How to fund solar for churches and non-profits

I was invited to make a 5 minute presentation at the SunShot Global Summit in Denver on June 14, 2012. I sent a PowerPoint presentation with embedded audio. The narrative that goes with the PowerPoint is pasted below. I've posted the PowerPoint (without audio) on SlideShare.

[Title Slide] Good afternoon, everyone. My name is Bruce Karney and I'd like share an idea that I began working on 3 years ago at SolarCity.

At that time SolarCity was best known for its community-wide solar discount programs. As Community Program Manager, I met several individuals who were looking for an affordable way to get PV systems for their church or favorite non-profit agency.

[Slide 2 - Photographs] By the way, throughout this talk I'll use the abbreviation CNP to mean church or non-profit.

I was impressed by their passion, and worked with them to find a financial structure that would meet their needs. Some groups wanted to lend money to the CNP and be repaid by the electricity savings. Others wanted to form a partnership to own the system and to capture the tax and depreciation benefits.

But as we examined the cash flows and tax laws, we could not find a viable investment model. Just as with residential solar in the days before PPAs and leases, only the wealthy or truly environmentally committed CNPs ended up installing solar, and they did not benefit from any tax incentives.

[Slide 3 – Current Situation] The core issue, of course, is that Federal solar incentives are tax incentives, so CNPs pay at least 30% more for solar than for-profit businesses do.

The large-scale investors that fund residential and commercial PPAs have avoided the CNP segment due to low profitability and perceived risk. There is a lot of overhead involved in each and every PPA. Most CNPs need systems that are too small for commercial PPAs to pencil out. The financial stability of CNPs is another barrier. CNPs don't have credit scores. Despite the fact that many have long histories of financial stability, disinterested third party financiers do not find their risk profiles appealing.

That being said, there are a huge number of churches and non-profits. With one simple change to federal tax law, I think it is possible to get 10% of them to go solar in the next 4 years.

[Slide 4 – Proposed Change in Tax Law] Since 1986, US law has only allowed losses from passive investments, such as real estate partnerships, to offset passive income. Passive losses cannot be used to offset active income, such as wages. Before 1986, passive losses could offset an unlimited amount of active income, but this was deemed to be an abusive tax sheltering strategy. Interestingly, and as a partial precedent for my proposal, a $25,000/year exception was carved out for low and middle-income taxpayers with passive losses.

I propose adding another limited exception for passive losses of up to $50,000 per year for solar systems owned individually or through a partnership. This exemption would only apply if the system is installed at a church or non-profit and placed in service between 2013 and 2016. Active participation in the management of the system would not be required for the investors to qualify for this exception. As tax changes go, this is truly a modest proposal. It is limited in amount, duration, and scope. It is not targeted at any special group of Americans. It is an opportunity available to any American taxpayer.

To unleash the expected tsunami of solar deployment, it would also be necessary to have standard legal documents for partnerships and PPAs, and simple software tools for partnership administration. These could easily be open-sourced and made available at very low cost.

[Slide 5 – Expected Results] I predict that this simple change could lead to the installation of 100,000 small solar systems in the next 4 years, averaging 20 kilowatts, but totaling 2 gigawatts.

While some people will invest six-figure amounts, the vast majority of investments will be just a few thousand dollars. Someone who invests four thousand dollars for 5% ownership of a 20 kilowatt system would get a $1200 tax credit and the modest amounts shown on the slide as passive depreciation losses in the first three years.

One very important attribute of the kind of investors who would support solar for their CNP is that their required hurdle rate is exceedingly low. Potential CNP investors have always told me that they just want to break even or earn a very small return. Instead of looking for 10% after-tax returns like Wall Street investors, they would be happy with 2%.

[Slide 6 – Conclusion] In closing, let me focus on political viability. This idea has bipartisan appeal. It will create tens of thousands of jobs, yet all of the funding is from voluntary investments of private capital.

Republicans will like that it will help American solar installers, which are usually small local businesses.

Democrats will like the rapid scalability, the environmental benefits, and the creation of 2 million new solar advocates.

I believe that the current Congress would approve this tax law change.

Please join me in urging it to do so.

Tax Law Change Could Help 150,000 US Churches and Non-Profits Go Solar

Here's a copy of a proposal I've sent to my representative in Congress, Anna Eshoo. If you like it, please copy it and send it to your representative too.

Opportunity
1) Congress could enable 100,000 churches and 50,000 small non-profit organizations to put solar panels on their roofs in 2009-11 by a minor and temporary change to existing tax law.
2) The example these churches and non-profits set is likely to inspire hundreds of thousands of homeowners to add solar to their homes, thereby stimulating the economy and helping the environment.

Current Situation / Problem Statement
Federal incentives for solar photovoltaic (PV) systems are tax incentives. This puts churches and other non-profit entities that want to get rooftop solar at a terrible disadvantage – they have no taxes to offset.

