According to Brian Jones, CEO of Windmill Capital Management in Menlo Park, Calif., solar tax equity has been increasing in popularity since 2008. Solar tax equity is an ownership position in a solar project that receives most of the tax benefits from the project. Jones discusses the tax planning opportunities surrounding this concept and what they mean for corporate accountants.
By: Jim DeLuccia, PICPA Communications Manager
According to Brian Jones, CEO of Windmill Capital Management in Menlo Park, Calif., solar tax equity has been growing steadily in popularity since the expansion of the energy investment credit in 2008. I'm lucky to be joined by Brian on the phone today. He's going to explain the tax planning opportunities surrounding solar tax equity for the corporate accountants in our audience. Brian, thanks so much for joining me today all the way from the west coast.
Thanks for having me, Jim.
First, I think it's important to begin with a definition of the concept of corporate tax planning with solar tax equity. Can you explain that a little bit?
Solar tax equity is an ownership position in a solar project that receives most of the tax benefits from the project. The tax benefits come from the investment tax credit for energy property under IRC Section 48, as you mentioned, as well as depreciation deductions. In addition, the tax equity position receives project cashflow over the investment duration, which is typically five years. There's a mandatory five-year holding requirement or else the credits can be recaptured under the law. On average more than 70 percent of the investment is returned from these tax benefits in the first year. After tax IRR's from these investments are approximately 9 percent to 12 percent, which is equivalent to eleven and a half percent to more than 15 percent on a pretax basis.
Brian, now that you've introduced the concept or explained it a little bit to our audience, why is this concept especially important now in 2019?
Currently the solar tax credit is 30 percent of eligible project costs, but that amount is set to step down beginning in 2020. The credit is 26 percent in 2020, 22 percent in 2021, and 10 percent in 2022 and thereafter. Note that while the credit is allowed in the year that the project is placed in service, the amount of the credit is determined based on when the project commences construction. In order to get the maximum credit, project construction must begin in 2019 and that's really what's brought tax equity, solar tax equity investing, to the forefront is the end of that 30 percent maximum credit. Getting that credit for 2019, in either in 2019 or 2020, is of high interest right now.
How does bonus depreciation factor into this type of planning?
Bonus depreciation of 100 percent was included in the 2017 tax bill for property acquired and placed in service before Jan. 1, 2023. The projects we're talking about here are generally eligible for that. The bonus depreciation is on adjusted basis and the basis of the project is adjusted for one half of the amount of the credit. Even though the credit could be 30 percent, the remaining basis is actually 85 percent of the project costs. The projects here that we're talking about here are generally eligible for bonus depreciation. That said, because of the reduced corporate tax rates as well as basis limitations on the losses that are allowed, bonus depreciation really is only of a limited value in the solar tax equity investments.
We're talking about projects. Are there a few examples that you can provide to our listeners as to how this might work?
I'll use large numbers here, just because they're easier to understand mathematically, but keep in mind that these projects range significantly in size. Imagine a $10 million project where the tax equity investment is $4 million. In year one, the tax credit is $3 million or 30 percent of that $10 million project cost, and the tax equity investor receives 99 percent or $2.97 million of that credit. The tax equity also gets $1.03 million of depreciation losses after limitations, which are worth $216,000 at a 21 percent tax rate. In total, year one tax benefits are $3.186 million or nearly 80 percent of the invested capital. The remaining investment returns, as I mentioned, of approximately 9 percent to 12 percent come from operating cashflow and that's typically tax free to the tax equity investor because of the suspended losses. As you can see, the real appeal of these tax equity investments is the ability to utilize a corporation or a bank's tax liability to generate low risk excess returns and of course these projects help the environment by reducing greenhouse gas emissions, which is a primary cause of climate change.
What action should listeners who are decision makers take right now regarding this planning strategy?
In our experience, decision makers typically aren't aware of the benefits of solar tax equity or they incorrectly believe that the benefits are available only to the largest banks and corporations. The first most important step is education. Talk to your tax adviser to get more information on the credit. We also have educational materials available on our website. If solar tax equity looks like an inappropriate planning tool, contact a firm like Windmill Capital, who can help evaluate available projects for executing that strategy. We see projects, new projects all the time and high-quality projects with tax equity investments ranging in size from approximately $500,000 to $2 million and up, are regularly available around the country.
Brian, your firm does work nationally, with companies all over the country?
That's correct. We have a network of solar developers who have projects both in their state, as well as outside of their states. There's ongoing solar developments, commercial solar developments all around the country. We didn't talk here about the additional state tax benefits, but in higher income tax states, there's also a benefit here from the depreciation deductions that can be taken. There's an additional state tax benefit which we don't quantify, because the rates and the rules vary state by state, but there is an additional benefit for investors who identify projects in their state to get additional benefits from a state tax credits.
Thanks again, Brian, for explaining this concept to our listeners out there. I'm sure they're going to find it quite helpful.
Thank you for the opportunity to talk about it. It's an exciting topic for us, something we spend a lot of time on and we think it's useful for people to better understand what the opportunity is.
I'm sure it's ever changing too, right? I’m sure there's always developments and new things happening out there.
The marketplace is always adapting to the economics around tax equity investing and the reduction in corporate rates change those dynamics. Last year where tax equity became a slightly smaller portion of the total project capitalization, the market will continue to evolve, but I think it'll continue still to be an important factor in financing these projects and compelling opportunity for corporations with tax liability to manage that tax liability as well as make a positive contribution to environmental conservation.