IRS Releases Favorable Guidance for Individual Investors in Community Solar to Claim Section 25D Tax Credit

The IRS recently issued a Private Letter Ruling (PLR) clarifying that an individual investor in a net-meted community solar project may claim the federal residential Investment Tax Credit (ITC) under Section 25D of the Internal Revenue Code. (A copy of the PLR is available here.) The PLR is also significant because it appears to eliminate a number of contractual requirements that the utility and taxpayer needed to agree to regarding the tracking and ownership of the power produced by the solar project to be eligible for the credit.

Section 25D Tax Credit and Prior IRS Guidance

Just like the Section 48 ITC, the Section 25D ITC permits an owner of solar and other renewable energy property installed before January 1, 2017 to receive a 30% tax credit against federal income taxes. However, in order to claim the credit the property must “generate electricity for use in a dwelling … used as a residence by the taxpayer.” Some tax practitioners interpreted that to meant the credit was limited to solar projects on or adjacent to the taxpayer’s residence. A few years ago, the IRS provided some guidance in Notice 2013-70 (at Q&A Nos. 26 and 27) that taxpayers could in fact claim the credit for off-site solar projects. However, the fact pattern in the Notice described an off-site net-metered project that was owned by the taxpayer, so questions remained whether taxpayers could claim the credit for investments in co-owned community solar projects. Further, the IRS limited the Notice so that it only applied to net-metering arrangements whereby the taxpayer specifically contracts with its local utility to track “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” as well as stipulate in the contract that the taxpayer holds title to the energy until it is delivered to the taxpayer’s residence. These requirements were problematic because they were often at odds with utility tariffs and state net-metering laws.

The PLR

The PLR is partially redacted but it was provided to a Vermont taxpayer requesting clarification as to whether his investment to purchase 10 solar panels in a 640-panel community solar farm along with a partial ownership in related racking, inverters and wiring is eligible for the Section 25D ITC. (A brief write-up about the project and taxpayer in the local press is available here.) The PLR explains that the project’s entire solar energy output is provided to the taxpayer’s local utility which then calculates a net-metering credit pursuant to its tariff and applies a portion of that credit against the taxpayer’s monthly electric bills. The PLR also explains that the taxpayer’s solar panels are not expected to generate electricity in excess of what the taxpayer will consume at his residence and that the taxpayer along with the other owners of the community solar project are members of an entity that coordinates with the utility the information needed to calculate each person’s allocable share of energy produced by the entire project. Based on these facts, the IRS determined that the taxpayer is entitled to the Section 25D credit. The PLR makes clear the fact that other individuals own solar panels in the project’s solar array does not disqualify the taxpayer from claiming the Section 25D ITC. The PLR did away with the requirement the utility specifically track the exact amount of electricity produced by the taxpayer’s portion of the community solar project and can instead determine the taxpayer’s allocable share of the entire project. The PLR also did away with the requirement the utility contractually agree that the taxpayer retains ownership of the electricity until delivered at his residence. Thus, to recap, under the PLR a taxpayer investing in a community solar project is generally entitled to the Section 25D ITC so long as: (1) the community solar project provides power to the taxpayer’s local utility, (2) the utility provides a credit for the taxpayer’s allocated energy production of the entire project, and (3) the taxpayer’s allocable share is not in excess of its residential needs.

Impact

It is important to note PLRs only apply to the individual taxpayer requesting the ruling and may not be cited or relied upon as precedent by other taxpayers. That said, PLRs provide valuable insight to the IRS’s views on a particular matter, and we expect that this PLR should incentivize investment in community solar and lead to even further expansion in the market. Until now, the market has been primarily driven by tax equity investors claiming the Section 48 ITC and depreciation, however, this PLR opens up opportunities for homeowners who cannot install solar systems for various reasons to invest in community solar.