Safe harboring in 2020’s rough waters: three crucial considerations

The U.S. solar industry is watching not just this November’s elections, but this year’s end to the 26% Federal Investment Tax Credit (ITC) for solar projects. In a year that’s been anything but stable, the usual appetite for safe harboring (“starting” a project in the current year to preserve that year’s tax credit value and finishing at a later point) has been disrupted by the turbulence in the economy.

That’s because safe harboring is effectively betting on future projects and business, which requires confidence that can be hard to come by, but I’ve made a case for it here.

Placing a safe harbor position today may be a smart move for reasons that are a bit unexpected. If you’re a residential solar installer that can’t participate in tax equity deals and safe harboring because you’re a “cash and loan” business, it’s still worth thinking about safe harboring in the context of a post-tax credit environment. It’s important to think about if you will be successful in your market, and if your competitor has access to tax credits and you don’t.

Safe Harbor background

The topic of safe harboring has been well-covered since the first iterations of the need to preserve a certain year’s incentive for the 1603 cash grant in lieu of the tax credit.

Anyone considering a Safe Harbor project should consult a tax attorney, as the circumstances of projects will vary. However, the basic mechanics are generally straightforward. If you incur at least 5% of a project’s qualified cost in the calendar year you’re claiming the tax credit value, then you’ve preserved the right to monetize the tax credit’s value as long as the system is placed in service before January 1, 2024. Due to Covie, the IRS recently granted a five-year period for projects begun in 2016 or 2017. So, it’s important to stay on top of developments.

With the ITC scheduled to drop from 26% to 22% this New Year’s Eve – by “starting” at least 5% of a project in 2020, you lock in the 26% tax credit value. That’s important because while going from 26% to 22% might not sound like a lot, the drop in tax credit value is roughly $1,000 for an average residential system. But the drop in value can be worth millions for large-scale utility projects. This is real money.

Another wrinkle to consider: To meet the IRS standard for incurring that threshold cost in a calendar year, if you’re using procurement of qualified materials, then the title for the material must be transferred from seller to buyer before midnight on New Year’s Eve. However, the transaction has 105 days after the title is transferred to be completed. In practical purposes, a buyer can pre-pay for material value of 5% of the anticipated project cost; the seller can transfer the title of the product before the end of the year; and then the final delivery of the product can occur up to roughly three-and-a-half months later.

This all becomes important because solar modules, the most commonly safe-harbored components in a solar system (due to their relative value and their individual serial number traceability), are currently subject to 20% import tariffs. To get a little more technical, this is known as Section 201 “safeguard” tariff, and it’s expected be reduced by 5% on February 7. By purchasing modules now, but taking delivery after February 7, purchasers can simultaneously preserve the current year’s tax credit while arbitraging the likely tariff reduction – if the product is imported after the tariff reduction and the counter-party is willing to price in an anticipated tariff reduction.

Finally, it’s important to understand that the ITC is referenced twice in the tax code. Section 25D covers an individual’s ability to claim the tax credit, and Section 48 covers a business entity’s ability to claim the tax credit. The important distinction in the context of safe harboring is that Section 25D does not have a safe harbor provision, while Section 48 does. This means that if I install (more) solar on my home, I personally can’t safe harbor the product. However, if I lease my system, the lessor may be eligible to safe harbor the components for my system – same house, same solar array. One is potentially eligible to safe harbor and one isn’t.

Considerations for 2020 Safe Harboring

In business it’s often better to “take the sure bet,” than ride a hand too long if there’s risk. If you have line-of- sight to notice to proceed (NTP) a project, and you have access to sufficient capital to tie the money up in finished goods that are sitting in a warehouse until you’re ready to consume them, then 26% is greater than 22% (or 10% or 0%). This isn’t high-level math, it’s simply placing chips down on your projects for a higher return.

But in the context of 2020, that straightforward math deserves some deeper analysis with your tax attorney. Everything everyone thought they knew during safe harboring cycles in 2019 didn’t play out as originally anticipated.

Consideration #1: Nov. 3, 2020

The outcome of the election will likely have long-term consequences for solar policy in the United States. Holding off on placing a safe harbor position until after the outcome of the election may be risky for several reasons:

• It’s possible that election results won’t be final when we wake up on Nov. 4, 2020.
• Given the complexity of a typical, safe harbor contract, waiting until mid-to-late November might not provide you sufficient time.
• There’s no certainty that a change in control of the Senate and/or White House will result in an ITC extension in 2021. If that’s the case, not safe harboring at 26% will have been a bad decision.
• Placing a pre-election safe harbor position hedges the macro market uncertainty that’s outside of any one person’s control.

Consideration #2: tariffs, exclusions and Executive Orders

While the S201 Tariff rate should decrease next February by 5%, there’s been a lot of volatility in the application of trade remedies. Expect the unexpected.

And, while there is a S201 exclusion from tariffs for bifacial panels, it is at risk of being eliminated in the near future. Finally, it’s unknown whether solar modules will be included in the Executive Order on bulk power. But it’s creating a lot of pent-up demand in the utility-scale sector. No one wants to bet wrong on a procurement if they don’t have to, and when the scope of the Executive Order is defined it could entirely upend the current solar supply-chains.

After talking with your tax attorney, placing a safe harbor bet with products not covered by the Executive Order – and valued via a 5% tariff reduction cut or the bifacial exemption – may be a smart hedge if the contracts sufficiently protect you as the buyer.

Consideration #3: de-risking 2021

As it stands today, 2021 will likely be one of the strongest markets for solar equipment manufacturers selling into the U.S. market. A perfect storm of a recovering market post-pandemic, access to cheap capital, and the impending ITC drop-off will create strong, near-term market demand, as well as intense safe harboring activities.

Anyone who waited too late to “safe harbor” in prior cycles knows the risk of attempting perfect timing. Assuming that component prices will drop faster than the reduction in current safe harbor value defies market dynamics. As a buyer in the 2021 safe harbor cycle, you might get boxed out or even forced to purchase components at a higher rate than you can source today. Placing a 2020 safe harbor position allows you to purchase when you have greater leverage.

Key takeaways

Safe harboring in 2020 isn’t for everyone. Again, consult with your tax attorney. Each project requires careful review of your specific circumstances and how they apply to the tax laws. There are many examples of companies that played their safe harbor cards wrong in prior years, causing massive financial distress.

For every reason to consider safe harboring discussed here, there’s a counterbalancing market force encouraging you to stay on the sidelines. While there’s no perfect or obvious answer, I think those who are in a position to make a sure bet should put the money down before things change.

For all solar businesses, whether or not you have the ability to safe harbor, now is the time to consider what your business looks like when the tax credit falls off the cliff at the end of 2021. Being proactive today can help ensure business continuity tomorrow.

Afterall this is solar, so change is the only certainty.

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Brian Lynch leads solar business development for LG Business Solutions USA.