To encourage investment in solar energy (and other alternative energy sources), the Internal Revenue Code offers a credit to taxpayers who install solar energy equipment. Specifically, the taxpayer may take a 30% credit for the costs of the solar panels and related equipment and material installed to generate electricity for use by a residential or commercial building.
Sec. 25D(g) provides a credit of 30% if the property was placed in service in a residence before Jan. 1, 2020, a 26% credit if the property was placed in service after Dec. 31, 2019, and before Jan. 1, 2021, and a 22% credit if the property was placed in service after Dec. 31, 2020, and before Jan. 1, 2022. Sec. 48(a)(2)(A) provides a 30% credit for solar energy equipment in commercial property if construction begins before Jan. 1, 2022.
This credit raises the question as to how much of the equipment and materials are properly includible for purposes of calculating the credit. Can a taxpayer include the entire cost of a new roof being installed in conjunction with the solar panels? Does it matter whether the roof is undamaged or in need of repair?
Searching the internet, as we all do when we're curious, you will see a mix of answers from various professionals and companies. Some say "yes" you can include the new roofing cost in calculating the solar energy credit while others say "no." The answer is a bit more complicated than the simple "yes or no" proposition. To determine the IRS's likely treatment, an analysis is necessary of two Code sections that address energy credits: Sec. 25D and Sec. 48.
Sec. 25D — Residential energy credit
Sec. 25D is the residential energy efficient property credit. An individual is "allowed as a credit against the tax imposed … for the taxable year, an amount equal to the sum" of "the qualified solar electric property expenditures." (Sec. 25D(a) also provides credits for fuel cell, wind energy, and geothermal property, but this article is focused on solar energy.) A qualified solar electric property expenditure (QSEPE) "means an expenditure for property which uses solar energy to generate electricity for use in a dwelling unit located in the United States and used as a residence of the taxpayer" (Sec. 25D(d)(2), emphasis added).
The labor costs "allocable to the onsite preparation, assembly, or original installation … and for piping or wiring to interconnect such property to the dwelling unit shall be taken into account for purposes of" calculating the QSEPE (Sec. 25D(e)(1)). Additionally, the QSEPE includes a category called "solar panels," which is applied as follows: "No expenditure relating to a solar panel or other property installed as a roof (or portion thereof) shall fail to be treated as [QSEPE] solely because it constitutes a structural component of the structure on which it is installed" (Sec. 25D(e)(2), emphasis added). Unfortunately, there are no Treasury Regulations or cases to assist with interpreting or defining aspects of Sec. 25D as it applies to solar energy.
Some IRS guidance, however, is helpful to further define what may be counted as QSEPE. Letter Ruling 201130003 involved, in part, a taxpayer's request for a determination of whether his expenditures for components of a solar energy system were properly includible as a QSEPE. "Expenditures for the labor costs that are allocable to the onsite preparation, assembly, or original installation of the qualified solar electric property and for piping or wiring to interconnect such property to the dwelling unit are eligible under §25D." The IRS concluded that costs related to solar panels, solar subpanels, portions of the air conditioning condensing unit, and wiring components are all QSEPEs.
In Letter Ruling 201809003, the taxpayer requested a determination whether "the cost of installing certain energy storage property to be integrated into other residential solar photovoltaic system property will qualify as [QSEPE] eligible for the tax credit under §25D." The IRS found that a "battery" that stores solar electricity generated by a solar energy system for use in a dwelling unit, as well as a software management tool necessary to monitor the charging and discharging of solar energy, is a properly includible cost in calculating the QSEPE amount.
Lastly, Notice 2013-70 provides two useful questions and answers:
Q-21: A taxpayer may claim a §25D credit if a qualifying property is installed in or on an existing home or a newly constructed home. In the case of a newly constructed home, how does the taxpayer determine the cost of the qualifying property under §25D?
A-21: The taxpayer may request that the homebuilder make a reasonable allocation or the taxpayer may use any other reasonable method to determine the cost of the property that is eligible for §25D.
. . .
Q-29: Is an expenditure for a solar powered exhaust fan eligible for the §25D credit?
