The December 2015 omnibus bill extended 50% bonus depreciation through 2017, declining to 40% in 2018, and then 30% in 2019. As a result, some developers are expecting better pricing for their solar deals. But how much does bonus depreciation really impact an individual solar deal? Unfortunately for developers, the answer may be less than you think – or not at all.
Investors must elect whether or not to factor bonus depreciation into their investments. For a pure play tax equity investor, that’s a toss-up depending on their investment criteria. Taking early losses matters less when the investment tenor is 5-6 years, and the investor’s ability to absorb losses and depreciation may be limited regardless by the structure of the fund.
The answer could be different for other tax efficient sources of capital, such as an unregulated arm of a utility that purchases a solar asset and holds it for 20-30 years. At this time, investors are still debating whether or not to elect bonus depreciation for their solar assets at all. For those that do elect to take it, this will also reduce their tax appetite, thus putting a smaller limit on the number of projects that they can own before they need to bring in third party tax equity.
Why the debate over whether to elect bonus depreciation? While bonus depreciation boosts project returns by a handful of basis points, it greatly reduces an investor’s short-term tax appetite. Solar investments are tax driven, and investors typically make decisions about tax planning well in advance. Some institutional investors in solar assets are prioritizing stability and deciding not to elect bonus depreciation to avoid spikes in short-term losses followed by taxable income in years with fewer or no losses. Reduced short-term tax appetite due to bonus depreciation can also limit investors’ flexibility to act on future opportunities.
Let’s also not forget that bonus depreciation does not solely apply to solar or renewable energy assets. Non-renewable investments can be included as well, such as infrastructure investments (e.g. electric transmission, pipelines, etc.). If an investor will be making investments in another qualified “property,” that could mean less tax appetite to go around for solar. This is concerning for an industry where tax equity is already a limiting nutrient, especially after the extension of the solar investment tax credit (ITC).
The takeaway? If some solar investors do ultimately decide to elect bonus depreciation, developers could receive a small boost to project economics. However, that could be cancelled out by a higher cost of capital given a shortage of tax equity in the market.
This is an excerpt from our February edition of SOURCE: the Sol Project Finance Journal, a monthly electronic newsletter analyzing the solar industry’s latest trends based on our unique position in the solar financing space. To view the full Journal or subscribe, please e-mail firstname.lastname@example.org
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