Residential solar panels treated as a business activity?

[Rapid Robert]

Client has forwarded to me a solar panel vendor's tax position analysis, a five-page (anonymous authorship) write-up that seems pretty thorough and professional at first glance.

If I understand correctly, the position is that a homeowner who installs solar panels and enters a Net Metering Agreement (NMA) which results in a "payment" (discount) received, now has taxable gross income from a business activity in the amount of the discount. As a result, they are entitled to the business (not residential) solar energy credit, plus depreciation deduction, interest deduction, and deduction of costs that are part of the NMA. The vendor asks for a questionnaire to be filled out (I haven't seen it), and then they say they will prepare pro forma forms 3468, 4562, and Schedule C.

My first question (practical) is whether this is actually going to generate a net bottom line benefit over the lifetime of the panel ownership. For example, upon sale there will be Sec 1250 gain treatment of the depreciation taken, plus the annual gross income will be higher than otherwise, and so on.

Second question (disclosure), is this a reasonable position, consist with the regs for purpose of Form 8275 disclosure.

[ATSMAN]

Client has forwarded to me a solar panel vendor's tax position analysis, a five-page (anonymous authorship)

This reminds me of another tax position paper by some Firefighter tax guru who basically said that food costs for firefighters who can't leave the station during work hours and must prepare food in the fire station is fully deductible.

[Lion]

Tell your client to ask for the tax code cite that substantiates the analysis.

[TaxGuyBill]

While it is hypothetically possible that is the correct treatment, I think a lot of it boils down to numbers. As you said, will this actually end up with an overall profit? If so, it is POSSIBLE that it MIGHT be a business. If it won't be profitable, I don't see any way possible it could be a business.

I think your first step would be to actually run the numbers to see if it would be profitable. If not, in my opinion the case is settled, it would not be a business. If you run the numbers and it could be profitable, well, then it gets more difficult to determine how to handle it.

It is an interesting situation, so please followup with us about how you handle it.

[Rapid Robert]

Thank you for comments so far. My initial reaction is also one of skepticism. But I am trying to keep an open mind. Let me spend a little more time trying to present the position (wish I could just post the five page document, since it has no copyright and no attribution). I don't want to post a link (so as not to promote anything), but it is from a financial and tax consulting firm that specializes in real estate tax incentives.

If you still think it is out of the question, please let me know at which step of the analysis you think it falls apart. I am going to quote and/or paraphrase what I think are the key points made, I'm not going to edit for grammar due to missing portions. Note at the very end, they claim they have an IRS PLR to back up their position.

1. NET METERING IS NOT JUST A DISCOUNT
"The basis for the treatment of solar equipment as income-producing property, and reporting
depreciation and related expenses, begins with the taxpayer’s entry into a formal agreement
with his utility company, normally referred to as a ‘Net-metering’ agreement (NMA) or an
‘Interconnection’ agreement (ICA)."

"The question then arises, if the homeowner sells the energy generated by the solar energy
property to a utility and, in exchange, the utility makes payments to him in the form of invoice/bill
credits, do such payments represent taxable income?
Due to lack of understanding, many professionals believe that, no, this does not represent
taxable income as the invoice credits are simply producing a discounted electric rate or, at
worst, a ‘refund’ for the return of purchased power." [emphasis added

"homeowners are not allowed to use on-peak [solar] production to offset off-peak usage. ---
So the homeowner is providing something of high value (on-peak power production) in return for something of
equal or lower value (on-peak or off-peak power usage)." Therefore, it is not just a discount, it is taxable gross income. "From a
strictly technical perspective, net-metering does not fit the criteria of a discount or refund at all,
but rather a service for service transaction."

2. GROSS INCOME
"IRC § 61(a)(3) states that gross income includes any gains derived from dealing in property.
In applying this subsection, states the term ‘property’ includes services and the right to use
property.
Homeowners install tangible property in the form of a solar array, over which they have
complete dominion. Rather than installing battery storage, or keeping a one-directional meter,
they exercise dominion and enter into an agreement to sell the energy back to the utility, for
which they receive compensation in the form of bill credits." There is some reference to Congressional intent here based on related proposals that are not yet law.

