The business energy tax credit can provide significant tax breaks to businesses that make certain energy-efficient improvements to buildings.
Depending on the type of improvement, the credit can be 30 percent or 10 percent. Currently, these incentives are slated for expiration as of Dec. 31, 2016.
To be eligible for the credit, the original use of the equipment must begin with the taxpayer, or the system must be constructed by the taxpayer. It can be taken only in the first year the property is operational. Performance and quality standards in effect at the time the equipment is acquired must also be met.
- Solar energy property includes eligible equipment that uses solar energy to generate electricity, to heat or cool a structure, or to provide solar process heat. Hybrid solar lighting systems also may be eligible. The credit is 30 percent of expenditures, with no maximum credit.
- Fuel cell credit is also 30 percent and may be claimed for fuel cells with a minimum capacity of 0.5 kilowatt. The cells must have an electricity-only generation efficiency of 30 percent or more. Although there is no maximum credit, it is limited to $1,500 per K.05 kilowatt of capacity.
- Small wind turbines receive a 30 percent credit with no maximum. However, the turbine must meet the performance and quality standards of the American Wind Energy Association or the International Electrotechnical Commission. Eligible property includes wind turbines up to 100 kilowatts of capacity.
- Geothermal systems include eligible geothermal heat pumps and equipment used to produce, distribute or use energy derived from a geothermic deposit. The credit is only 10 percent but has no maximum stated. Additionally, this credit has no stated expiration date, unlike other eligible property.
- Microturbines have a 10 percent credit that has no explicit maximum. However, it is capped at $200 per kilowatt of capacity. Eligible microturbines are those with up to two megawatts of capacity with an electricity-only generation efficiency of at least 26 percent.
- Combined heat and power (CHP) has a 10 percent credit with no maximum limit. Eligible property includes systems up to 50 megawatts capacity with at least 60 percent energy efficiency.
The investment tax credit (ITC) may be taken using IRS Form 3468, Investment Credit, as a part of the annual income tax return. The ITC also gives businesses a break in terms of depreciation.
Assume that an eligible property has a cost basis of $500,000, and the company takes a 30 percent credit of $150,000. Normally, this would reduce the basis for depreciation to $350,000.
However, under the ITC, the basis for depreciation is 85 percent of the cost basis, or $425,000 in this example. The property may be depreciated using MACRS, and it is eligible for bonus depreciation if it is generally available in the year of installation.
Property on which the credit has been claimed must be retained until the sixth year of the system’s operation or there will be a recapture of the credit at the rate of 20 percent per year before the sixth year. Any unused credits may be carried back one year and forward 20 years. After 20 years, half of any unused credit can be deducted with the remaining credit expiring.
If the business does not have a large tax liability, tax-equity financing may be used. Common arrangements include sale-leaseback, partnership flips and inverted leases. These methods allow the investor to take advantage of the credits and presumably pass some of the savings to the business using the equipment.
Tax-exempt organizations cannot claim the credit. However, some states allow a third-party ownership (TPO) arrangement under which the tax-exempt entity purchases the electricity produced by the equipment. The partner would be allowed to take the credit.
This arrangement is permitted in 24 states and Washington, D. C. It is expressly prohibited by five states, and the status is unclear in the other states. Again, the expectation would be that the tax-exempt organization would be the beneficiary of savings from the credit.
The United States has lagged behind other nations in giving tax advantages to energy-efficient initiatives. Hopefully, the ITC is only a first step and will not be permitted to expire at the end of 2016.