Is Solar Property Eligible For Bonus Depreciation?

Table of Contents

What is Bonus Depreciation?

Bonus depreciation is a tax incentive that allows businesses to immediately deduct a percentage of the purchase price of eligible new assets in the year they are placed in service. This allows businesses to accelerate depreciation deductions and take a larger tax deduction earlier on. The intention behind bonus depreciation is to spur capital investment and growth by giving businesses larger upfront tax deductions.

Normally when a business purchases a depreciable asset, they deduct the costs over several years based on IRS depreciation schedules. Bonus depreciation allows an immediate deduction of a bonus percentage of the asset’s cost in addition to regular depreciation. For example, a 50% bonus depreciation deduction would allow a business to immediately deduct 50% of the purchase price in the first year.

The goals of bonus depreciation are to incentivize business investment, boost the economy, create jobs, and provide tax relief. The larger upfront deductions can improve business cash flow and potentially enable businesses to invest in additional assets and growth.

History and Impact of Bonus Depreciation

Bonus depreciation was first introduced in the Job Creation and Worker Assistance Act of 2002. This allowed businesses to immediately deduct 30% of the adjusted basis of qualified property placed in service between September 11, 2001 and September 10, 2004. The intention was to provide an economic stimulus by encouraging businesses to invest in capital expenditures.

Bonus depreciation was then expanded through a series of legislation over the years:

The Jobs and Growth Tax Relief Reconciliation Act of 2003 increased the rate to 50% for investments made between May 6, 2003 and December 31, 2004.

The Economic Stimulus Act of 2008 reintroduced 50% bonus depreciation for 2008.
The American Recovery and Reinvestment Act of 2009 extended 50% bonus depreciation through 2009.
The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 extended 50% bonus depreciation through 2011.

This pattern of introducing and expanding bonus depreciation during economic downturns highlights its use as a fiscal policy tool to stimulate business investment and economic growth. Studies have shown that bonus depreciation is an effective way to increase equipment and machinery spending in the short run.

Qualified Property for Bonus Depreciation

To be eligible for bonus depreciation, the property must be qualified property. This generally means the property must be:

New property – The original use of the property must begin with the taxpayer claiming the bonus depreciation. Used property does not qualify.
Certain types of property – The main types of property that can qualify for bonus depreciation include tangible property with a depreciation recovery period of 20 years or less, off-the-shelf computer software, water utility property, and qualified improvement property.

Not specifically excluded – Bonus depreciation cannot be claimed on properties like real estate, most property used outside the U.S., or property used by tax-exempt organizations.

The specific qualified property rules can be complex. But in general, newly purchased equipment, machinery, and certain other tangible property used in a trade or business will meet the requirements to claim bonus depreciation.

Solar Property and Eligibility

Solar energy systems like solar panels or solar hot water systems are treated as 5-year property under the Modified Accelerated Cost Recovery System (MACRS) depreciation system. This means the cost of installing a solar system is recovered over 5 years for tax purposes.

For solar property to qualify for bonus depreciation, it must meet requirements under section 168(k) of the tax code:

The solar property must have a depreciable life of 20 years or less. Solar systems are 5-year property so they meet this requirement.
The original use of the solar property must begin with the taxpayer. In other words, the taxpayer claiming bonus depreciation must be the first user of the solar system.
The solar property must be acquired and placed in service after September 27, 2017.

Provided these requirements are met, expenditures on solar energy systems can qualify for 100% bonus depreciation under current tax law. This allows the taxpayer to immediately deduct the full cost of installing solar panels or other solar property in the first year.

Claiming Bonus Depreciation on Solar

Solar property such as solar panels, inverters, and related equipment can qualify for bonus depreciation if placed into service after September 27, 2017. The bonus depreciation percentage applies to the full cost basis of the solar assets. This can provide a significant upfront tax deduction and cash flow benefit.

Importantly, claiming bonus depreciation on solar property does not reduce the basis for claiming the solar investment tax credit (ITC). The full cost basis of the solar assets can be used to calculate both bonus depreciation and the ITC. The ITC is claimed based on the placed-in-service date and the bonus depreciation is calculated on the remaining basis after applying the ITC. This favorable interaction allows solar investments to leverage both incentives.

For example, a $100,000 solar array placed into service in 2020 would qualify for a 26% ITC of $26,000. The remaining $74,000 basis would then qualify for 100% bonus depreciation. This results in a total first-year tax deduction of $100,000 ($26,000 ITC plus $74,000 bonus depreciation). The taxpayer gets the full benefit of both incentives.

Consulting a tax professional is important when planning to claim both solar tax credits and bonus depreciation. Proper planning and timing of the solar investment can maximize the tax benefits.