The solar industry and Wall Street have partially addressed this problem by creating Power Purchase Agreements (PPAs). With a PPA, an investment firm buys, owns, and maintains the solar system on the roof of a non-profit in exchange for a long-term contract to sell all the power from the system to the non-profit. PPAs effectively and legally move the 30% investment tax credit (ITC) and depreciation of the solar assets from the non-profit “host customer” to the for-profit PPA provider.

However, the PPAs are not being offered for the small solar systems – the size most churches and non-profits need -- because the administrative overhead of selling and setting up a PPA is essentially the same no matter how large or small the system is. The very few PPA providers who have ever tried providing quotes for systems smaller than 30 kW found that the offers are not being accepted and have withdrawn from this market segment. As a result, there is no financially viable way for most churches and other small non-profits to install solar PV without paying for them using cash or borrowed funds.

Potential Solution / Tax Roadblock
For solar systems in the 5-30 kW range ($25,000 - $180,000 after incentives), many individuals have adequate capital to fund and own a solar system on a non-profit’s roof. In California, such an investor could earn a modest after tax return of 3-7% if two impediments in the tax code were removed. The first issue is the passive activity loss limitation which prevents most taxpayers from using the depreciation of their solar system to offset ordinary earned income. The second is the difficulty of passing the active participation tests. (If a taxpayer passes one of these tests, he or he can treat passive income as active).

Requested Change in Law

1. For a limited period (such as tax years 2009-2011)
2. For a limited class of renewable energy investments (such as solar PV and solar thermal)
3. For a limited group of eligible projects (such as 501(c) non-profit entities)
4. For a limited group of taxpayers (such as filers with AGIs less than $400,000 if married filing jointly or $200,000 if single)
5. Amend the passive loss rules to allow passive losses from leases and power purchase agreements to offset active income, not just passive income.

Example
Suppose that Jane and John Smith want to help their church go solar by purchasing a solar system that will be installed on the church’s roof. They want to recoup their investment by entering into a 15-year PPA with their church. Assume the Smiths have “modified adjusted gross income” of $155,000.

Under current law, if they invest $80,000 to buy a 10 kW solar system (a fairly typical size) they would be able to claim $48,000 of depreciation as a passive loss in the first year of ownership[1]. However, because their income exceeds the Passive Loss Allowance Limit of $150,000, they could not offset any of their non-passive income with this passive loss. Therefore, they will not be able to use this loss from a tax standpoint until the solar system’s revenues exceed its expenses many years in the future. The fact that the tax benefits cannot be harvested early in the ownership period makes this an unattractive investment for them.

Example with Change in Law
The Smiths would see things quite differently if they could benefit from the depreciation immediately. The investment would be quite attractive, and the Smiths would be willing to invest in solar for their church even though the overall IRR is modest. From their perspective, it would be like buying a bond or annuity but with an added environmental benefit. The church would benefit by getting 15 years of renewable energy with no upfront investment. The example set by the church would probably inspire many parishioners to purchase solar for their own homes who would not otherwise have done so.

Argument from Precedent
Current tax law already recognizes that some taxpayers should be able to use passive losses to offset some amount of non-passive income. That’s the whole purpose of the passive activity loss allowance, which allows taxpayers with modified AGI of $100,000 or less to offset up to $25,000 of passive losses against non-passive income. The proposal expands the existing rule to investments in renewable energy.

Scale of the Opportunity
Suppose 100,000 churches and non-profits entered into solar PPAs, with an average system size of 10 kW and price of $80,000 (before incentives). That’s one million kilowatts or 1,000 megawatts – about 600 times what Google has put on the roof of its headquarters in Mountain View. The amount of private investment leveraged would be $8 billion. These figures do not include the impact from homeowners who purchase solar systems because they were inspired by their church’s example, but their purchases could add a 3x multiplier or more.

Current tax law already allows these tax benefits to be achieved, but only by large investors who have shunned this particular market segment. The proposal opens up a new path for capital to flow to churches and small non-profits – money from parishioners who are wealthy enough to want to help their parish and their planet, but not so wealthy that they would ever consider an outright donation of solar. There are millions of Americans who fit that description.

Having a 2 or 3 year time limit on this program would spur all parties to move quickly. This sense of urgency would stimulate the economy and hasten the end of the recession.

___
[1] 5 Year MACRS with 50% stimulus depreciation allows them to depreciate 60% of their investment in Year 1.

Solar for your Church or Favorite Non-Profit

One of my new projects is to develop tools and templates to help not-for-profit organizations like churches and charities that own their own buildings go solar.

Non-profits with large enough electrical bills and enough roof space can already go solar for no money down with a Power Purchase Agreement (PPA). This form of solar financing is available from some sources for projects as small as 20 kW, though more frequently a minimum of 50 kW is required. (20 kW of solar would cost a non-profit about $110,000 after incentives in California.)

However, I'm not aware of any provider who offers PPAs to churches and charities who need less than 20 kW. That's the niche I'm trying to fill. If you'd like to offer suggestions or know more, please leave a comment on this entry.