Commercial solar photovoltaic systems are very dependable, durable and rugged. This is partly because they are largely a solid-state technology, have few (if any) moving parts, and typically have a useful life in excess of 30 years.
Despite this lengthy useful life, the U.S. IRS allows system owners to recuperate their investment by completely depreciating the solar system’s financial value (from a tax perspective) over five years. This depreciation method is called Modified Accelerated Cost Recovery System (MACRS), and it was established in 1986 to boost capital investments. With MACRS, the owner of a solar system can financially expense the solar system’s depreciable value within the first five years of initial investment. From the perspective of the IRS, depreciation expense increases and taxable income will decrease. This means that the system owner will pay fewer taxes.
To be clear, your solar system will last far longer than five years. However, you are expensing the asset to a five year period rather than a twenty or thirty year period. The tax shield you receive from depreciating your solar asset over a twenty year period will be the same as over a five year period. MACRS allows you to frontload the depreciation benefit from the system, thereby realizing a more rapid benefit from the cash taxes saved through the depreciation expense shield.
The MACRS schedule itself is split to 20%, 32%, 19%, 11.5%, 11.5% and 6% over the first five years. For example, a solar system with a depreciable basis of $1M can depreciate 20% ($200K) of its value in year one. If we assume that the system owner’s effective tax rate is 35%, then there will be a tax shield of $70K in the first taxable year after installation. Put simply, the system owner pays $70K less in taxes.
The tax savings attributable to this beneficial MACRs depreciation treatment is one of the primary government incentives which the solar industry uses in order to help level the playing field with the massively-subsidized fossil-fuel industry. Furthermore, the benefits of depreciation for your solar system do not stop there.
Following the 2007 financial crisis, the Economic Stimulus Act of 2008 was enacted in February 2008 with bonus depreciation for renewable energy systems. This means that you can depreciate an additional 50% of a solar system’s value in the first taxable year after installation. Essentially, bonus depreciation allows system owners to receive tax savings even more rapidly.
Bonus depreciation has been extended several times between 2008 and 2014. The Consolidated Appropriations Act was recently signed in 2015 and it extends eligible systems for bonus depreciation until Jan 1, 2018. Solar systems placed in service in 2018 and 2019 are eligible for 40% and 30% bonus depreciation, respectively. It is important to note that the depreciation rules for individual states can vary significantly when it comes to the adoption of bonus depreciation at the state level.
Using the example from before, a system with a $1M depreciable basis can depreciate 50% ($500K) in the first year. With a 35% effective tax rate, the system owner enjoys a tax shield of $175K. This equates to a total tax saving of $245K in year one. These calculations of depreciation economics are used as an example, as actual results incorporate the effect of the federal investment tax credit (ITC) on the depreciable basis. Without diverging too much, the IRS subtracts a portion of the federal ITC from the system cost to create a depreciable basis. A system owner can only depreciate your solar system based on this depreciable basis. Conceptually, the depreciable basis prevents system owners from ‘double-dipping’ into the available solar incentives.
For more information on how either the MACRS depreciation schedule or bonus depreciation can help you afford a solar system, please feel free to contact us.