Time to read: 6 minutes
Welcome back to our finance series with IES Solar!
So far in this series, we have covered Cash Purchases, Bank Loans, and Capital Leases. In this post, IES energy solutions manager Justin Charles describes the next financing option in the series: Operating Leases.
New to this series? If you are, then we recommend starting with our first installment on Cash Purchases to get an in depth look at tax incentives and depreciation incentives.
Justin has 12 years of experience in the solar industry and runs the solar division of IES and focuses on building commercial opportunities, particularly in regard to creative design, engineering, and helping customers with finance solutions that allow them to afford the projects they want.
As a refresher, IES views solar as their primary while also offering generator solutions, backup batteries, and LED lighting to reduce energy consumption. Energy solutions are viewed as a holistic opportunity, and the goal is to help reduce energy consumption before producing energy on top of finding affordable solutions for customers.
What is an Operating Lease and what are the advantages?
“The first three scenarios we discussed were cash purchases, bank loans, and capital leases. Today we’re going to discuss operating leases, which is considered a true lease by the IRS. In this situation, there isn’t a predetermined buyout at the end of the lease. At the end of the lease, you have three choices: continuing the lease, removing the system, or buying it for fair market value. At fair market value, you don’t know what it is. However, usually what you do know is that you can write a buyout for the year before at a predetermined value.”
“If it’s a seven-year lease, you can put a buyout in at year six for 15% or you can make it an eight-year lease with a seven year buyout for 15%. That residual value plus the payments becomes what you consider the total cost of the system. In these situations, this type of lease is a true lease for IRS purposes. In that situation, the leasor who bought this system for you can take advantage of the tax credits, and this is important. They depreciate the system, take advantage of the tax credits, and use that to give you a reduced payment option. The reason that you would look at this in particular is there are maybe three good reasons to look at an operating lease.”
No Tax Liability
“First, you don’t have tax liability. If you don’t have tax liability at the end of the year, you can’t absorb a tax credit. Let’s say you’re rolling forward $5 million in depreciation, or you’ve got carry forward losses and you’re not going to be able to take advantage of the tax credit for 10 or 20 years. They take advantage of the tax credit. They reduce your monthly payments. At the end, you pay maybe 75% to 80% of what the system would’ve cost. That’s not as good as if you had paid cash and gotten it for 50% of the system. You are, however, still saving, and it’s way better than getting no tax advantages.”
Capital Expenditure
“For the second reason, let’s use an example for clarity; let’s say your particular company has capital expenditure requirements. You have to be able to get a CapEx investment back in three or five years and the payback on the system is seven years. But, you could do it as an operating expense. You have plenty of room in your operating budget for that. Instead of buying a system, you lease a system, you get savings, but they’re not as great as if you bought it. That’s because your company can make better savings by buying other things and expanding. They’re building and buying a new operating line or upgrading some other piece of equipment. That’s a better use of their capital expenditure dollars. But you have an extra $10,000 in your operating budget for utilities, so I could spend an extra $1,000 a year on utilities and it wouldn’t really impact my corporate budget. And so, I lease the system for seven years and then I buy it at the end of that period. I’ve saved money in the long run, but I didn’t have to do it out of the budget. The capital expenditure budget is a protected budget.”
S-Corps, LLCs, ESOPs
“The third reason, and this is what’s really important, is that you have pass-through companies like S-corps, LLCs, and even employee owned ESOPs. So with an S-Corp and an LLC, if it’s a single member, it’s not necessarily a big deal but when you have multi-member LLCs, you have owners who are going to take advantage of the tax credits and that’s going to flow through to them. If you are counting on that money being back in the business, then the owner has to take advantage of the tax credit and then physically put the money back into the business with a check. You may have five or 10 owners and they don’t all pay the same tax credit or the same tax rate. They might not all be willing to put the money back into the business.”
“If you’re looking at it as a business investment that has a personal rate of return as opposed to a business rate of return, it creates issues, especially in an ESOP, an employee owned business where you have 500 employees that each own a small percentage of this business. And now instead of the money being in the business where it needs to be, it’s flowing down to their individual taxes. An operating lease allows the money to stay in the company where it needs to be in order for it to flow and make sense as an investment for the business. And just like the capital lease, it’s no money out-of-pocket and it doesn’t show up as debt on the company books. It doesn’t reduce their borrowing potential.”
“There are times that both the capital lease and an operating lease might seem to make sense and the difference between them is who’s going to take the tax credit and if you can you absorb the tax liability. That’s how you help choose between which one of those two options you want to consider.”
At this point in the series, we’ve covered four different commercial finance options. In the final article of this series, we will be taking a look at what is perhaps the most complex common finance option, PPAs (Power Purchaser Agreements).
Solar is a phenomenal and stable financial investment for almost any and all types of businesses and the best way to figure out if it’s right for your business is to talk to a consultant. Start by getting them at least one, but preferably 12 months, of your energy bills to see what kind of opportunity there is for you in savings. We can then look to see if there is a perfect financial vehicle for you. If purchasing it outright with cash isn’t the right option, there are several ways to do it with no money out-of-pocket. Don’t make cost a barrier to entry for you. Doing a lease can start for system purchases as low as $50,000.
If you are considering switching to solar for your home or business, reach out to us by going to our website, iestxsolar.com, or by giving us a call at (855) 447-6527.
