[UPDATE: 30% Investment Tax Credit on renewables in the
IRA Act 2022. See our Blog post here. This makes all the financial discussions
below much more profitable. Also, higher inflation and higher power inflation.]
The Renewable Investment Tax Credit, which is currently in
2019 at 30% of the qualifying investment, is a wonderful incentive to put in
renewable power including solar, wind and qualifying battery backup. The ITC
will drop down by 4% in 2020 and then again by 4% in 2021. After 2021, the ITC
drops off a cliff, to 10% for businesses and zero (0%) for residential. Here is
the stepdown in Solar Investment Tax Credit (ITC): https://seia.org/initiatives/solar-investment-tax-credit-itc
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.
Solar Example in December of 2019
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.
Solar is a Different Kind of Investment
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.