Bonus Depreciation Phase-Out

Bonus depreciation percentages have been steadily reduced over time since the policy was first introduced. Under the Tax Cuts and Jobs Act of 2017, 100% bonus depreciation was available for qualified property placed in service between September 27, 2017 and December 31, 2022. However, the percentage is phased down starting in 2023:

80% bonus depreciation in 2023
60% bonus depreciation in 2024
40% bonus depreciation in 2025

20% bonus depreciation in 2026

Unless extended by Congress, bonus depreciation is set to expire after 2026. At that point, businesses would no longer be able to claim bonus depreciation and would have to claim regular depreciation deductions.

The phase-down and expiration schedule for bonus depreciation creates planning opportunities and incentives for businesses making qualified property purchases. Accelerating purchases to earlier tax years with higher bonus depreciation rates can maximize tax savings.

Qualified Improvement Property

Qualified Improvement Property (QIP) refers to improvements made to the interior of non-residential real property after the date the property was first placed in service. In order for solar installations to potentially qualify as QIP, the solar panels or equipment must be considered an improvement or addition to the existing commercial building.

In general, QIP must meet the following requirements:

Improvements must be made to an interior portion of a building.

Improvements do not include enlargements, elevators/escalators, or changes to the internal structural framework of the building.
The building must have been placed in service prior to the improvements.
QIP does not include improvements attributable to the installation or replacement of any qualified property that receives bonus depreciation.

Installing solar panels on a commercial building roof could potentially qualify as QIP if the solar equipment and wiring can be considered an improvement to the interior portion of the building. For example, if solar panels are wired directly into the electrical system of the building to provide supplementary power, this may be considered an interior improvement. Each solar installation should be evaluated based on specific circumstances.

Planning Considerations

When claiming bonus depreciation on solar property investments, careful planning and timing is crucial. Two key factors to keep in mind are:

Importance of Placed-in-Service Date

The placed-in-service date is when the solar property is ready and available for use. To qualify for bonus depreciation, the solar property must be placed in service before the phase-out begins. For 100% bonus depreciation, the property had to be placed in service before January 1, 2023. Coordinating project timelines to meet placed-in-service deadlines can maximize tax benefits.

Coordination with Accountants/Tax Advisors

Claiming bonus depreciation involves navigating complex tax rules and regulations. Work closely with your tax professionals and accountants when making major solar investments. They can advise on optimizing depreciation deductions, avoiding mistakes, and staying compliant. Their expertise is key for maximizing tax incentives and savings.

Bonus Depreciation vs. Section 179

Two of the most commonly used depreciation methods are bonus depreciation and Section 179. Both allow businesses to accelerate depreciation deductions, but there are some key differences between the two:

Comparison:

Bonus depreciation applies only to qualified new assets, while Section 179 can be claimed on both new and used assets.
Bonus depreciation allows you to deduct a percentage of an asset’s cost upfront, while Section 179 allows deducting up to a set dollar amount.
For bonus depreciation, there is no cap on the total amount that can be deducted. Section 179 has a maximum deduction limit.

Bonus depreciation automatically applies to eligible property, while Section 179 requires making an election.

Limits:

The maximum Section 179 deduction is $1,050,000 for 2022 and indexed to inflation for future years.

The Section 179 deduction begins to phase out when total qualifying asset purchases exceed $2,700,000.
Bonus depreciation does not have any dollar limits.

Eligibility:

Section 179 can be claimed on new or used assets.
Bonus depreciation only applies to new assets.
Both require the assets be used for business purposes and have determinable useful lives.

Weighing the pros and cons of each can help businesses pick the optimal depreciation strategy and maximize tax savings.

The Future of Bonus Depreciation

Bonus depreciation has gone through many changes over the years, but the future remains uncertain as legislators continue to debate extensions, expansions or reductions. Some key considerations for the future of bonus depreciation include:

Potential legislative changes – Bonus depreciation is currently set to phase down starting in 2023 before expiring completely in 2027. However, Congress has repeatedly extended and enhanced bonus depreciation in the past. Business advocates are pushing for another extension and expansion of bonus depreciation to spur investment. However, concerns over growing budget deficits could lead some legislators to scale back or eliminate bonus depreciation earlier. The future will depend on the political climate and priorities.

Business advocate positions – Major business and manufacturing groups generally support maximizing bonus depreciation. Allowing immediate full expensing through bonus depreciation incentivizes new equipment purchases and facilities investments. Groups like the U.S. Chamber of Commerce argue this stimulates economic growth and job creation. However, some economists counter that bonus depreciation is an inefficient subsidy. The debate will continue as long as legislators consider changes to the tax code.

In summary, the future of bonus depreciation remains uncertain and depends largely on the political winds. Business advocates push for extensions and enhancements, while budget hawks favor earlier phase-outs. Companies claiming bonus depreciation should stay informed on potential changes as they map out future investments and tax planning strategies.