19 - Taxpayer Had Basis in Solar Panels for Purposes of Bonus Depreciation and Energy Credit

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1 19 - Taxpayer Had Basis in Solar Panels for Purposes of Bonus Depreciation and Energy Credit Golan, TC Memo The Tax Court has concluded that a taxpayer established a basis in solar panels and related equipment for purposes of claiming an energy credit under Code Sec. 46 and Code Sec. 48 and bonus depreciation under Code Sec. 168(k)(5). Further, the taxpayer satisfied the Code Sec. 465 at-risk and Code Sec. 469 passive activity requirements. Background. The Code Sec. 48 business energy credit is a tax incentive to implement the government policy to encourage the production and use of, or conversion to, business equipment using energy sources other than oil or gas (or a derived product) as a primary source of industrial or agricultural energy. Under Code Sec. 48(a), for purposes of the Code Sec. 46 investment credit, the energy credit for any tax year is generally the energy percentage (in this case 30%) of the basis of each energy property placed in service during the tax year. For the years at issue, former Sec. 168(k)(5) provided for a special first-year (bonus) depreciation allowance of 100% of the adjusted basis of certain qualified property. Qualified property was property that met the following requirements: (1) the property was MACRS property with an applicable recovery period of 20 years or less, unless it was certain computer software, water utility property, or qualified leasehold improvement property; (2) the original use of the property commenced with the taxpayer after Dec. 31, 2007; (3) the taxpayer acquired the property after Sept. 8, 2010, and before Jan. 1, 2012; and (4) the taxpayer placed the property in service before Jan. 1, Under Reg (a)-11(e)(1)(i), property is first placed in service when first placed in a condition or state of readiness and availability for a specifically assigned function. The Tax Court has held that property is not placed in service until it is ready and available for full operation on a regular basis for its intended use. (Brown, TC Memo ) Under Code Sec. 465, a taxpayer's loss deduction is limited to those amounts for which he is at risk with respect to the activity. A taxpayer is at risk to the extent of any money and the adjusted basis of any property contributed to the activity. A taxpayer also is generally considered to be at risk to the extent that he is personally liable for the repayment of amounts borrowed for use in the activity. (Code Sec. 465(b)(1), Code Sec. 465(b)(2)) However, amounts borrowed from any person having an interest in the activity (other than an interest as a creditor), 61

2 i.e., a prohibited continuing interest, are not considered to be at risk. (Code Sec. 465(b)(3)) Under Reg (b)(1), a person has a prohibited continuing interest under Code Sec. 465(b)(3) only if the person has either a capital interest in the activity or an interest in the net profits of the activity. A capital interest is defined as an interest in the assets of the activity which is distributable to the owner of the capital interest upon the liquidation of the activity. (Reg (b)(2)) A person may have an interest in the net profits of an activity even though he or she does not possess any incidents of ownership in the activity. (Reg (b)(3)) Code Sec. 465(b)(3) contemplates fixed and definite rights or interests that realistically may cause creditors to act contrary to how independent creditors would act with respect to their rights under the debt obligations in question. Code Sec. 469 generally prohibits using a loss from a passive activity to reduce income from nonpassive activities during any tax year. In general, a passive activity is a trade or business in which the taxpayer does not materially participate. A taxpayer materially participates in an activity when he or she is involved in the activity on a regular, continuous, and substantial basis. (Code Sec. 469(h)(1)) A taxpayer can establish material participation by satisfying any one of seven tests provided in the regs. For example, the individual may show that he or she participated in the activity for more than 100 hours during the tax year, and his or her participation in the activity for the tax year was not less than the participation in the activity of any other individual (including individuals who were not owners of interests in the activity) for such year. (Reg T(a)(3)) Facts. Mr. Salveson formed Solar Energy Equities LLC (the LLC). Through the LLC, Mr. Salveson identified property owners and offered them discounted electricity in exchange for permission to install solar panels and related equipment (solar equipment) on their properties (host properties). The LLC remained the owner of the solar equipment and temporarily retained the burdens and benefits of ownership (including all resulting tax credits and rebates). Then, the LLC sold the solar equipment (and all rights and obligations therewith) to a buyer. One such buyer was the taxpayer here, Mr. Golan, who purchased solar equipment on three host properties. With Mr. Salveson's assistance, the owners of three host properties filed an application with the local utility company for an interconnection agreement under which the utility companies agreed to connect the properties' solar equipment to the electric grid; a precondition required the owner to first install a bidirectional meter. The owner and the LLC entered into a power purchase agreement (PPA) which provided: (1) the LLC would sell the owner's electricity from solar equipment it installed on the property; (2) the owner would receive discounted electricity for a 5-year term while the LLC would retain ownership of the solar equipment and the right to any tax or other financial benefits; (3) the owner could not assign the agreement to another party without the LLC's consent, but the LLC 62

