Corporations such as Amazon and Apple have been taking advantage of tax savings stemming from the purchase of commercial solar projects for many years now. Recently, these tax strategies have become accessible to individual taxpayers, including those with income from W-2s, 1099s, K-1s, and business income.
As a result, those high-income earners working in fields such as tech or medicine can now make a green impact on the environment and generate passive income, while simultaneously gaining access to a powerful tax reduction strategy. Let’s answer all of your questions on how Investment Tax Credits (ITC) from commercial solar projects can reduce income tax liability in 2024.
How does a commercial solar project differ from a residential solar purchase?
Purchasing solar panels for your home is a big decision, one that includes tax benefits alongside positive environmental effects. Residential solar purchases are different from participating in a commercial solar project, though, not only in scope but also in how the strategies will affect your income tax liability.
If you decide to purchase solar panels for your own household, i.e. invest in a residential solar project, the IRS will give you a Residential Clean Energy Credit that equals 30% of the costs of a new, qualified clean energy property, installed anytime between 2022 through 20321.
If you qualify and spend $100,000 on the solar project, the Residential Clean Energy Credit will equal $30,000, to be applied against your individual income taxes. As a result, you will be out of pocket $70,000 for the project. This is a great discount and certainly an incentive, but at the end of the day you are still spending money, and you do not have an ROI on the purchase.
In the case of a commercial solar project, though, you are purchasing solar assets for a third party, such as a school, small business, or a place of worship. This third party will be the one using and benefitting from the solar project.
This third party may not have the means to pay out of pocket for the solar project or may be a non-profit with no use for the tax benefits associated with the purchase. In either case, it is still beneficial for the third party to switch to solar power and significantly lower their monthly electricity costs.
With a commercial solar project tax strategy, a high-income earner funds the solar project and collects both passive income from the sale of electricity to this third party and receives tax benefits. These benefits combined exceed the initial solar asset purchase price, with an ROI generally falling between 130% to 150% of the purchase amount, spread over 6 years, with most of the benefits incurred during Year 1.
How does the purchase of a commercial solar project help high-income households reduce tax liability?
In exchange for funding a commercial solar project, a high-income earner will receive:
- A Federal Investment Tax Credit (ITC), between 30% and 70%,
- A federal depreciation deduction (in 2024, you can receive a bonus depreciation deduction of 60%, or higher, depending on pending legislation2),
- You may qualify for a depreciation deduction with your state, and
- You may also receive cash flow from the sale of electricity.
When you add up these tax benefits, they will exceed your initial purchase price—and make the purchase very worthwhile!
What amount of tax savings can be expected from the purchase of a commercial solar project?
It is not unreasonable to see benefits along the lines of a 130% to 150% return on investment, with the majority of benefits to be claimed the same year you make the solar purchase. This means you can claim benefits on your 2024 income tax return if you make a successful purchase in 2024.
Your ROI comes in the form of tax credits or deductions and is not considered income to you. Therefore, you will not be paying any income tax or capital gains tax on these tax benefits. This further increases your ROI when compared to strategies subject to capital gains tax or ordinary income tax.
However, the benefits of commercial solar projects differ depending on a variety of factors:
- Location of project,
- Amount of ITC per project (between 30% and 70%),
- Whether or not the purchaser receives state depreciation deduction benefits (e.g. you will not receive state benefits if you live in a state without income taxes),
- Amount of cash flow per project.
The tax benefits can also differ depending on the commercial solar company facilitating your purchase, if any.
Who qualifies to purchase a commercial solar project?
Anyone with the available funds can participate in a commercial solar project and benefit from both cash flow and tax reduction benefits.
That being said, in order to take full advantage of tax credits and depreciation, the best results are obtained by individuals in the 35% or, ideally, 37% tax brackets.
Additionally, residents of states with high income taxes, such as California, will see a higher ROI than residents of states with no income taxes, such as Nevada. Nevadans will, however, still enjoy all allowable federal tax savings.
Is ITC a one-time benefit? Can it lower my past tax liability?
Yes and no. Depending on the size of your project and your tax liability, you may be able to claim all allowable Investment Tax Credit in a single tax year (in Year 1).
However, if you have excess ITC any given tax year, the Inflation Reduction Act of 20223 made it possible for taxpayers to apply this excess ITC up to 3 years back, by amending past income tax returns. In 2024, this would apply to 2021, 2022, and 2023 income tax returns4.
This makes ITC an extremely beneficial tax credit, and one of the only ways to reclaim tax paid in previous tax years! Excess ITC can also be carried forward to future tax years.
Is this an investment?
The purchase of a commercial solar project is not an investment in the way we normally define the term.
When purchasing a stock or an investment real estate property, the buyer bets on their purchase appreciating in value. They will then sell the appreciated asset, and their gain will be the difference between the purchase price and the appreciated sale price.
