Sunlight In Your Pocket: Solar Energy Tax Incentives

Published: October 10, 2023

For a number of years, certain Federal, state and local tax incentives have been available to promote, among other things, the importance of renewable energy like solar power. These incentives benefit Florida’s business owners and residents who choose to implement solar energy systems on their property.

How these incentives are applied, and how long they are available, have been changed by the recent adoption of the Inflation Reduction Act of 2022. Although this article focuses on opportunities for solar power, similar or comparable incentives are available for other forms of renewable energy, such as wind and biofuels.

Federal Tax Incentives

Code § 48(a) provides for an energy credit, commonly known as the “investment tax credit”, up to thirty percent (30%) of the cost basis of qualifying energy property placed in service during a taxable year, the construction of which begins before January 1, 2025.  For these purposes, “energy property” means equipment using solar energy to generate electricity, to heat or cool (or provide hot water for use in) a structure, or to provide solar process heat, but not with regard to heating a swimming pool. Additionally, such property must be depreciable, with an estimated useful life of at least three (3) years.  The IRS issued guidance providing that investing at least five percent (5%) of the total expected installation cost will constitute “beginning construction.”   Prior to the adoption of the Inflation Reduction Act, the investment tax credit was subject to a phase-out period to incentivize not waiting to convert, however how the credit is earned was changed by the Act. Projects now have the opportunity once again to receive the full 30% tax credit. The base rate for projects beginning construction prior to January 1, 2025, is now set at 6%, but the full 30% rate is available to projects that are under 1MW of generation output or which meet new requirements for prevailing wages and apprenticeships. Notice 2022-61 was issued on November 30, 2022, providing the first guidance on the new requirements:

Prevailing Wages

• All laborers and mechanics employed by the taxpayer, or any contractors or subcontractors of the taxpayer in relation to the specific project must be paid the prevailing wage for the locality in which the facility is located for work performed in the construction of the facility and for ongoing repairs and alterations during the applicable tax credit period.
• “Wages” means the basic hourly rate of pay and fringe benefits such as insurance, vacation pay, pensions.
• “Laborer or mechanic” generally includes workers whose duties are manual or physical in nature, including workers who use tools or who are performing the work of a trade, as distinguished from mental or managerial. This term also includes working foremen who devote more than 20% of their time during a workweek to mechanic or laborer duties.
• Prevailing wages are determined by the Secretary of Labor, and if relevant publications of prevailing wages are available for the type and geographical location of the work these should be used as the prevailing wage. In the event there is no published prevailing wage then the taxpayer must request a wage determination or wage rate from the Department of Labor.
• Taxpayers, and their contractors and subcontractors, will be responsible to maintain records of work performed and wages paid to sufficiently establish compliance with wage requirements.

Apprenticeships

• A certain percentage of labor hours must be performed by qualified apprentices:
  • 5% of hours if construction began after January 29, 2023, and before January 1, 2024;
  • 15% of hours for construction beginning after December 31, 2023.
• The taxpayer and each contractor or subcontractor must employ four (4) or more individuals for construction, alteration or repair work must employ one (1) or more qualified apprentice to perform the work.
• Taxpayers are provided a “Good-Faith Effort” exception in the event they can show that their request to provide a qualified apprentice from a registered apprentice program were denied, so long as denial was not the result of their own refusal to comply with established standards of the program, or if the program fails to respond within five (5) days of the request for an apprentice.
• Like the wages requirement the taxpayer and their contractors and subcontractors are required to maintain records to sufficiently establish their compliance with the hours and participation requirements.

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Code § 48(e) also adds the ability for certain qualifying solar projects that can increase their investment tax credit by up to an additional 20%.

A 10% increase is allowed for properties located in low-income communities (Category 1) or located on Indian land (Category 2). An increase of 20% is available for projects that part of a qualified low-income residential building project (Category 3) or a qualified low-income economic benefit project (Category 4). These additional credits are limited by capacity limitations, which for the 2023 program year are as follows:

• Category 1: Located in a Low-Income Community – 700 megawatts
• Category 2: Located on Indian Land – 200 megawatts
• Category 3: Qualified Low-Income Residential Building Project – 200 megawatts
• Category 4: Qualified Low-Income Economic Benefit Project – 700 megawatts

Because of the limits on capacity these deductions require applications be submitted to the Department of Energy for evaluation and a recommendation whether to award any of the capacity limitation to the IRS for award or denial.

