Commercial Depreciation On A Solar Energy System

Commercial properties are eligible for the Business Energy Investment Tax Credit (ITC) of 30%. This is the business version of the Residential Renewable Tax Credit of 30% for homeowners. The American Recovery and Reinvestment Act of 2009 established the tax credit to include solar installations and is in force through 2019 at the 30% level. The entire cost of the system qualifies for the credit from design, to components, to installation. Solar systems can also be depreciated in a way to allow for businesses to take a higher deduction earlier than what is usual.

What Is Depreciation?

Depreciation is an accounting term used to quantify the decline in value of an asset over its useful life. Most business properties that last more than one year may be depreciated. Any property not expected to last more than a year is considered to be a business expense. Solar energy systems are depreciable property just like land or buildings.

In this case, solar energy systems have been determined by the IRS to have a useful life of five years. Even though solar arrays will last for decades, the IRS expects that a business will apportion the entire value of the array over five years in their taxes.

MACRS Depreciation

Solar energy systems also qualify for accelerated depreciation under a 5-year MACRS schedule. The MACRS has been in use by the IRS since 1986 and is a way for businesses to achieve a partial tax break for their business. It is twice the rate of straight-line depreciation during the first three years and switches to straight-line depreciation for the remainder. There is a convention of taking a 'half year convention' in the first year. A common deduction schedule is as follows:

Year

Depreciation

1

20.00%

2

32.00%

3

19.20%

4

11.52%

5

11.52%

6

5.76%

 

Yearly depreciation is accelerated under MACRS which is a contrast with "straight line" depreciation. "Straight line" means the total value of the asset is divided equally among each year of its useful life and depreciated equally, in this case, by 20% per year over the course of five years. "Accelerated" depreciation means a higher percentage is taken earlier in the depreciation schedule.

Bonus Depreciation

After the economic recession of 2008, capital investment was incentivized through the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. Under this Congressional act, companies could elect to depreciate 50% of the cost of the property while the remaining 50% is depreciated under a normal MACRS recovery period.

It should be noted that 85% of total solar installation costs are eligible for depreciation. After a company has deducted the 30% ITC off the system, they are allowed to add back some of that money in order to get a full depreciation. In this case, we assume the 'depreciation basis' is the Net Cost (after incentives) and then we add back 50% of the federal tax credit. Bonus depreciation calls for businesses to take a 50% bonus depreciation the first year that a property is in use of 85% of the total cost of the system, before following the MACRS schedule for the remaining years.

The Consolidated Appropriations Act was signed in December of 2015 and extended the "placed in service" deadline for bonus depreciation. Equipment placed in service before January 1, 2018 can qualify for 50% bonus depreciation.

What would a schedule of depreciation look like for a $50,000 solar energy system that is depreciated using MACRS depreciation, bonus depreciation, and a straight-line method of depreciation? We assume the business has a 30% tax bracket.

Gross System Cost

 

 

 

 $50,000

Tax Credit (30%)

     

 $15,000

NET COST

       

 $35,000

Total Solar Asset Depreciable Amount

 

 $42,500

 

       

 

Tax Bracket (assumed 30% default)

 

30%

 

 

  MACRS Bonus % Straight-Line
Year 1 20.00% 60.00% 20.00%
Year 2 32.00% 16.00% 20.00%
Year 3 19.20% 9.60% 20.00%
Year 4 11.50% 5.76% 20.00%
Year 5 11.50% 5.76% 20.00%
Year 6 5.80% 2.88% -

 

 

Depreciation Table Total      
       
  MACRS Bonus Straight-Line
Year 1 $2,550 $7,650 $2,550
Year 2 $4,080 $2,040 $2,550
Year 3 $2,448 $1,224 $2,550
Year 4 $1,469 $734 $2,550
Year 5 $1,469 $734 $2,550
Year 6 $734 $367 $0

 

 

The clear advantage of depreciating your solar energy system with an accelerated system is that a business will be subjected to a lower tax liability. The net present value is a little bit lower because the business would be receiving a higher break at the beginning. So what would it look like if there were a 5% discount rate on a system's depreciation? What would the net present value numbers be? Let's take a look using the example:

 

Depreciation Schedule With a 5% Discount Rate For the Cost of Capital
       
  MACRS Bonus Straight-Line
Year 1 $2,428.57 $7,285.71 $2,428.57
Year 2 $3,700.68 $1,850.34 $2,312.93
Year 3 $2,114.67 $1,057.34 $2,202.79
Year 4 $1,208.39 $604.19 $2,097.89
Year 5 $1,150.84 $575.42 $1,997.99
Year 6 $548.02 $274.01 $0.00
Total $11,151.18 $11,647.02 $11,040.17

 

 

In this example, a business using a bonus depreciation schedule on a $50,000 solar energy system would be able to depreciate $42,500 with a first year rate of 50%. If we discount the system in order to get a present value using a conservative 5% cost of capital, we can see that a business that uses the bonus acceleration method will save a little more than five hundred dollars than a business that depreciates the same system using a straight-line method. So there are definite advantages to business depreciation. Obviously, this is one example and the discount rate will vary for a specific business.  

There are some companies that will choose to depreciate more of their system later on in the useful lifecycle because they already have existing tax credits. In other words, they would want to spread the tax incentives over their later years. In this case, companies would want to more frequently use a straight-line depreciation method.

It should be restated here that solar energy systems are exempt from property taxes for all systems less than 250 kW. There is also a sales tax exemption at the time of purchase along with use and corporate franchise tax. The only deduction that is reduced by purchasing a solar array for business usage is that since payments for energy are deductible as an operating expense, installing solar pv will reduce these expenses because the customer will be buying less energy. However, this is also a positive, since the energy that will be produced is less expensive over the long run.