Friday, December 20, 2019
You can still get your foot in the door on the tax credits in December. The “Safe Harbor” on ITC pertains to launching the investment in the current year and locking in that higher level of tax credit. The safe harbor allows businesses to take advantage of the current ITC rate even though they didn’t allow enough time to fully install this year. Generally, figure 5% or more down payment in the current year and continuous progress toward the finished project. One reason for the safe harbor, in general, is that someone might want to launch in 2020, but there is such an end-of-year demand for solar panels that it is not possible to get them before January 1st. Winter storms, trade storms, government permits during holidays, etc., might delay the full installation before the year ends.
Safe Harbor requires continuous progress on the solar project, and there is a fixed deadline when the system must be completed to maintain the qualification for the higher tax credit. Here are some details on when the investment must start, and finalize, in order to be eligible for the higher ITC: https://www.foley.com/en/insights/publications/2019/09/solar-renewable-energy-investment-tax-credits
So let’s work an example for a business that has a $100,000 solar investment in consideration in 2019. (See the table below.)
First there’s the $30k tax credit that reduces the business tax liabilities, dollar for dollar. This is money that you simply do not pay out to the IRS. Then there’s the possibility of 100% depreciation of an asset in the first year, so the tax shield is based on the reduction in net income based on depreciation. (The tax shield is equal to the tax rate times the amount of depreciation; the asset basis is reduced by half of the ITC, or 33% of $85k in this example.) Therefore, the actual investment is only about 42% of the solar system costs, once all the tax benefits of the investment are considered. If the savings are $7,200 yearly (assuming no increases in power costs), then there’s a 17% return on investment each year. Simple payback is less than 6 years!
That is crazy profitable for a long-term investment. It is especially profitable when considering that the business is already committing to paying for power indefinitely from the power company. So, taking a loan of say 15 years could result in loan payments that are lower than the payments for power, especially when considering that the power company raises rates (you should figure at least the rate of CPI inflation). At 2% power inflation, the net present value (NPV) of the investment jumps to $108k from about $75k (30 years at 4.5% loan rate).
So the investment is profitable. Very profitable. But what if you want to do the investment next year? What is the cost of waiting? I’m glad you asked!
With the safe harbor on Solar ITC you can lock in the ITC savings this year. You will need to put 5% down in 2019 and starting progress on the system. Here’s what your cashflow would look like for 2019: $30k ITC savings in taxes less the $5k deposit on the solar system. That’s a positive $25k cash flow this year.
Since the investment tax credit drops by 4% (to 26% in 2020) the lost ITC is $4,000 if you buy the solar system and take the tax credit in 2020. The $4,000 opportunity loss, compared to the $5,000 deposit in 2019 is only $1,000 difference. If you plan to do the solar system anyway, then the costs of delay are relatively large, especially when adding a year of power savings. The delay for a year could easily be a loss of $10k or more in opportunity lost.
There are two major points, however, that make this different from most typical investment analyses. (Three, really, if you were to discuss the environmental savings, but that’s for another article.) First, the money your spending is committed money for power as long as the business is open and operating. Taking a loan to buy the solar system might prove to be cash positive indefinitely. Take $100,000 loan; pay interest only of $4,500 (4.5%) for first year or two until you realize the tax benefits of the solar ITC and depreciation; apply the tax savings to the loan; and then make payments on the loan for 8 years. The loan payments could be about $1,000 less per year than what you would have paid in electric bills, especially as the cost of power from the utility company increase over time. Once the loan is paid off, the price of power that you generate for yourself is pure profit!
Speaking of profit, here is the second point. Every dollar you reduce your power bill is pure profit. Things like smart thermostats, insulation, weather stripping, adjusting habits/processes, etc. might result in reducing the power bill by 5% to 25% at little or no out-of-pocket costs. That could result in a perpetuity of savings. If the firm’s cost of capital is, let’s say 8%, then the present value of the perpetuity of savings of $1,200 per year ($100/mo) would be $15,000 in present value terms. Plus, being more energy efficient means that a smaller system is required when going solar.
An even more interesting concept related to energy savings is looking at the sales volume required to equal the $7,200 savings annually. If the firm has a 10% profit margin, the sales to cover the power bill is $72,000 per year (once the loan is payed off). In the current loan example, cash flows (savings really) are positive every year and go up based on power inflation. When the loan is payed off in year 11 you start to realize huge savings (profits).
By the way, someone buying this property would pay more for the business because it comes with “free” electricity. A Lawrence-Berkley study found that some properties would appreciate by 20 times the annual electric savings. Therefore, the property might be worth about $144k more based on 20 times the $7,200 annual savings. Since the net investment after taxes is about $42k, the property could appreciate about $102k over the solar investment. That’s a property appreciation of almost 3.5 times the net investment.
In short, the investment in solar power can be crazy profitable. After January, it is not quite so crazy profitable. But, if you are planning to go solar in 2020, you need to seriously consider launching the project in 2019 and reaping the additional tax savings (and energy) savings.
About SBP. Strategic Business Planning Company has been working on various telework, solar and energy efficiency projects. There are several factors that we consider in a more comprehensive analysis of a Solar investment that are not represented here. We also enjoy doing the planning associated with Intellectual Property (Patents) ventures; look for our Perpetual Innovation™ line of books on patent commercialization.