3 could do so with 30 days' notice; and (4) the LLC would remain responsible for servicing and repairing the solar equipment. The utility company advised the owner that he or she was entitled to a rebate and the owner then assigned the rebate to the LLC. In January 2011, Mr. Golan purchased the solar equipment for the three host properties from Mr. Salveson. The sale was effected by several documents including: (i) a solar project asset purchase agreement, dated Jan. 10, 2011 (purchase agreement); (ii) Mr. Golan's promissory note, dated Jan. 15, 2011; (iii) Mr. Golan's guaranty (to ensure personal liability), dated Jan. 10, 2011; and (iv) a bill of sale and conveyance, dated Jan. 10, 2011 (bill of sale). Under the purchase agreement Mr. Golan agreed to buy the solar equipment on the three host properties and the rights and obligations under the corresponding PPAs. The stated purchase price under the purchase agreement was $300,000, which was the sum of (a) a $90,000 down payment (due on the closing date); (b) a $57,750 credit for the rebates the owners had assigned to the LLC; and (c) Mr. Golan's promissory note in the principal amount of $152,250. Under the promissory note, Mr. Golan promised to pay Mr. Salveson the principal amount with interest at 2% per annum. The note required Mr. Golan to pay towards the note all monthly revenue generated by the solar equipment, but the total amount due during any calendar month would not exceed the amount of such monthly receipts. If the accrued interest exceeded the monthly receipts in any month, the difference would be carried forward and owed by Mr. Golan in future months. The note was secured by the solar equipment, and, in the event of a default, Mr. Salveson agreed to seek recourse against the solar equipment before exercising any rights or remedies against Mr. Golan. However, the note also stated that Mr. Golan was liable to pay any deficiency owed in the event that a foreclosure and sale was insufficient to pay all amounts owed to Mr. Salveson under the note. For purposes of calculating bonus depreciation and the energy credit, the taxpayer reported a basis in the solar equipment of $300,000, equaling the sum of: (1) the $90,000 down payment; (2) the $57,750 credit for the utility company rebates the host property owners assigned to the LLC; and (3) the $152,250 principal amount of Mr. Golan's promissory note. On his return, the taxpayer claimed $255,000 bonus depreciation and a $90,000 energy credit (30% of $300,000). (Because the taxpayer also claimed an energy credit of $90,000, he was required to reduce his basis in the solar equipment by $45,000 under Code Sec. 50(c).) On audit, IRS disallowed the taxpayer's depreciation deduction and energy credit (although mistakenly asserting that the taxpayer had claimed a Code Sec. 179 expense election and a Code Sec. 47 rehabilitation credit). At trial, IRS maintained that the taxpayer couldn't claim either bonus depreciation or the energy credit. On brief IRS asserted: (1) the taxpayer failed to establish a basis 63

