For the past decade, companies in the U.S. have used the solar Investment Tax Credit (ITC), along with other solar incentives, to help fund the deployment of renewable energy systems. In particular, the tax credit has significantly impacted the economics of commercial solar deployment. However, with the solar ITC step-down taking effect in 2020, companies now face a make-or-break decision that hinges on how soon they can begin construction on a solar project.
It pays to start now
According to an article on Smart Energy Decisions, the key word here is “begin.” That’s because initiating a solar project prior to 2020 could allow you to leverage the full tax credit rate (as long as you complete the project by 2023). But first, a bit of background about when to go solar…
The renewable energy tax credit allows solar system owners to offset federal tax payments equal to 30% of the cost basis of a solar photovoltaic (PV) system. Beginning in 2020, that percentage steps down to 26%—with percentages falling even further for projects started in 2021 (22%) and all the way down to 10% for projects beginning in 2022 and beyond.
These looming rate reductions threaten to significantly alter the cost of solar projects in terms of internal rate of return (IRR) and power purchase agreement (PPA) rates. For example, the article states:
…a typical 5MW commercial solar project in California with the scheduled step-down next year to a 26% ITC would result in IRRs falling by about 100-150 basis points and PPA rates increasing by up to 7-10% under standard assumptions.
A cloudy forecast has a silver lining
Even with the step-down on the horizon, there’s some good news if you have the flexibility to choose when to go solar. First, the Internal Revenue Service has provided relatively broad guidance (in its Notice 2018-59) about what exactly constitutes “beginning construction.”
The article highlights two primary methods companies can use to satisfy this requirement:
1) Begin actual physical work of a significant nature (“Physical Work Test”)
2) Pay or incur 5% or more of the total cost of the solar project (“Five Percent Test”).
The “Five Percent Test” provides (some) luxury of time
Of these two methods, the Five Percent Test tends to provide greater flexibility about when you formally start the construction process. The key to satisfying the IRS requirement is to continually make progress on your solar project once you’ve started. If your timing is right, you might be able lock in the maximum 30% ITC level, as long as you finish your solar project no later than the end of 2023.
From the article:
Smart planning…can provide the ability to grandfather solar projects into the 30% ITC, even if these projects are not actually completed until 2020, 2021, 2022 or even 2023.
If you’ve been thinking about a potential solar project but haven’t yet started, now’s the time to engage with your tax experts and solar company. Start by making sure everyone is on the same page in terms of the possible tax implications and what constitutes “beginning of construction.” Doing so could help you reap the full economic benefits of the 30% solar Investment Tax Credit while you still can.