With continuing advances in renewable energy technology, many people may be convinced that it is worth spending money now on energy-efficient products in order to reap savings in the future. As part of the economic stimulus, federal and state governments are stepping up their efforts to encourage individuals and businesses to take advantage of renewable energy technologies to be more energy efficient. These incentives include income tax incentives, sales or property tax incentives, rebates, grants, loans, industry support, and bonds (these vary by jurisdiction). There are many forms of renewable energy, including solar energy, fuel cells, wind turbines, geothermal systems, and microturbines.
Many states offer tax-exempt grants to help taxpayers finance the costs (including installation) of renewable energy systems. For example, according to the Illinois Department of Commerce and Economic Opportunity, that state offers tax-exempt grants in an amount equal to 30% of the applicants’ qualified expenditure, up to the maximum of $500,000. Details of different incentive programs offered by various states can be found at www.dsireusa.org, a useful website provided by the Database of State Incentives for Renewables and Efficiency. Federal funding of these state programs is limited; taxpayers should take advantage of these programs now.
There are several different federal financial incentives related to renewable energies. They include (but are not limited to):
- Bonus depreciation1 and five-year modified accelerated cost recovery system (MACRS) depreciation for qualified solar, wind, geothermal, and qualified fuel cell energy equipment;2
- The business energy investment tax credit provided under Sec. 48 and the renewable energy production credit provided under Sec. 45;
- Treasury’s Tribal Energy Program grants3 and renewable energy grants and the U.S. Department of Agriculture’s Rural Energy for America Program grants;4
- Various federal loan programs;
- Credits for manufacturers of energyefficient appliances5 and builders of energy-efficient homes;6
- A deduction for energy-efficient commercial buildings;7 and
- An exclusion from income for residential energy conservation subsidies paid by public utilities to customers for purchasing or installing energy conservation measures.8
Tax Credits and Depreciation
Generally, Sec. 48(a) provides corporate taxpayers with a credit equal to 30% of the costs of certain qualified energy properties. These provisions originally expired at the end of 2008. However, the Energy Improvement and Extension Act of 20089 extended the expiration until, in most cases, the end of 2013 or 2016, depending on the specific renewable energy property. The American Recovery and Reinvestment Act of 200910 (ARRA) further expanded these provisions. For example, that act eliminated the basis reduction requirement for property put in service after December 31, 2008, and financed by subsidized energy financing or industrial development bonds.11 Taxpayers who receive state-provided tax-exempt energy grants are thus not required to reduce the tax basis of the energy property. Under the old rule, the basis of energy properties put in service before January 1, 2009, was reduced by the government subsidies. However, the elimination of the basis reduction is solely for the purpose of calculating the Sec. 48 energy property credit.
A similar credit for residential energy efficient property is provided to individual taxpayers under Sec. 25D. ARRA not only extended the provision until the end of 2016 but also eliminated the statutory maximum credit amounts and replaced them with a straight 30% of the eligible cost of certain qualified energy properties. Taxpayers can claim a credit for qualified expenses to install various qualified energy-producing systems, including solar electric, solar water heating, fuel cell, and small wind energy properties.
Individuals can also take advantage of the residential energy-efficiency credit under Sec. 25C, which was also extended (through 2010) by ARRA. It provides a credit of 30% of the cost of improving the energy efficiency of a building’s envelope and for the cost of purchasing and installing various energy-efficient heating and cooling equipment.
The Sec. 168(k) 50% bonus depreciation was brought back in 2008, and ARRA extended it to 2009. Currently another bill, H.R. 212, referred to the House Ways and Means Committee, will, if passed, extend this provision for two more years until the end of 2011. Given the current economic situation, it would be surprising if Congress did not pass this bill or similar provisions.
Federal Energy Grants
The energy credit is nonrefundable. When Congress drafted ARRA, it anticipated that, under the current economic situation, investors’ demand for income tax credits might be diminished. As a result, Congress added Section 1603 to ARRA to create a grant that is equal to 30% (or 10% for certain properties) of the basis of eligible energy properties as defined under Sec. 45, which relates to the renewable electricity production credit, or Sec. 48, which relates to the energy property investment credit. However, taxpayers cannot claim these credits and also receive a federal energy grant. Any energy credit claimed before receipt of the grant will be subject to recapture. This grant program is available only for business energy properties. Certain organizations are not eligible to receive an energy grant. These include:
- Federal, state, and local governments and their related agencies;
- Sec. 501(c) organizations;
- Clean renewable energy bond lenders, cooperative electric companies, and governmental bodies;12 and
- Any flowthrough entity owned directly or indirectly by any ineligible applicant as described above.
