On June 5, 2018, the United States Tax Court ruled in favor of the petitioner Taxpayer in claiming the Solar Energy Credit under sections 46 and 48 and MACRS bonus depreciation under section 168(k)(5).
Facts
Ken Salveson initially entered into agreements with three property owners to provide discounted electricity in exchange for permission to install solar panels and equipment and retain all benefits and burdens of ownership (including any resulting tax credits and rebates). The initial agreements were entered into and the equipment was installed between March 2010 and Dec. 2010. The local utility companies connected the equipment to the grid thereafter in 2011. The three properties generated a total of $57,750 in tax rebates, assigned to Mr. Salveson. In Jan. 2011, Petitioner Taxpayer Donald Golan agreed to purchase the equipment on the three properties for $300,000, comprising of 1) a $90,000 down payment, 2) a $57,750 credit for the tax rebates, and 3) a promissory note of $152,250. The note was secured by the equipment and guaranteed by Mr. Golan, and while Mr. Golan was in default regarding the down payment in 2011, the contract was never cancelled.
Mr. Golan claimed depreciation of $255,000 and an energy investment credit of $90,000 (30 percent of $300,000). The Internal Revenue Service (IRS) disallowed the deduction and credit, although citing inaccurate and irrelevant code sections. As such, the IRS held the burden of proof for the following issues subsequently raised:
- Petitioner failed to establish a basis in the property
- Petitioner did not satisfy the requirements of section 168(k)(5) for 100 percent special depreciation
- Petitioner did not have sufficient amounts at risk under section 465
- Losses attributed to petitioner are subject to section 469 passive activity loss limitations
Analysis and conclusions
For each issue, the Tax Court ruled as follows:
- In order to claim the depreciation and credit, the taxpayer must have a tax basis in the property. Mr. Golan did not pay towards the down payment in 2011, and the tax rebates were assigned to Mr. Salveson (which acted as a price reduction). Therefore, the note of $152,250 is Mr. Golan’s basis in the equipment.
- Depreciation under section 168(k)(5) is dependent on when the property is placed in service. As Mr. Golan purchased the equipment in 2011, it was therefore acquired by him in 2011 and cannot be placed in service prior. Additionally, because the equipment was not connected to the grid until 2011, it is considered placed in service in 2011 and eligible for the accelerated depreciation.
- Section 465 limits the loss deduction to the amount at risk. Reviewing the facts and circumstances and the possibility of Mr. Salveson’s continuing interest in the equipment, Mr. Golan did maintain financial risk as the promissory note required monthly payments of revenue generated. Mr. Salveson’s right to the gross revenue is permitted within the regulations, and Mr. Golan was at risk with respect to the $152,250 promissory note.
- Under section 469, passive activity losses cannot reduce income from non-passive activities. With reference to case law, Mr. Golan materially participated in the solar activity on a continuous, substantial basis with over 100 hours on the activity in 2011 (which is not less than that of any other individual).
The Tax Court also held that Mr. Golan acted with reasonable cause and in good faith, as he frequently met with his competent tax preparer and provided the necessary documentation. As such, Mr. Golan was not liable for accuracy related penalties.
Takeaways
- Solar energy property that is to be connected to the energy grid is not considered placed in service until it is connected to the grid and capable of generating electricity, even if it is otherwise ready and available for testing.
- It is possible for a party to purchase solar equipment that another party developed and constructed shortly before the solar arrays are placed in service and still be eligible to claim the energy investment credit; even if the original developer had already executed power purchase agreements with the property owners who will be using the solar energy.
- Taxpayers should be mindful of the amounts considered at risk for purposes of calculating a tax basis.
- In order to claim section 168(k) bonus depreciation, timing is crucial as allowance is only available “for the taxable year in which such property is placed in service.”
- Section 465 deductions are only limited to amounts for which the taxpayer is at risk, oftentimes what they are personally liable for. Be mindful of any other parties that may have an interest in the property at question.
- The passive activity loss limitations of section 469 may require a look into the taxpayer’s activities, including material participation activities involvement.
- A facts and circumstances approach is used to defend again accuracy related penalties, primarily based on reasonable cause and good faith.
