The U.S. uses the federal tax code to promote the deployment of renewable energy across the country. And whether you think these tax incentives are a pointless concession to the solar industry or a prudent attempt to counteract the decades of incentives enjoyed by the fossil-fuel industry, they have become integral to the economics of solar projects in the U.S.
For the last decade, the primary federal solar tax benefit has been the 30% Investment Tax Credit (ITC), which is provided by section 48 of the Internal Revenue Code. The ITC provides owners of solar systems with the ability to offset tax payments owed to the IRS in an amount equal to 30% of the eligible cost basis of a solar photovoltaic system.
While there are several ways for companies to go solar – through a Power Purchase Agreement (PPA), a solar operating lease or the direct ownership of a solar system – the ITC is a primary determinant of the underlying economics for every option. However, changes are coming to the ITC beginning in 2020.
The Step-Down Cometh:
The 30% ITC, which has been the lynchpin for solar deployment in the U.S. over the last decade, will decline to 26% for projects that “begin construction” in 2020. It will decline further to 22% for projects beginning in 2021 and finally to only 10% for projects beginning in 2022 and thereafter.
For corporate solar projects, the reduction in the ITC can significantly impair solar project economics. As an example, a typical 5MW commercial solar project in California with the scheduled step-down next year to a 26% ITC would result in IRRs falling by about 100–150 basis points and PPA rates increasing by up to 7–10% under standard assumptions.
Methods to Mitigate the Step-Down:
The good news is that, with proper planning, there are several clearly identified strategies that corporates can use to mitigate next year’s ITC step-down. In June 2018, the IRS provided guidance in its Notice 2018-59, which clarifies exactly what it defines as “beginning construction.” Fortunately, this term is a bit broader than what many of us would assume.
In a nutshell, the IRS notes that there are two methods for a taxpayer (i.e. system owner) to satisfy this “beginning construction” requirement. They can: (1) begin actual physical work of a significant nature (“Physical Work Test”); or (2) pay or incur 5% or more of the total cost of the solar project (“Five Percent Test”). In our experience, the Five Percent Test is the more flexible and reliable method for system owners to formally “begin construction.”
System owners who satisfy either of these requirements, and make continuous progress towards completion once “construction” has begun (among other requirements), can enjoy the full 30% ITC as long as the solar project is completed by the end of 2023.
For corporates, and in particular, corporates with large real estate portfolios, smart planning now in 2019 can provide the ability to grandfather solar projects into the 30% ITC, even if these projects are not actually completed until 2020, 2021, 2022 or even 2023.
At EnterSolar, we are currently working with many of our corporate clients (and their tax experts) to holistically assess solar project opportunities across their entire U.S. real estate portfolios. Together, we can identify projects that will likely be eligible for the full 30% ITC and take steps to ensure that our clients reap the full benefit of this tax incentive while it lasts.
If you are interested in going solar, now is the time to act. Contact EnterSolar today for a customized analysis based on your company’s real estate portfolio, energy usage and the available incentives. EnterSolar is agnostic to project structuring and provides a turnkey solution to corporates looking to transition to clean, renewable solar energy. Call us at 888-225-0270 or contact us today.