While many view taxes as a necessary evil, small businesses and investors should embrace the tax code incentives, especially when it comes to investing in the environment.
Here’s an overview of five great tax incentives for investing in the environment:
The tax law has two primary purposes. Most of us understand the first purpose is to raise revenue. What many people forget is that raising revenue is a minor part of the 5,800 pages of tax code. Ninety-nine percent of the tax law is simply a guide to reducing taxes. Governments of all countries, including the U.S., have figured out that the most efficient way to motivate taxpayers to follow their policy initiatives is to provide a tax incentive for doing so.
For example, if the government wants people to send their children to college, it provides a tax deduction and/or tax credit for doing so. If the government wants people to donate to charities, it allows a tax deduction for those donations. If the government wants people to buy houses, it gives tax deductions for mortgage interest and property taxes.
This is especially true for economic policy. The government wants businesses to hire veterans, so it gives a tax credit for hiring veterans. It wants businesses to buy new equipment, so it gives a tax deduction for buying equipment. Businesses and their owners get more tax benefits than all other groups combined.
One type of tax benefit businesses tend to miss is the array of tax benefits for improving the environment—environmental tax incentives. There are multiple deductions and credits for investing in the environment. Some of these are restricted to businesses and some are available to everyone.
- Nonbusiness Energy Property Credit – One of the great tax incentives available to the general public is the Nonbusiness Energy Property Credit. This credit includes tax benefits for energy efficient windows and fans as well as energy efficient heat pumps and other energy efficient residential energy property.
- Residential Energy Efficient Property Credit – Another terrific energy tax benefit for homeowners is the Residential Energy Efficient Property Credit. This credit includes tax benefits for solar panels to heat or cool your home as well as tax credits for wind energy property and geothermal heat pump expenses.
- Energy Tax Credit – Most of the environmental benefits are restricted to business owners and investors. One of the major tax credits for business owners is the energy tax credit of Section 48. This is a major credit in the amount of 30 percent of your qualified expenditures. This means that 30 percent of your expenditures for windmills, solar energy, solar lighting, and geothermal energy equipment are available as a direct credit against your income taxes. In addition, there are tax credits for efficient energy such as clean coal, biomass (agricultural or plant waste), and hydrogen plants that are used to convert these materials into natural gas. There is also a credit for equipment purchased for other advanced renewable energy production.
- Nuclear and other Advanced Energy Credits – There is even a credit for certain nuclear energy production. I imagine that Doc Brown’s equipment in Back to the Future II for converting banana peels and beer into nuclear energy (fusion) would qualify so long as Doc Brown used the DeLorean for business purposes. In fact, if a business owner purchases equipment that produces electricity other than through basic oil or gas there is probably a related tax credit.
- Charitable Deductions for Easements – One of the most significant tax benefits available for taking care of the environment is rarely discussed. It can provide an enormous tax benefit and few people take advantage of it. This is the charitable deduction for conservation easements. Here is how it works.
You own a farm, a ranch, or some wetlands that is on the outskirts of what might someday be developed. You agree to put an easement on the land that will prevent it from ever being developed and you donate that easement to the (insert name of conservation authority). You receive a tax deduction for the difference between the value of the property as if it were developed and the value of the property without development. Here is an example.
Suppose you have a ranch in the mountains of Montana with a nice little river running through it. You could put in a nice community with 40 or 50 home lots. You hire a developer to plan this out. The developer does plans for the community and determines that if you were to sell all of the lots that the value of the property would be $5 million. The cost to do the development (i.e., to put in the offsite improvements including roads, electricity and water) would run about $1 million. So the net value of the development would be about $4 million. Without the development, the property is only worth $1 million. You put a conservation easement on the property and receive a charitable deduction for $3 million ($4 million net value of the development less the $1m of the value without the development). And you never have to do the development.
This tax benefit works really well in two or three real situations. The first is where you own the ranch and never want it developed in the first place. You get a big tax deduction for doing what you planned to do all along. The second would be where someone else has property and wants to continue farming it instead of it being developed.
In this case, the farmer sells the property to an investment partnership. Other investors and you put up the money to purchase the land from the farmer and lease it back to him for a small annual lease payment. You hire the developer to come up with the plans and the valuation of the developed property versus the property used as a farm. The partnership puts a conservation easement on the property. You get the income from the farmer and a big charitable deduction. The farmer can ensure his ability to farm the property indefinitely while getting a big cash payment for the value of the farm.
The environment gets a farm that will never be developed. Everyone wins.
You just have to be very careful to hire a developer who really knows their business. There are several companies who do nothing but conservation easement development work. Some are better than others and have had their valuations upheld by the Tax Court. Just be sure to do your due diligence and don’t get greedy or cut corners.
Done properly, this is one of the best tax benefits available for people who want to invest in the environment. Frequently, the conservation easement deduction will be as much as 4 times the amount you invest. At a 40 percent tax rate, this amounts to a real tax benefit of $160,000 on each $100,000 invested or an instant 60 percent return on investment. Not something to take lightly.
Tom Wheelwright, CPA, is the creative force behind ProVision, the world’s premier strategic CPA firm. As the founder and CEO, Tom has been responsible for innovating new tax, business, and wealth consulting and strategy services for premium clientele for over 30 years. He is a leading expert and published author on partnerships and corporation tax strategies, a well-known platform speaker and a wealth education innovator. Tom is the author of the bestseller, Tax-Free Wealth.