When was the last time someone told you that you can make a purchase, and recover your purchase amount, plus an ROI, within a tax year—from the IRS, which is certainly not the most giving of institutions? Additionally, the government has earmarked billions for these types of projects, and the benefits can also be retroactive, allowing you to recoup taxes you paid in the last three years.
It may sound too good to be true, but with commercial solar projects and new legislative changes, this is exactly the case, no matter your source of income.
In this article, we’ll break down how commercial solar projects can be leveraged for tax reduction planning for high-income individuals.
Commercial Solar Projects as a Tax Reduction Strategy
Here’s the crux of this tax reduction strategy: purchase a commercial solar project for a third party (a business, a school, or a place of worship; not your own residence – hence, commercial project), and receive tax benefits that exceed your purchase price, the same year. In addition, continue receiving tax benefits, and perhaps even cash flow, over the next few years.
It’s no surprise that the tax strategy can raise an eyebrow or two when worded this way, but it’s a legitimate strategy that every high-income earner should be learning about if they are interested in reducing income tax liability on federal and possibly state levels, all while helping the environment.
Lowering Your Tax Liability with Commercial Solar Projects
Commercial solar projects are a great way to lower your tax liability, whether your source of income is W-2, 1099, K-1s, business income, or otherwise.
Most high-income earners are aware of the most common tax reduction options, including starting a business, maxing out your retirement, or investing in real estate.
While all of the above can be legitimate tax reduction strategies, what about your individual income tax liability? If you’re successful in business or make a profit renting a property, you cannot run away from income taxes, even if you take all the deductions your CPA allows. Statutory limitations make it difficult to defer (not reduce) your income taxes to any substantial degree if your income is high enough, through retirement planning.
What about high W-2 income earners who simply do not have the time for a side gig? Doctors, IT professionals, lawyers, and others have all been told to bite the bullet and pay the IRS.
The beauty of the commercial solar tax reduction strategy is it can be effective regardless of your main source of income. All you need is high income tax liability, which usually means an adjusted gross income (AGI) of $500,000-$600,000 and up.
Why?
The tax benefits of commercial solar projects lower your individual income tax liability. As long as it’s on your 1040, this strategy can help you lower it.
Income Requirements for Commercial Solar Tax Reduction Strategies
Commercial solar projects are best suited for high-income individuals in the highest tax brackets. As mentioned above, an AGI of $500,000-$600,000 and up is best suited for the strategy.
This is because for there to be tax reduction, an individual needs to first have high tax liability. Otherwise, due to regulatory limitations, it is not possible to claim all the tax benefits from the strategy in Year 1, and the return on the solar asset purchase amount will be deferred to future years. This may not be beneficial to the taxpayer.
Benefits from Participating in a Commercial Solar Project
When implemented correctly, a commercial solar project offers four distinct benefits:
- Tax credits (in this case, it’s Investment Tax Credits, or ITC), ranging from 30% all the way to 70%, depending on the type of project you’d be purchasing
- Federal depreciation deduction
- State depreciation deduction (if applicable)
- Possible annual cash flow from the sale of electricity to the third party
Each benefit is exciting on its own, but ITC especially has tax saving potential. As a result of the Inflation Reduction Act of 2022, ITC that is not used up in one tax year can be applied retroactively three years in arrears—giving you what can possibly be the only opportunity to reclaim federal income taxes that you already paid. This is a very exciting opportunity.
Solar Investment Tax Credits Are Not Subject to Capital Gains Taxes or Income Taxes
If you own an investment account you know that every dollar earned above your purchase price is subject to income taxes, at the ordinary or long-term capital gains rates, depending on how long you hold on to the investment (or on investment type).
This is not the case with tax credits or depreciation. These benefits are not subject to any taxes, as they are not considered income. The only portion you would get taxed on is the cash flow from the sale of electricity. This benefit, however, is not very large, and any resulting taxes will not put much of a dent in your tax savings.
Wait, Why Does the Government Want You to Buy Commercial Solar Assets?
Many countries want to be more sustainable and produce more electricity via renewable sources, such as wind or solar. Unfortunately, the purchase of solar panels is like the purchase of an average car. I’m sure you’ve heard the old saying that a car depreciates in value as soon as you drive it off the lot.
The same can be said for solar assets.
Solar assets depreciate, must be insured, must be maintained and cleaned, take up real estate, lose value after purchase, and, most importantly, generate a relatively low amount of income because electricity is cheap (though it may not seem this way to homeowners!).
This means that, without the tax incentives, if you wanted to buy solar panels to provide electricity to a third party as an investment, it would take a considerable amount of time for you to break even and start making money. In the meantime, a lot of your cash would be tied up in the purchase of the panels.