4 in the solar equipment; (2) the taxpayer didn't satisfy the bonus depreciation requirements; (3) the taxpayer did not have sufficient amounts at risk; and (4) losses and credits attributable to his solar energy venture were subject to the passive activity loss limitations. Court's conclusion. The Tax Court rejected IRS's contention that the taxpayer did not have a basis in the solar equipment for 2011 because it found that no money changed hands between Mr. Golan and Mr. Salveson in that year. The Court concluded that that the taxpayer' basis in the solar equipment for 2011 was $152,250. Mr. Golan's $152,250 promissory recourse note was issued in exchange for the solar equipment; and so the taxpayer could include the face amount of the note in his basis. IRS did not argue that Mr. Golan couldn't reasonably be expected to repay the face amount of the note. Nor did IRS introduce credible evidence that the solar equipment was overvalued. IRS did not contend that Mr. Golan's promissory note to Mr. Salveson was, or should be treated as, nonrecourse debt. However, the Court concluded that the taxpayer could not add the $90,000 down payment to his basis for 2011 because there was no payment in cash or other property during The Court also agreed that the $57,750 credit couldn't be added to basis. The host property owners assigned the utility company rebates to the LLC prior to the sale of the solar equipment. Mr. Golan neither received nor reported the rebates as income. Rather, the Court found that the credit was really a price reduction to account for the LLC's receipt of the rebates prior to the sale of the solar equipment to Mr. Golan. As such, the rebates were not part of the solar equipment's cost to Mr. Golan. Bonus depreciation. The Tax Court found that Mr. Golan placed the solar equipment in service in 2011 and that the taxpayer satisfied the requirements of former Sec. 168(k)(5). IRS argued that, because Mr. Salveson installed the solar panels on two of the host properties in the summer of 2010, he must have acquired them before Sept. 8, And, it noted that former Sec. 168(k)(5) applied to "property acquired by the taxpayer after September 8, 2010." IRS did not cite, and the Court could not find, any authority for the proposition that the bonus depreciation allowance was available only to the original purchasers of manufactured property. Reg 1.168(k)-1(b)(3)(ii)(B) provides that, "If a person initially acquires new property and holds the property primarily for sale to customers in the ordinary course of the person's business and a taxpayer subsequently acquires the property primarily for the taxpayer's production of income, the taxpayer is considered the original user[.]"). Since Mr. Golan acquired the solar equipment in January 2011, the Tax Court found that the solar property was acquired by the taxpayer after Sept. 8, 2010, and before Jan. 1,

5 The Court also rejected IRS's argument that because Mr. Salveson installed the solar panels on the host properties in 2010, they were placed in service in 2010 (and so first-year bonus depreciation was unavailable for 2011). Given that Mr. Golan did not purchase the solar property until January 2011, the Court found it hard to see how the property was ready and available to him for full operation on a regular basis in Further, there was no evidence that the solar equipment was placed in service by anyone before The intended use of the solar property was the provision of discounted electricity through an arrangement with the utility company. Accordingly, the solar equipment needed to be connected to the electric grid. While the utility company agreed to the interconnection for the host properties on Sept. 20, 2010 and Dec. 30, 2010, IRS failed to show the precise dates of each bidirectional meter's installation (a precondition for interconnection with the electric grid). As the burden of proving this point was IRS's (because it was raised as a new matter at trial), the Tax Court concluded that the solar equipment was not ready and available for full operation on a regular basis until The Tax Court also held that the taxpayer was at risk with respect to Mr. Golan's $152,250 promissory note. The Court rejected IRS's contention that Mr. Salveson had a prohibited continuing interest in the solar equipment activity under Code Sec. 465(b)(3). The fact that Mr. Salveson may have been a promoter of the transaction did not change this result. IRS failed to identify any provision of Mr. Golan's and Mr. Salveson's agreement under which Mr. Salveson would be entitled to the assets of Mr. Golan's solar energy venture upon its liquidation. Nor did IRS show that Mr. Salveson had an interest in the net profits of Mr. Golan's solar energy venture. To be sure, the promissory note required Mr. Golan to pay Mr. Salveson all monthly revenue generated by the solar equipment towards the note. However, Mr. Salveson's right to all monthly revenue was a gross receipts interest, which the regs permitted. Finally, the Court found that the taxpayer was not subject to the passive activity loss limitations with respect to Mr. Golan's solar energy venture for Mr. Golan maintained that he participated in his solar energy venture for at least 100 hours in 2011 and that his participation was not less than that of any other individual. IRS (which also bore the burden of proof for this issue) failed to established otherwise. 65