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Explaining SolarCity's Tax Problems

SolarCity's (NASDAQ: SCTY  ) stock has taken a drubbing this week after Sen. Jeff Sessions, R-Ala., sent a letter to the Treasury secretary asking for an investigation into solar grants and tax credits.  

Investors were spooked by the potential of a federal investigation, but those are they're nothing new for SolarCity, which was under investigation by the inspector general before the company went public in 2012. In fact, it's the same tax credit taken by SunPower (NASDAQ: SPWR  ) and First Solar (NASDAQ: FSLR  ) on their solar projects.  

SCTY Total Return Price Chart

SCTY Total Return Price data by YCharts

So, is the latest inquiry into SolarCity's finances a concern? Let's take a look.

What has the Feds so hot and bothered?
The investigation facing SolarCity has to do with how it accounts for solar projects and how much it received in investment-tax credits. When SunPower or First Solar builds a utility-scale project they usually sell it to an investor, making the value of the project known. But SolarCity holds the project and reports a tax value higher than cost, making the value figure a gray area.

Let's say a residential solar system costs $16,000 for SolarCity to build. That system is then "sold" to an equity investor who then takes the tax credits. I say "sold" because the project eventually ends up back on SolarCity's balance sheet, so it's more of a temporary sale that usually lasts about five years.

SolarCity residential solar installations. Image courtesy of SolarCity.

The tax-equity investor gets to write-off 30% of the cost as an investment-tax credit. Only SolarCity doesn't sell the project for $16,000; it sells it for $20,000. Similarly, the asset is depreciated at a $20,000 base instead of $16,000.  

The result of the $20,000 "sale" is a $6,000 tax credit plus $10,200 in depreciation based on bonus and accelerated depreciation available in 2013. Total tax savings based on a 35% tax rate would be $9,570 in year one alone.

If the $16,000 figure was used, the tax credit would fall to $4,800 and depreciation would be $8,160. Total tax savings would be $7,656.

The argument people like Sessions are making is that SolarCity is using an artificially high value for its tax basis, essentially costing the government money.

Should you sell now?
If SolarCity is found to have inflated the value of its solar projects there will be a fine that could run into the tens of millions of dollars. That's a big hit for a company that has yet to make a profit -- and worse, it would make returns for tax-equity investors even lower, increasing the cost of capital for SolarCity.

This is a risk for investors because SolarCity is reliant on tax-equity investors to fund new projects and it may have to pay back taxes on overestimated value. I don't think it's a reason to sell today, but it's worth watching.

For project builders SunPower and First Solar, the risk is far less. SunPower has a small residential solar business, which may run into the same problems of SolarCity, but panel sales and utility-scale projects are a bigger part of its business. For First Solar, it sells projects -- so there's little doubt of their value for tax purposes.

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Read/Post Comments (5) | Recommend This Article (2)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 20, 2013, at 1:51 PM, eddiemoy wrote:

    why you guys keep printing this garbage?

    same crap that the barrons article was full of...

    solar city couldn't even correct them at the time because they were in their quite period...

    here is the correction

    http://blog.solarcity.com/

  • Report this Comment On November 20, 2013, at 3:26 PM, CaptainLee wrote:

    Flush this article! Solar City seems to be attacked at every opportunity by folks like you who will publish anything without even checking facts ! Are you jealous of Elon Musk or trying to make money shorting the stock ? Or....maybe just STUPID !!!!

  • Report this Comment On November 21, 2013, at 1:15 AM, jtinsj98 wrote:

    The author is not stupid, but he definitely has a bias against SolarCity and is very pro Sunpower. I have seen this bias in just about every article he has written on the solar industry.

    Perhaps someone should write an article that poses the question "Should you buy now?" because SolarCity has done nothing wrong and will win this case … well, if it weren't for all the people trying to bring them down and pushing on the government for assistance in that endeavor.

    Articles like this, stupid letters written by stupid, un-informed REPUBLICAN senators, and the treasury investigation are just like the reports of fires in Tesla Model Ss - pure nonsense stemming from jealousy of success and other desires to simply root against someone's potential success. After all, we don't see reports of all the other vehicles that have caught fire after crashes … and there are MANY! Pure propaganda on all fronts from those with a vested interest in competitors or competing technologies i.e. the oil and gas industry.

  • Report this Comment On November 21, 2013, at 4:24 PM, Ccaptain wrote:

    Are there anymore Solar city employees who want to throw in thier two cents? None of the above have explained why there are differences in the values of solar city's investments from the purchase prices, to the grant values, to the values that are sold to the investors. If they are found to be shady why does the government and tax payers have to pick up the tab?. My two cents on Tesla- Elon did not found Tesla- he won that desination in a court battle after he almost broke himself buying up/out the board so he could take over the company.. The vision and credit goes to Martin.

  • Report this Comment On November 21, 2013, at 6:07 PM, shawnicek wrote:

    The article is flawed whether there exists a bias against SCTY. They do not sell the system for a markup in the lease program. The IRS has long allowed for assets that are not sold to be valued based a 3rd party Fair Market Value that can be based on a discounted cash flow calculation. While it is clear that SCTY has received FMV calculations at substantially above the prices for which they sell the same sized systems, this is a problem for the IRS/Treasury to resolve by changing the rules. Treasury has also taken steps to set limits/guidelines on the FMVs for new systems. SCTY will end up paying a meaningful sum to Treasury for past valuations, but I don't think this will end up being a major issue for the stock value going forward. Systems costs are coming down and will likely be sufficient to offset the impact of the lower tax credits.

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