How does the federal solar tax credit work?
Renewable energy incentives reduce your tax bill
The solar investment tax credit (ITC), also called the federal solar tax credit, allows qualifying property owners to deduct 26% of the cost to install a solar energy system on their federal taxes.
Solar panel costs have decreased dramatically in the last 20 years, but the ITC can still save individuals and businesses a great deal on their federal taxes. If you are considering installing or have recently installed one, it's important to know how this credit works, if you qualify and how to claim it on your taxes.
- After 2022, the federal solar investment tax credit (ITC) will be reduced from 26% to 22%.
- The ITC is applied directly to your tax payment (it’s not a taxable income deduction).
- You must own your solar system in order to receive the ITC, though it’s fine if you’re financing the payments.
- Any type of home is eligible for the ITC, including mobile homes, condos and houseboats.
How solar tax credits work
The tax credit is a reduction in an individual’s or business's tax liability based on the cost of the solar property. It’s a nonrefundable tax credit, meaning you won’t get more back than the amount you owe in taxes.
Projects that begin construction in 2021 and 2022 are eligible for the 26% federal tax credit, while projects that begin construction in 2023 are eligible for a 22% tax credit. Residential tax credits drop to 0% after 2023, but commercial projects will drop to (and remain at) 10%.
As of 2021, the solar ITC is a 26% federal tax credit.
Homeowners who purchase a newly built home with a solar system are eligible for the ITC the year they move into the house if they own the solar system. Those who lease a solar system or who purchase electricity through a power purchase agreement (PPA) are not eligible for the ITC — the company that leases the system or offers the PPA collects the credit.
Anyone wishing to claim the credit should first consult with a tax professional to ensure that they are eligible. It's smart to speak with an advisor before making a major investment that you intend to claim on your taxes.
Kelly McCann, an attorney at a law firm that specializes in real estate and construction law in Portland, Oregon, said these tax credits can be a huge bonus for taxpayers — when they understand how they work.
“I find consumers are confused as to the difference between a tax credit and a tax deduction," he said. "A tax credit offers a dollar-for-dollar reduction in the amount of income tax the taxpayer would otherwise pay.”
McCann offered the following example:
- Tax credit: If you receive a $1,000 tax credit, your federal income taxes will be reduced by $1,000.
- Tax deduction: If you get a $1,000 tax deduction, your reportable income will be reduced by $1,000, and your taxes will drop as a result of this reduced taxable income. So, if you’re in the 32% tax bracket in this scenario, you’ll likely save $320 on your taxes.
“Suffice it to say, tax credits are better for the taxpayer than are tax deductions,” McCann said.
How to claim solar tax credit
Those who are eligible and who wish to claim the credit should file IRS Form 5695 with their tax return. Part I of the form calculates the credit. The final amount is listed on the 1040 form. Individuals who failed to claim the credit when they were supposed to can file an amended return later.
Residential solar energy investors claim this tax credit under Section 25D, while commercial solar investors claim it under Section 48. Individuals claim the residential tax credit on their personal income taxes, while businesses that claim the credit do so on their business taxes.
History of the solar investment tax credit
In the early days of solar energy, residential systems were far more expensive than they are now. By many homeowner standards, however, they’re still expensive today. For example, in 2009, it cost $8.50 per watt to install solar panels; the current cost per watt, as of publishing, is about $2.40 to $3.22.
This point-of-entry cost into the world of renewable residential solar power dramatically limited the number of homeowners who could take advantage of solar for their home.
The solar investment tax credit was established by the Energy Policy Act of 2005, which established standards for renewable fuels, mandated an increase in the use of biofuels and established renewable energy-related tax incentives.
Under this law, the original policy was set to expire at the end of 2007. However, the solar ITC has been so popular (and successful at promoting solar panel installation on residential properties) that its expiration date has been extended multiple times.
Solar panel costs have decreased dramatically in the last 20 years, but the ITC can still save individuals and businesses a great deal on their federal taxes.”
