
Updated information on the status of the ITC: DSIRE at www.dsireusa.org