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The Inflation Reduction Act has also added Code § 48E, a new investment tax credit for projects placed into service after December 31, 2024, which extends through at maximum value through at least 2033. Projects that would have qualified under the original Code § 48(a) will also qualify under the new section. This section is subject to the same rates and requirements listed above for Code § 48(a), a base rate of 6% that may be increased to a 30% bonus credit by meeting the wage and apprenticeship requirements or falling under the 1MW production threshold. The length of time which the full credit is available is guaranteed to be through at least January 1, 2033; however, this may be extended until such year following the calendar year that the Secretary determines that US greenhouse gas emissions have decreased by 75% from their 2022 levels. In the later of the previous years, the maximum bonus credit shall be decreased to 22.5%, and then the following year it shall decrease to 15% before being totally phased out. This new section also includes a similar incentive for projects in low-income communities as that discussed in Code § 48(e), being found in Code § 48E(h).

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The Inflation Reduction Act created Code § 6418 which has also added the ability for taxpayers receiving the investment tax credit to transfer these credits in a tax-free sale for cash. The IRS released its first proposed rules in Notice 2023-12799 which was published June 21, 2023. Eligible taxpayers who wish to transfer any credits must register each eligible facility prior to filing and provide the IRS with necessary information and supporting documentation relating to construction of the qualified property or facility as well as evidence of qualification for the credit. Both parties involved in any transfer will be required to attach a transfer election statement to their returns. The proposed rules have also clarified that taxpayers will be able to transfer their credits to multiple parties using the same registrations. As this implies, taxpayers will be allowed to transfer all or part of their available credits. Transfer will not be allowed in the case of a lease passthrough, which is when the owner of a qualified property on which a project is located passes the credit to the lessee who created the project. Transfers of credits will only be allowed once, and buyers will not be able to take advantage of the same tax-free treatment of the sale of tax credits.

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Beyond the credit, qualifying depreciable renewable energy property receives an additional benefit from accelerated and bonus depreciation.  Code § 168(e)(3)(B)(vi) provides that most solar energy property is five-year property, which qualifies under Code § 168(k) for bonus depreciation.  The practical effect of this is great as for the year 2023 eighty percent (80%) of the cost of qualified energy property (reduced first by fifty percent (50%) of the Investment Tax Credit taken, if applicable) is immediately deductible in the year it is placed in service.  This is part of a phase out period which began following the year 2022 were the percentage immediately deductible decreases by twenty (20) percentage points annually until completely phased out at the beginning of the 2027 tax year.

Together, the investment tax credit and the depreciation benefits allow a significant portion of the cost of investing in solar energy to be essentially paid for by federal tax incentives.

For example, assume a taxpayer installed a solar energy system in 2023 with a cost basis of $100,000.  In 2023, the taxpayer qualifies for the investment tax bonus credit of 30% of that basis of $30,000.  The taxpayer also qualifies for bonus depreciation of 80% of the cost, reduced by 50% of the investment tax credit taken, or in this case $65,000.

State Tax Incentives

The Florida property tax exemption available for solar energy systems (and other renewable energy source devices – including wind energy and geothermal energy) was expanded effective January 1, 2018.  The exclusion is extended to 80% of the assessed value of such systems installed on or after January 1, 2018, for nonresidential properties.  Eligible solar energy source devices include portions of the system up to the point of interconnection to an electric utility’s distribution grid or transmission lines.  These changes to the law are scheduled to expire at the end of 2037.  New regulations governing the terms of contracts for the sale or lease of solar energy systems, including numerous required disclosures, became effective July 1, 2017.

Additionally, the purchase of qualifying solar energy systems are exempt from Florida’s sales and use tax.  A list of the qualifying materials and suggested exemption certificate are provided in the Department of Revenue’s Taxpayer Information Publication 19A01-09.

It is important to be mindful of the fact that many of the incentives contained in this article have time limitations making early participation potentially more advantageous due to phase outs or limited availability.  Contact your tax advisor to take advantage of these opportunities.