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Evaluating Cost Basis for Solar Photovoltaic Properties1

The review of applications for payment under the Section 1603 program includes a 

determination as to whether the applicant has properly represented and calculated its cost 

basis. Each application is evaluated to determine whether the cost basis includes only eligible 

items and that it represents the applicant’s actual costs or, in certain cases, fair market value

for the eligible property. This document, intended to assist with preparing Section 1603 

applications, outlines the process used by the Section 1603 team to evaluate basis and the 

principles that guide this process. These principles are consistent with tax concepts used to 

determine basis for federal tax purposes.2

Basis

As described in various Internal Revenue Service (IRS) publications, basis is the amount of a 

business’ investment in property for tax purposes. Basis is generally the cost of the property3

and may also include the capitalized portion of certain other costs related to buying or 

producing the property (e.g. permitting, engineering, and interest during construction).4

However, as described in Bryant v. Commissioner of Internal Revenue (790 F.2d 1463), “the 

courts have determined that in certain circumstances, a taxpayer's stated cost for an asset does 

not reflect the true economic cost of that asset to the taxpayer and will be ignored for purposes 

of determining the basis of the asset.” For example, a stated cost may be inconsistent with the 

eligible property’s true basis “where a transaction is not conducted at arm's-length by two 

economically self-interested parties or where a transaction is based upon ‘peculiar 

circumstances’ which influence the purchaser to agree to a price in excess of the property's fair 

market value.”

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In order to ensure that a Section 1603 applicant’s claimed cost basis reflects the eligible 

property’s fair market value, basis is more closely scrutinized in cases involving related parties, 

related transactions, or other unusual circumstances. Similar to the authority of the IRS in the 

context of investment tax credits, in making cash payments under Section 1603, the Treasury 

Department has authority to decide that “an applicant has miscalculated or misrepresented the 

basis of its property.”6 

The first step the review team takes to evaluate the claimed basis for solar photovoltaic (PV)

properties is to compare the claimed basis to certain benchmarks. The benchmarks used by the 

review team for solar PV cost basis are predicated on an open-market, arm’s-length transaction 

 

1 Although this paper addresses only solar PV properties the methods used to evaluate cost basis described herein 

apply to all types of properties

2 This document has been developed by the Office of the Fiscal Assistant Secretary in consultation with the Office 

of Tax Policy

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26 U.S.C. 1012

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26 CFR 1.263A-1

5 Lemmen v. Comr., 77 T.C. 1326, 1348 (1981). 

6 ARRA Energy Company I et al. v. U.S., 97 Fed.Cl. 12 (2011).
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between two entirely unrelated parties with adverse economic interests, specifically with 

respect to setting the eligible property’s price. 

Benchmarks considered by the 1603 review team are continuously updated (as warranted) 

drawing on relevant publicly available information and analyses by various experts, data from 

existing 1603 applications and other confidential sources, and the 1603 review team’s 

experience with solar PV properties.

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 As of the first quarter of 2011, benchmark solar PV 

market expectations are as follows:

Residential Residential/

Small Commercial Commercial

Large Commercial/

Utility

Size Range < 10 kW 10 - 100 kW 100 – 1000 kW > 1 MW

Typical Size 5 kW 25 kW 250 kW 2 MW

Turnkey Price per W +/- $7 +/- $6 +/- $5 +/- $4

These prices reflect a high quality of equipment (modules, inverters, racking) installed by 

reputable companies across the United States and include profit. 

The review team understands that each system is different. Technology choice affects cost, as 

do regional market differences and differences in size within the above categories. A property 

may have specific characteristics that increase (or decrease) eligible costs. Such factors are 

considered in evaluating how a given application’s basis compares with benchmark prices. 

If claimed basis is deemed consistent with benchmark prices, the review team typically focuses 

the remainder of its cost review on examining line items provided in the detailed cost 

breakdown to ensure that only eligible items have been included and that no costs have been 

inappropriately attributed to the property. If there are no ineligible items, the basis reflects 

only items appropriately attributable to the eligible property, and there is adequate

documentation to support that the costs reflect actual costs, the cost basis is accepted. 

The review team may ask the applicant to provide additional detail if a cost breakdown line 

item is defined too generally. If ineligible items are identified, they are removed, and the 

payment is based on the corrected amount. For example, although a project may necessitate a 

fence for security or a building for operations and maintenance, such costs are not eligible. 

Applications with a claimed basis that is materially higher than benchmarks will receive closer 

scrutiny. In addition to ensuring that only eligible costs are included, the review team looks at 

whether there are related party considerations, or other unusual circumstances, such as where 

the transaction determining basis may be influenced by other related transactions. One 

example of related transactions would be a case in which the benefits of a power purchase 

agreement are acquired at the same time the Section 1603 eligible property is acquired.

 

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For example, some sources include: the U.S. Department of Energy’s $1 per Watt Study, the California Solar 

Initiative, Tracking the Sun report, and confidential interviews with nationally-recognized solar industry officials.
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Common examples of related party or other unusual circumstances include:

1. Owner/applicant is related to the developer, installer, or supplier (collectively referred 

to as the “developer”). The developer may be a separate, legally-organized business, 

but there is common ownership/control.

