IRS Opens the Door to Expanded Use of Residential Section 25D Credit in Offsite Solar and Other Renewables Projects

by Foley Hoag LLP - Energy and Cleantech
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The IRS has released new guidance (Notice 2013-70) (the “Guidance”) in the form of a Q-and-A interpreting tax credits available to individual taxpayers under IRC Section 25D (Residential Energy Efficient Property) (the “25D Credit”) and IRC Section 25C (Nonbusiness Energy Property). Particularly noteworthy are the Questions and Answers interpreting the eligibility of off-site installations and net-metering arrangements on individual taxpayers’ eligibility to take the 25D Credit, specifically Questions and Answers 25 and 26, the full text of which are copied below this post.

Like the IRC Section 48 Investment Tax Credit (the “ITC”), which has driven the rapid growth of residential installation of solar assets models by the likes of the SolarCity and others, the Section 25D Credit permits an owner of solar and other renewable energy and energy conservation equipment installed before January 1, 2017 to receive a 30% tax credit which can be applied against federal income taxes due by the owner and, if not used in full in the first year, carried over to future years’ federal income tax payments.  However, unlike the ITC, which is an investment tax credit available to taxpayers engaged in a trade or business, the 25D Credit is  statutory language authorizing the 25D Credit imposes an express requirement that qualified property must, e.g. in the case of solar, “generate electricity for use in a dwelling … used as a residence by the taxpayer.” With this requirement, many had concluded that electricity produced off site by a solar PV installation on someone else’s land and not at the taxpayer’s home cannot be considered as being “used” in that person’s dwelling; or can it? Actually, says the IRS in this Guidance, it can. As it turns out, if a taxpayer is “net-metering” electricity produced by solar PV not installed at his or her home, and the PV system meets other conditions, that taxpayer is not disqualified from taking the 25D Credit. (See Q-and-A number 26, below).

The express language of the guidance is drafted to narrowly apply to instances where a single taxpayer owns panels that are (1) installed offsite (2) are subject to a very specific type of net metering arrangement and (3) are not used to generate significantly more power than is consumed by that taxpayer at his or her home. Still, limited as it is, the Guidance appears to effect a change in policy that holds the potential for adding to the emergent legal support for community-owned or group-owned solar and other renewable energy projects. For instance, if the Guidance could be applied to permit multiple taxpayers to take the 25D Credit proportionately when they jointly own a solar project developed under a “solar garden” or another “community-solar,” “virtual net-metering” or similar model, this Guidance could represent the removal of a major impediment to the efficient use of the 25D Credit on such projects. It could also provide needed relief to developers of such projects who have been unable to efficiently monetize the ITC among participants in such projects due to passive activity loss limitation rules applicable to the ITC. Further analysis is merited, perhaps by requests to the IRS for application of this Guidance under Private Letter Rulings analyzing specific models of common ownership.

Note that, in its guidance, the IRS describes the contractual arrangement for net metering and adds the requirement that “[t]he contract [with the utility] states that the taxpayer owns the energy transmitted by the solar panels to the utility grid until drawn from the grid at his residence…” The devil may now lie even in the details of the utility’s net metering tariffs. Could customers in some utility territories benefit from this guidance while others might not? If so, this power ownership obligation is an unfortunate — and probably unnecessary – addition to link “usage” of power. Not all utilities’ net metering tariffs and contracts may be so clear as to who “owns” electric power delivered to the utility for net metering.

Other than determining how broadly the Guidance could be applied and nailing down the wording of particular eligible net metering tariffs, there remain other legal rules that must be navigated correctly to make community ownership and community-financing successful, not the least of which are securities laws (query whether crowd funding will make that process work more efficiently). And there do remain other risks involved in community owned solar, such as what happens when a participant exits before the payback point has been reached and how to manage admission of new participants. But those are not new issues for solar. Putting the Section 25D credit to better use for larger, shared systems makes good policy sense.

Here are the pertinent Qs-and-As:

Q-25: If a taxpayer installs solar electric property other than directly on the taxpayer’s home, may the taxpayer claim the § 25D credit?

A-25: Section 25D(d)(2) defines a qualified solar electric property expenditure, in part, as an expenditure for property that uses solar energy to generate electricity for use in a dwelling unit that is used as a residence by the taxpayer. Therefore, if solar panels that are not directly located on the taxpayer’s home use solar energy to generate electricity directly for the taxpayer’s home the taxpayer may claim the § 25D credit.

Q-26: A taxpayer purchases solar panels that are placed on an off-site solar array and connected to the local public utility’s electrical grid that supplies electricity to the taxpayer’s residence. The taxpayer enters into a direct contractual arrangement with the local public utility that supplies electricity to the taxpayer’s residence to allow the taxpayer to provide electricity to the grid using a net metering system that measures the amount of electricity produced by the taxpayer’s solar panels and transmitted to the grid and the amount of electricity used by the taxpayer’s residence and drawn from the grid. The contract states that the taxpayer owns the energy transmitted by the solar panels to the utility grid until drawn from the grid at his residence. Absent unusual circumstances, the panels will not generate electricity for a specified period  in excess of the amount expected to be consumed at the taxpayer’s residence during that specified period. Can the taxpayer claim the § 25D credit?

A-26: Yes. Section 25D(d)(2) defines a qualified solar electric property expenditure, in part, as an expenditure for property that uses solar energy to generate electricity for use in a dwelling unit used as a residence by the taxpayer. The taxpayer’s expenditure for off-site solar panels  under this type of contractual arrangement with a local public utility that supplies electricity to the taxpayer’s residence meets the definition of qualified solar electric property expenditure.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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