In this week’s edition of Kinect with Kurt, we’re going to depart from our normally tech-focused subjects to talk about Safe Harboring. If you or your customers have been putting off procurement until after the election, there are now just a few short weeks to preserve eligibility for the 26% federal income tax credit (ITC). On January 1, 2021, the ITC drops to 22%, with the potential to leave large sums of money on the table.
Consult Your CPA or Tax Attorney
This may go without saying, but this article is for informative purposes only and is in no way meant to be construed as or replace sound legal advice. While we do our research and try to provide the most accurate and up to date information, we are not tax attorneys or even tax experts. Every business and project is unique, so please consult your accountant or tax attorney before making any decisions related to safe harboring solar equipment.
Safe Harbor: What is it?
If you’re not familiar with safe harboring, the basics are pretty simple. To receive the current 26% ITC for commercial solar projects, the taxpayer has two options. The first is to begin construction before December 31, 2020, by performing physical work of a significant nature and maintaining continuous work without interruption, from commencement to commissioning. This is often called the physical work test. The second option is to begin construction by incurring at least 5% of the project’s ITC eligible costs in 2020, often referred to as the 5% of cost test, or just 5% test. Each option comes with its own set of pros and cons, but the 5% test is usually more practical for solar installers and the most commonly used.
The Physical Work Test
The physical work test requires the commencement of “physical work of a significant nature” and continuous work on the project until commissioning. Preliminary work such as design, permitting, or securing funding does not qualify as physical work. Perhaps more importantly, work involving assets already held in inventory does not qualify as significant work either. The “customized equipment” rule, though, allows for custom-built components, that are “outside the manufacturer’s specs”, to be used for safe harbor as the beginning or continuity of work. In theory, this could include custom components like racking or transformers. The physical work test is by far, the more challenging method and requires more documentation, time, and legal expense to utilize effectively. IRS rules for the physical work test are vague, and there are no specific standards for what qualifies as the beginning of physical work or the continuation of that work. Installing racking, electrical equipment, or inverters will most likely qualify as physical work. Still, the onus to prove the start and continuation of work lies with the party attempting to claim the ITC. This route also requires more careful planning and foresight. Pictures of your ground-breaking ceremony on New Year’s Eve probably won’t meet IRS standards.
The 5 Percent Test
The 5% test is generally considered to be more straightforward and requires that the project owner incurs at least 5% of the total ITC eligible project cost on or before December 31, 2020. Because of the price relative to total ITC eligible project cost, purchasing inverters and/or modules is a common and less complicated way to meet the 5% benchmark. There are several essential steps to follow if you go this route:
- The taxpayer can incur the cost of safe harbor property that is equal to or greater than 5% of the total ITC eligible project cost. Under this scenario, the taxpayer doesn’t necessarily need to have paid for 100% of the safe harbor property before 2021 as long as they have been transferred ownership title of the property on or before 12/31/2020.
- If the taxpayer is unable to receive ownership title on or before 12/31/2020, then the taxpayer can still be treated as having incurred the cost under what is known as the 3 ½ month rule. Under the 3 ½ month rule, the taxpayer pays for the safe harbor property in full on or before 12/31/2020 and then has the reasonable expectation of taking delivery of the safe harbor property within 3 ½ months of making said payment.
While the 5% test route is generally more straightforward and preferred by market participants, there are some important considerations and potential drawbacks. All contracts and other documentation need to be legally binding under federal and state law where the project is being installed. Installers need to carefully maintain records such as receipts and equipment serial numbers. Project costs can increase due to overruns so purchasing equipment costing more than 5% is a wise decision. While 5% is a relatively small portion of the project’s total cost, that number can run into the millions of dollars and tie up substantial capital for small and medium-sized companies. In a rapidly evolving solar industry, grandfathered equipment that helps you meet your 5% threshold may become outdated by the time the project is commissioned.
How Kinect Can Help
No matter your safe harbor needs, Kinect Solar is here to help. We have modules, inverters, and module-level power electronics (MLPE) in stock that all qualify for safe harbor. Our expert account managers can walk you through the process, arrange easy payment, and provide you with all the documentation required for safe harboring. Kinect also offers procurement services for major projects. Using our relationships with leading manufacturers, we can coordinate product delivery to meet safe harbor needs and help ensure the financial success of even the largest projects.
If you’d like to take advantage of the 26% ITC but can’t take delivery within 3 ½ months, our sister company SunLogix Global is here to help with a multitude of logistics and warehousing options.
With nearly a year of pent-up demand and the impending 4% drop in the ITC, the solar industry is poised for a strong finish to 2020 and a robust 2021. However, the solar coaster will no doubt continue its up and down trajectory. We’ve seen the attempted repeal of tariff exemptions for bifacial modules. An explosion at the GCL silicone factory threatened the supply chain. Glass shortages are causing price increases and production delays across the industry. And that doesn’t include the global pandemic that’s impacted everyone’s business. That was just this year.
With all that in mind, now may be the ideal time to safe harbor and lock in ITCs for those projects in your near-term pipeline.
Until next time, thanks for reading and you stay sunny planet earth.