Have you heard that commercial solar projects are providing the next wave of tax-saving strategies for high-income earners? Whether your income is primarily W-2, K-1, 1099 or business income, all high-income earners can take advantage of commercial solar projects to help lower their federal (and possibly state) income tax liability.
As you can tell by the term “commercial” solar projects, these are not solar panels for you to install on your own roof. Instead, they will be providing electricity for a school, a place of worship, a small business, or other institution.
You buy the panels, so you get tax benefits greater than your purchase amount – while a non-profit organization or for-profit business gets cheap electricity. Everyone wins.
4 Potential Benefits of Commercial Solar Projects
Potential benefits of investing in commercial solar projects include:
- Federal Investment Tax Credit (ITC)
- Federal depreciation deduction
- Possible state depreciation deduction, depending on state tax laws
- Possible cash flow from the sale of electricity
The benefits vary depending on your unique tax situation and the state you reside in. To explore which benefits may be available to you, contact a tax advisor at Ratio CPA.
To read more, see our past article.
What Are Investment Tax Credits?
Tax credits are a dollar-for-dollar income tax reduction (and they are far superior to deductions!). Federal Investment Tax Credits (ITC) for commercial projects are offered at a range of 30% to 70%, pursuant to several other factors.
Let’s break down how a tax credit works. While the term may seem intimidating, it’s a relatively simple strategy when put in practice. If you owe the IRS $5,000, but have a $1,000 tax credit, your total tax liability at the end of the day is reduced to $4,000.
ITC regulations permit purchasers to deduct a percentage of certain investment costs (such as the cost of a solar panel purchase), from their tax liability, in addition to the normal allowances for depreciation.
When used in combination with depreciation, ITC can make it possible for you to receive a return on your purchase – in year one.
Also, as ITC is not income, you do not pay any taxes on your credits. No capital gains tax, no income tax. Nada.
What Is Federal Depreciation?
While tax credits offer dollar-for-dollar tax reduction, federal depreciation lowers your taxable income on the federal side by a percentage.
You may be wondering: why can you depreciate a commercial solar project?
Imagine purchasing a car for your business. The value of this car goes down as soon as you drive it out of the dealership. Your $50,000 SUV now has a resale value of, say, $45,000.
The $5,000 loss in value is called depreciation. The IRS allows you to deduct this amount from your taxes as a loss.
Solar panels also lose value, or depreciate, in a predictable way, called a schedule.
In 2023, purchasers can depreciate 80% of the total value of their solar panels in Year One (this is called bonus depreciation) and the remaining 20% over a series of following years.
Just like ITC, depreciation is not income, you do not pay any taxes on your deduction. No capital gains tax, no income tax. Zilch.
What Is State Depreciation?
Some states allow you to depreciate your commercial solar project on the state level, in addition to the federal level.
This, of course, does not apply if you live in a state with no income taxes, like Texas.
Your state might allow bonus depreciation in Year One or might require you to depreciate your commercial solar project equally over a period of several years. Availability of this benefit is decided on a state-by-state basis, but the bottom line is you may be able to reduce your state income taxes as well as federal taxes.
Cash Flow from the Sale of Electricity
The solar panels you purchase will be generating electricity for a third party. This third party will be paying you for electricity, as you own the panels.
This cash flow is a source of passive income to those who own a commercial solar project and is the only taxable element listed in this article. Ordinary income taxes apply.
Bonus: A Hidden Fifth Benefit
There is a finite amount of ITC that a taxpayer may claim in any given tax year. What happens if you have more ITC than you can claim? Fortunately, you do not lose it. You can carry it forward for 22 years, or carry it back for three years.
ITC makes it possible for you to reclaim taxes paid in previous years – for a project purchased in 2023, those years would be 2020, 2021 and 2022. Whichever year you choose, you’ll be able to apply the tax credit to alleviate your tax liability.
Imagine getting some of your already-paid tax liability back!
Who Qualifies?
If the Adjusted Gross Income (AGI) for your household is close to or exceeds $600,000 annually, you could be a good candidate to participate in commercial solar projects to lower your federal (and potentially state) income tax liability, regardless of the form you receive your income on (W-2, 1099, K-1, business income, etc.). This is due to the amount of tax liability families with AGIs over $600,000 owe on an annual basis.
According to the IRS, AGI is defined as “gross income minus adjustments to income.” It’s important to note that your gross income includes your wages plus all other income, including dividends, capital gains, retirement distributions, and other income sources. Adjustments include certain expenses, such as alimony payments, student loan interest payments, some retirement account contributions, and more.
Have Questions? Schedule a Call
Always speak with a qualified CPA regarding commercial solar projects or other tax planning strategies, and do not dive in on your own. A CPA will prepare tax projections and make sure you can fully benefit from these projects.
Have questions? Feel free to schedule a complimentary consultation.