2. Owner/applicant is a party to one or more related transactions with the developer such 

that economic interests in the specific transaction determining basis may not be 

adverse. For example, the owner/applicant purchased the energy property from the 

developer and leased the property back to the developer.

Where such circumstances are present, the review team evaluates whether the claimed basis is 

consistent with the property’s fair market value.8As one aspect of this evaluation, where 

related transactions or other unusual circumstances are present, the review team will consider 

the applicant’s allocation of the cost to the eligible property, relative to other ineligible assets, 

rights, or contracts that may have been explicitly or implicitly conveyed in the transaction(s). In 

this context, the owner/applicant may be asked to submit a more detailed cost breakdown. 

Specifically, original manufacturer’s invoices/costs to the developer should be provided for 

major equipment, subsequent markups by the developer should be enumerated, and any 

markups by the owner identified. The owner may also submit a detailed and credible thirdparty appraisal (discussed below) demonstrating that the claimed basis is consistent with a 

market transaction between unrelated parties with adverse economic interests.

Ultimately, the review team determines whether or not the claimed basis was properly 

calculated and/or properly represented fair market value, taking into account market 

expectations, the specifics of the application in question, and supporting documentation 

provided by the applicant. If the review team determines that the basis was not properly 

calculated or represented, the review team may adjust the basis on which a 1603 payment is 

made to a level consistent with the review team’s view of the property’s true cost, as informed 

by documentation provided by the applicant and other relevant information and analysis. This 

is no different than what might take place upon examination by the IRS if the applicant elected 

the Section 48 tax credit rather than the Section 1603 payment.

Fair Market Value

The IRS generally defines fair market value (FMV) as “the price at which property would change 

hands between a buyer and a seller, neither having to buy or sell, and both having reasonable 

knowledge of all necessary facts.”

 

8 An evaluation of the property’s fair market value is also relevant in the context of applications by lessees of leased 

property, where the applicant has chosen fair market value as the basis.
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The review team does not prepare appraisals for energy property. Rather, the review team 

evaluates appraisals provided by applicants and prepared by independent, certified appraisers 

with expertise in solar PV properties. There are three broad and interrelated methods that are 

used in valuation efforts: the cost approach, market approach, and income approach.

Cost Approach

Based on the actual cost to build the property. This approach should clearly show the cost 

buildup, including hard costs, soft costs, and profit. Because the 1603 program only applies to 

energy property placed in service after December 2008, properties are new, and the actual 

costs should be readily available. Because cost data for PV systems is increasingly timely and 

available, this approach tends to be the most concrete and supportable analysis and is favored 

by the review team. 

The Section 1603 review team will accept a cost approach that includes only eligible property 

and a markup that is consistent with industry standards and with the scope of work for which 

the markup is received. While appropriate markups are case-specific and can depend on the 

ultimate transaction price, the 1603 review team has found that appropriate markups typically 

fall in the range of 10 to 20 percent. A cost approach that includes a markup should explicitly 

address the appropriateness of the selected markup in light of the activity, capital investment, 

and risk for which that markup is compensating. 

Market Approach

Based on sales of comparable properties. Thousands of solar PV properties have been installed 

in the last two years, and market data are readily available. However, consideration must be 

given to ensuring that the prices of chosen comparables reflect only the value of eligible 

property.

Income Approach

Based on the discounted value of future cash flows generated by and appropriately allocable to 

the eligible property. Numerous assumptions must be made, including forecasts of all relevant 

project revenue and cost streams, cost of capital (debt and equity), rates of inflation and taxes, 

number of periods of income, and residual value. The review team has found this to be the 

least reliable method of valuation given the number of variables that are subject to speculation 

and open to debate. 

Importantly, an income approach also often requires careful consideration of the appropriate 

allocation of value to the eligible energy property. In cases where the income approach yields a 

value that exceeds the cost to build the property by a significant margin, this raises a question 

of whether a portion of the claimed value should, in fact, be allocated to other ineligible assets, 

rights, or contracts associated with the production of income from the eligible property, such as 

a power purchase agreement. In such instances, applicants can accelerate reviews of their 

applications by ensuring that appraisals adequately address the issue of appropriate allocation 

of basis to the eligible property. For example, appraisals should address the FMV of the eligible 

property specifically, and not the “project” in which that property is being used. 
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For purposes of Section 1603, a credible income approach to valuation will consist of a detailed 

spreadsheet model showing annual revenue and expenses over the term of the contract with a 

reasonable residual value at contract termination.

Key Assumptions include:

 

 Inflation rates should be supported by credible sources.

 Discount rates should reflect an appropriate risk premium above the risk-free rate.

 Speculative revenue (i.e., revenue that is not specifically contracted and guaranteed by 

a credit-worthy customer) will be closely scrutinized and must be well-supported and 

documented. Projected revenue beyond contracted periods should be based on 

conservative, publicly-available data.

 All expenses must be included, both annual ordinary operating expenses and major 

maintenance (e.g., inverter replacement).

 All depreciation, taxes, and other considerations should be incorporated into the model.

These and all other assumptions should be well-reasoned and sufficiently documented, and 

should reflect market expectations. Moreover, the income approach should explicitly address 

the allocation of the estimated discounted cash flows to the eligible property. 

Questions related to cost basis may be directed to 1603questions@treasury.gov .