This gain can be subject to capital gains taxes (short or long-term capital gains taxes, depending on the amount of time that has lapsed between the purchase and sale).
No one can truly foresee whether an investment will go up in value. Investors may be just as likely to have a capital loss as they are of making a taxable capital gain.
In the case of the solar purchase, we can use tax regulations to calculate benefits very precisely (considering ITC percentages as well as state and federal depreciation schedules). These tax reduction benefits are not subject to fluctuations in the way stock or real estate prices are; the benefit is the result of tax law, and not fickle market forces.
Additionally, because the vast majority of your ROI is in the form of tax benefits, your “gains” are not considered income to you and are not subject to income taxes or capital gains taxes.
That being said, all purchases come with a risk. Potential commercial solar buyers should show caution and do their due diligence, including carefully reading all agreements and speaking with their CPA, or attorney, before making a purchase.
What should I watch out for when considering a commercial solar project tax strategy?
In the course of the last few years, commercial solar projects have become more popular, and several solar companies are selling commercial projects to individual buyers. As with everything, the more popular a thing becomes, the more you need to watch out for “bad actors.”
A few things to watch out for include:
- Buying a project that seems to be a lot more expensive than market value. The IRS will not allow taxpayers to claim tax benefits that are excessive as the result of an overvalued solar project. Buyers must watch out for projects that produce very little electricity but offer very high tax benefits.
- Entering into a partnership, if you need to mitigate taxes from active income. There are many hoops individual taxpayers must jump through in order to claim depreciation benefits against their active (e.g. W-2 or 1099) income. Entering into a partnership may cause the depreciation to be a passive loss. Passive losses cannot usually be deducted from active income.
- Buying a nonexistent project. Buyers must make sure the solar asset they purchase is actually being built, has all necessary permits, and is generating electricity. Busy high-income earners may be pressed for time to do this due diligence, but it’s an essential aspect of ensuring this tax strategy succeeds.
- Going DIY. This final aspect is very difficult to overcome. After all, many high-income earners are used to educating themselves regarding financial decisions. If we can invest our own money online, why can’t we just find a solar company, buy the project, and bypass the CPA, thus saving some time and cash? A commercial solar purchase is an extremely complex purchase, and many conditions must be met in order to remain in compliance with IRS regulations. It is ill-advised to depend on internet resources or DIY this type of purchase. A trusted CPA can make all the difference when it comes to pursuing this tax strategy.
What role does a CPA firm play in the purchase of a commercial solar project?
A CPA firm will work closely with you and conduct an analysis of your past, present, and future income tax liability. A trusted CPA firm like Ratio CPA is experienced in advanced tax reduction planning, including tax strategies that leverage purchases in commercial solar projects.
Based on this analysis, you should be offered:
- A tax plan that includes a range of purchase and tax savings scenarios, applicable to your individual situation and tailored to your purchasing power,
- An in-depth dive into the steps comprising the purchase of the solar asset, as well as IRS compliance,
- An introduction to an experienced and vetted solar company that will guide you through the purchase process,
- Additional tax reduction strategies that may be an alternative to, or supplement, a green energy purchase.
An experienced CPA firm will be your guide through the complex and convoluted landscape of tax law and will offer greater insight into the benefits and the technicalities of the purchase.
Using Commercial Solar Investment Tax Credits to Reduce Your Tax Liability
A commercial solar project purchase allows high-income households to not only contribute to making the world a greener place but also to claim passive income and tax benefits. A successful commercial solar purchase can realize an ROI of approximately 130% to 150% over the course of 6 years (depending on a multitude of factors).
The Investment Tax Credit received by buyers can furthermore be carried back up to three tax years, making it one of the only ways for taxpayers to reclaim previous tax liability.
The strategy is very involved, though, so collaboration with an experienced CPA firm is highly recommended. At Ratio CPA, we can guide you through this unique tax reduction strategy thanks to our years of experience and commitment to your financial goals.
If you’re interested in exploring whether this passive income and tax reduction purchase is right for you, schedule a no-strings consultation with our Tax Reduction Adviser or send us a message.
1 For further IRS guidelines concerning the Residential Clean energy Tax Credit, read here
2 The Tax Relief for American Families and Workers Act of 2024 can potentially increase the Year 1 bonus depreciation deduction to 100%. The Act passed the House of Representatives with a vast majority and has the support of President Biden. As of writing this article, the Act has not yet received sufficient votes in the Senate (As of August 1st, 2024: Cloture on the motion to proceed to the measure not invoked in Senate by Yea-Nay Vote. 48 – 44). The tax community is divided on whether or not the Act will pass in 2024. You can follow the actions of Congress regarding the Tax Relief for American Families and Workers Act of 2024 here.
3 See the Inflation Reduction Act of 2022 here.
4 Certain conditions apply.