The exhibit lists the Code sections, credit termination dates, and applicable percentage of eligible cost basis used in computing the credit or federal grant for each energy property specified.
In order to qualify for the federal grant, the eligible property must be originally put into service in 2009 or 2010 (regardless of when construction begins) or put into service after 2010 but before the termination date of the related credit (if construction begins in 2009 or 2010). Per the guidance published by Treasury in July 2009, the applicant must be the original user of the energy property.13 If the cost of used parts contained in the qualified property is less than 20% of the total costs, however, the applicant can still be qualified as the original user. If the eligible basis is more than $500,000, the applicant is required to submit an independent accountant’s certification attesting to the accuracy of the costs.
Sec. 48(d)(3) clearly states that any federal Treasury grant received is not considered income of the taxpayer. On the other hand, it requires taxpayers to reduce the basis of the energy property by an amount equal to 50% of the federal grant received. If the taxpayer elects to claim the Sec. 48(a) energy property credit, the reduction of basis shall be 50% of the credit allowed.
Per the Treasury guidance, installation and freight costs are includible in basis. However, costs deducted for federal income tax purposes in the year in which they are paid or incurred (such as deductions allowed under Sec. 179) are not includible in the basis.
Sec. 167 defines the basis for depreciation by referring to the Sec. 1011 provisions, which then refer to the definitions provided by Sec. 1012. Sec. 1012 defines the basis of property as the cost of such property (except as otherwise provided in subchapters C, K, O, and P). Sec. 1016 (in subchapter O) provides different situations in which the adjustment to the basis of the property is required. However, Sec. 1016 makes no reference to any requirement for basis adjustment as a result of grants or subsidies received on the acquisition of the property. As a result, the depreciable basis of the energy property will be the total costs, less the tax-exempt state grant received and less 50% of the Sec. 48 credit or federal grant received.
The following example illustrates how a corporate taxpayer can take advantage of the above-mentioned provisions.
Example: In 2009 taxpayer A, an Illinois C corporation, installed a solar panel electricity generation system that is qualified as an energy property under Sec. 48 and ARRA Section 1603. The total cost, including installation and freight, is $1 million. The corporation receives $300,000 of tax-exempt grants from the state. A is also entitled to a $300,000 Sec. 48credit, which is calculated on a basis not reduced by the state grant received. After subtracting the state grant and the federal credit, A’s out-of-pocket expenditure is $400,000. The depreciable basis of the system, however, is $550,000, which is the initial cost of $1 million less the $300,000 state grant received and less $150,000, which is 50% of the Sec. 48 credit received. The solar panel system qualifies as a five-year property and also qualifies for the 50% bonus depreciation under Sec. 168. As a result, A is entitled to a depreciation expense of $330,000, which is 60% of the $550,000 depreciable basis.
Assuming the tax rate is 34%, A will receive a tax savings of $112,200 on the depreciation. The true net out-of-pocket expense in the first year is thus only $287,800 on a $1 million solar system before taking into consideration the intrinsic benefits of the solar panel system, which will generate renewable energy for the life of the system. In many cases, taxpayers will be able to sell back to the utility company any unused electricity generated by the solar panel system. More importantly, A can act as a good corporate citizen.
Christopher Lau is a tax manager with RSM McGladrey, Inc., in Chicago, IL. For more information about this article, contact Mr. Lau at email@example.com.
1 Sec. 168(k).
2 Sec. 168(e)(3)(B)(vi).
5 Sec. 45M.
6 Sec. 45L.
7 Sec. 179D.
8 Sec. 136.
9 Energy Improvement and Extension Act of 2008, P.L. 110-343.
10 American Recovery and Reinvestment Act of 2009, P.L. 111-5.
11 Sec. 48(a)(4)(D).
12 Entities referred to in Sec. 54(j)(4).