A-29: Only the component part of a property that actually generates electricity for the dwelling unit is eligible for the §25D credit. If a solar panel on a fan generates electricity to power the fan for use in the dwelling unit, the cost of the panel component may be eligible for §25D credit if all the requirements of §25D are met; however, the entire cost of the fan is not eligible. Additionally, §25D(e)(1) specifically allows certain labor costs to be taken into account when calculating the credit. Under this provision, a taxpayer may take into account only the labor costs allocable to the qualifying component when calculating the credit. [Emphasis added]
Sec. 48 — Commercial energy credit
Sec. 48 is the commercial energy credit for "energy property placed in service during [the] taxable year" (Sec. 48(a)(1)). Energy property is defined as any "equipment which uses solar energy to generate electricity to … a structure" and "equipment which uses solar energy to illuminate the inside of a structure" (Sec. 48(a)(3), emphasis added). Regs. Sec.1.48-9(d)(1) provides that "'solar energy property' includes equipment and materials (and parts related to the functioning of such equipment) that use solar energy directly to (i) generate electricity (ii) heat or cool a building or structure, or (iii) provide hot water for use within a building or structure" (emphasis added). Regs. Sec. 1.48-9(d)(3) defines electric generation equipment:
Solar energy property includes equipment that uses solar energy to generate electricity, and includes storage devices, power conditioning equipment, transfer equipment, and parts related to the functioning of those items. In general, this process involves the transformation of sunlight into electricity through the use of such devices as solar cells or other collectors. However, solar energy property used to generate electricity includes only equipment up to (but not including) the stage that transmits or uses electricity. [Emphasis added]
Additionally, "[p]ipes and ducts that are used exclusively to carry energy derived from solar energy are solar energy property" (Regs. Sec. 1.48-9(d)(4)).
Letter Ruling 201523014 is instructive on the application of the energy credit as it relates to the roof of the structure. The taxpayer requested a determination whether a special "reflective roof," when installed with a solar energy system, constitutes Sec. 48 energy property. The reflective roof involves special materials and equipment, which are designed to reflect sunlight striking the roof. The solar panel design "allows sunlight to shine through the clear spaces of the [solar panel] and reflect back upon the underside of the panels from the surface on which the panels are installed." Being designed in this manner allows the solar panels to "generate electricity using sunlight reflected from the surface on which the panels rest."
In its analysis, the IRS cites to the definition of "incremental cost," in Regs. Sec. 1.48-9(k), which "means the excess of the total cost of equipment over the amount that would have been expended for the equipment if the equipment were not used for qualifying purposes." The IRS determined that the reflective roof constituted "equipment that uses solar energy to generate electricity." However, the IRS proceeded to apply the definition of "incremental cost" to the reflective roof and stated that "to the extent that the cost of the Reflective Roof exceeds the cost of reroofing Taxpayer's building with a non-reflective roof that is allowed by local law" it constitutes energy property under Sec. 48.
For commercial solar energy under Sec. 48, one may reasonably assume that the IRS would take a position consistent with Letter Ruling 201523014 and only permit the "incremental costs," as defined in Regs. Sec. 1.48-9(k), to be included in calculating the energy credit when adding a new roof and solar panels to the property.
The real question lies with treatment under Sec. 25D for residential property. Some commentators have argued that the language "installed as a roof" contained in Sec. 25D(e)(2) allows for different treatment than Sec. 48 and would permit the cost of a new roof to be included when calculating the residential energy credit. In the author's opinion, that appears to be a very aggressive position, which the author would not be comfortable advising a client to take.
Rather than merely relying on an assumed interpretation of an undefined phrase, it is instructive to look to Sec. 48, its regulations, and interpretations for guidance. Both Code sections refer to "solar energy to generate electricity" for purposes of receiving the tax credit. That phrase is not defined. Letter Ruling 20153014, interpreting Sec. 48 (which uses language similar to Sec. 25D), only permits the "incremental costs" of a new roof, limiting the amount that may be included for purposes of the residential energy tax credit only to amounts that exceed the cost to install a new normal roof. Therefore, it is reasonable to believe the IRS would also take a similar position for Sec. 25D, not permitting the entire cost of the new roof being installed as part of a solar energy upgrade.
Joseph M. Percopo, J.D., LL.M., is a partner at Mateer & Harbert, P.A. in Orlando, Fla. To comment on this article or to suggest an idea for another article, please contact Sally Schreiber, senior editor, at Sally.Schreiber@aicpa-cima.com.