Enter the government.
By providing powerful tax benefits, such as depreciation and solar investment tax credit, ranging from 30% all the way to 70%, it became worthwhile for a high-income earner to acquire solar projects in lieu of making a tax payment, then use the tax benefits generated from that acquisition to pay for the tax liability. The benefits generated that same year are ultimately higher than the cash amount used to acquire the solar projects.
With the Inflation Reduction Act (IRA), the government has earmarked hundreds of billions of dollars to help the private sector convert to renewable energy. High-income individuals can benefit directly from the clean energy movement. Multi-billion-dollar corporations have enjoyed these tax benefits for many years, but now individuals can make green energy purchases and generate those significant tax benefits just like the big companies.
There is no longer a need to wait years for a return of capital on an investment, as the ITC and depreciation are claimed by the individual taxpayer and provide a full return of capital in Year 1.
This is clearly a win-win for the individual, the commercial customer, the government, and the environment. The high-earning individual gets to use the tax benefits including the solar investment tax credit, the country gets to increase green energy usage percentages without depleting its resources, the commercial and/or nonprofit customer receives cheaper and cleaner electricity, and the environment is less polluted.
One Caveat: Proper Tax Strategy Implementation Required
There is nothing more important than working with a solar company that has experience in helping high-income individuals lower their tax liability. While this strategy is certainly powerful, a lot depends on the implementation.
If implemented incorrectly, your depreciation benefit may be a passive benefit and will only help lower taxes for those who have income from passive sources, such as rental income or participation in limited partnerships. This does not include W-2s, many 1099s, or business income.
Additional Caveat: You Need an Experienced CPA
In addition, you will need to work with a CPA who understands the commercial solar tax reduction strategy and has experience preparing income tax returns with commercial solar projects. Your individual income tax return will have very high complexity once you add solar to the equation. An incorrectly prepared tax return can jeopardize your chances of getting a full tax benefit and increase your chances of an IRS notice as a result of an erroneous return.
You will need to make sure your CPA specializes in these types of returns, as there are not many CPA firms that do! Fortunately, Ratio CPA specializes in solar investment tax credits and related strategies for high-income individuals.
You also need to forget about self-filing, which, as a high-income taxpayer, is not recommended even if you do not participate in tax reduction strategies.
Act Quickly to Leverage this Tax Strategy
While we never want to rush anyone into making financial decisions that can have long-lasting effects, it is important to keep in mind that a commercial solar project must be operational and supplying electricity to the third party the same year you claim the tax benefit.
This means that for a 2024 tax benefit, the project must be operational by December 31, 2024.
Also, the supply of projects is limited.
This means that a decision towards the beginning of the year will give you the best results and the best opportunity for tax savings. If you wait too long, there may be no projects that fit your needs, or the projects will not be completed in time.
Tax Strategies that Deliver Environmental Benefits
Finally, we must not forget about the environmental impact of commercial solar projects. Tax benefits are not the only consideration, as you would also be contributing towards a cleaner and greener future. This is precisely why the Inflation Reduction Act of 2022 has made the benefits so worthwhile for high-income individuals.
Don’t forget you also get bragging rights!
Understanding Commercial Solar Projects for Tax Reduction Planning
The commercial solar tax strategy is very complex, and it is impossible to squeeze all information into one article. There are many moving parts and factors to consider, so your CPA or experienced tax reduction strategist should be the ones making recommendations, projections of tax savings, and referrals to solar companies.
High-income earners who qualify and participate in commercial solar energy projects can expect a great return of investment, with most benefits in the form of ITC and depreciation in Year 1. There is no long wait to recoup funds. There is also the possibility of passive income in the form of annual payments made by the commercial and/or non-profit customers on the sale of electricity generated by solar projects.
Some high-income earners may have only two choices: make a solar purchase and save on taxes or do nothing and pay your tax bill. Participation in a solar energy project can help high-income earners lower individual income tax liability, no matter the source of income.
Main benefits include solar investment tax credits, federal (and possibly state) depreciation deductions, and cash flow from the sale of electricity. ITC can be carried 22 years forward or 3 years back. ROI in the form of income tax breaks expected in Year 1.
Tax reduction planning through commercial solar projects can seem overwhelming, but, fortunately, the expert team at Ratio CPA can help you navigate this complex world. We’ll take into consideration your income sources and long-term goals to formulate a comprehensive tax reduction plan just for you.
Contact us to connect with a Tax Reduction Adviser to see if a solar investment tax credit strategy is right for you.
Disclaimer: Please note that this article is for informational purposes only, and not meant to serve as tax advice. Not everyone will qualify to participate in the strategy, and results are not guaranteed. You must consult a tax reduction or ITC specialist before participating in a project.