3. FAIR MARKET VALUE
"Since the NMA/ICA stipulates when, how, and at what rate the energy production is paid, the
fair market value can be calculated by simply reviewing the homeowner’s utility bills and annual
true up statement.
According to IRS FS-2007-26 (Nov 2007) income/gain from the exchange of goods or services
(ie. KWhs) may be reported on Form 1040, Line 21 or on Schedule C. As the income is derived
from tangible property, taxpayers are allowed under IRC §212 to report related expenses
incurred:"

4. TRADE OR BUSINESS
The analysis notes Congress has never defined trade/business, but cites Commissioner V. Groetzinger, 480 U.S.23, 35 (1987).

5. BUSINESS CREDIT, DEPRECIATiON
"IRC § 48 includes in the definition of energy property, solar equipment used to generate
electricity, to heat or cool a structure or provide illumination. This section also defines energy
property qualifying for the business energy credit as property to which depreciation is allowable
IRC § 48(3)(C)"
"Section 50(c)(1) states,
“ IN GENERAL: F or purposes of this subtitle, if a credit is determined under this subpart with
respect to any property, the basis of such property shall be reduced by the amount of the credit
so determined,”"

6. IT ACTUALLY WORKS
"Our firm has filed several thousand of these types of returns for homeowners over the years,
and have never had a return challenged. In fact, we have a Private Ruling Letter from the IRS
confirming our stance."

[Rapid Robert]

If it won't be profitable, I don't see any way possible it could be a business.

My previous reply was more detail on the position taken, without discussion. Now, we still have to deal with hobby loss (not-for-profit) activity rules. After all the taxpayer does not want to increase their tax by having a profitable business due to their home-based solar panels. But if year after year goes by showing only a loss, then yes, how can we call it a business?

Also, the biggest expense to me seems to be the depreciation. Under the normal scenario, the solar panels are non-depreciable personal-use property, they get added to the basis of the house, but for many homeowners it won't matter due to Sec 121 exclusion upon sale. However, if we depreciate them, they do get to write off the cost against current income, but upon resale I believe they will have Sec 1250 gain which is not excludable under Sec 121. So at best we have deferred some tax (maybe worth it to some taxpayers).

[ATSMAN]

If someone takes the position that the Net Metering Discount is taxable income then the utility should send a 1099-Misc for that amount. Do they? I have never heard of that.

[TaxGuyBill]

I would think you would need to read the actual agreement with the utility company (which possibly may be dependent on State rules). Another thing to consider is how much energy goes to the utility company?

I think in MOST cases, the homeowner purchases more electricity than is given to the electric company. So the actual contract/agreement with the utility company may say that the electricity given to the utility company is a "loan" to the utility company, and the "loan" is paid back to the customer by giving them an equal amount of energy (which results in a credit on their billing statement). To me, that is the most logical treatment, but it would depend on exactly what the contract/agreement says.


Even if it is truly a "sale", I still struggle with it being a "business". The PRIMARY purpose and function is for personal use. A secondary effect (which requires no almost no additional effort) is the 'extra' electricity. To me, that seems like in most cases it would not be a business (it would be more like a "hobby", or just "other income").

PLRs are actually public, but my Google skills hasn't been able to find anything pertinent. Perhaps somebody with a research program may be able to find that PLR that they are talking about.

[ATSMAN]

This is how it works in MA. So I am thinking that a residential customer is not getting any "taxable income" because it is a dollar credit that rolls over to pay for future usage.

Customers who net meter are billed for their net consumption of electricity.

Net monthly consumption = (total electricity consumed in a month) - (total electricity generated in a month).

• If your net consumption is positive, you must pay an electricity bill to your electric company for the excess consumption at the end of the billing period. 220 CMR 18.03(4).
• If your net consumption is negative, you will receive a net metering credit on your electricity bill. Therefore, you will not owe the electric company money during that billing period. 220 CMR 18.03(3). The net metering credits appear as a dollar amount (not as kilowatt hours) on your bill. The credits never expire and will rollover to the next billing period.