Today, solar systems are far less expensive due to changes in the industry and the manufacturing of certain parts that make up the solar system. Solar panels, lithium batteries and inverters are all far less expensive to make and buy now than they were in those early days.
It's projected that the price of these products will continue to fall for several more decades. If the federal solar tax credit continues to be extended, it's unclear how these falling prices will impact the tax credit overall.
Are there other solar energy incentives?
In addition to the federal ITC, there are other incentives available to people going solar, including the following:
- Utility company incentives: Local utility companies often offer incentives to get homeowners to purchase home solar power systems. Some companies subsidize the cost of installation or offer rebates, depending on the amount of energy a system produces.
- State solar rebates: State governments can also offer cash rebates for installing solar panels. These rebates often help reduce the cost of installation by 10% to 20%.
- State solar tax credits: Some states also offer tax credits to encourage residents to purchase solar panel systems. If this is true in your state, you may be able to claim both your state’s tax credit and the federal ITC.
Other incentives may include subsidized loans, tax exemptions and solar renewable energy certificates (SRECs). Before purchasing a system, talk to your local solar panel supplier about your options — they likely know about the incentives available in your area.
Solar tax credit FAQ
- If the solar tax credit exceeds my tax liability, will I get a refund?
The solar tax credit is nonrefundable, which means it cannot result in a refund if the individual's tax credit exceeds their liability. Instead, the leftover amount can be carried over to the following year.
For example, if you owe $1,500 in taxes and your tax credit totals $2,000, then the amount you owe is subtracted from the tax credit and the remaining $500 will be credited to your taxes the following year. This is sometimes called “rolling over.”
- What is the difference between a tax credit and a tax rebate?
A tax credit is only used to offset a due balance, while a tax rebate is an amount paid to the taxpayer.
- Do other clean energy incentives I get affect my federal tax credit?
Typically, tax credits from the state do not affect your federal tax credit and vice versa. However, a large state tax credit could affect the overall taxable income from the state, which would affect your federal tax return. This means that the amount you claim for your state tax credit will be taxable on your federal tax return.
It's important to work with a tax professional who can help you determine the best way to navigate these complex issues so you can receive the maximum benefit from your solar system.
- Do rental properties qualify for the solar tax credit?
The residential tax credit does not allow you to claim solar installation costs on a rental property. However, there are some important caveats to take into consideration when determining whether a solar tax credit can be applied.
Individuals can claim the solar tax credit if they live in the house for part of the year and use the house as a rental when they're not present. If the house is a vacation home, for example, and the homeowner lives in the house 25% of the year, they can claim 25% of the credit.
Rental properties may also qualify under section 48 as a business tax credit. Again, it's important to work with a tax professional to determine eligibility for your solar system. Your advisor can help you determine if your property is qualified for a tax credit and the best way to apply the credit to your annual taxes.
- How much longer is the solar tax credit available?
The solar tax credit is currently available at a rate of 26% through 2022, then at 22% for construction projects that begin in 2023. The residential tax credit is reduced to nothing in 2024, while the commercial tax credit will drop to and stay at 10% in 2024.
However, these tax credits have been routinely extended since the first credits were implemented in 2005. Homeowners who would like to install a solar system on their property and want to be sure they can claim the tax credit should begin construction on the solar system by the end of 2023. Homeowners who would like to install a solar system later may still enjoy a tax credit if the ITC is extended again, but there is no guarantee this will happen.
- Can you claim the solar tax credit twice?
Generally, homeowners can only claim one tax credit per solar system. It might be possible to claim the credit again if you install panels on another property. Tax regulations are complicated, so it’s best to ask a professional for advice about your specific situation.
- Are owners of condos and mobile homes eligible for the solar tax credit?
Almost any U.S. residence — whether it’s a house, a mobile home, a condominium, a manufactured home, a houseboat or a cooperative apartment — may be eligible for the ITC.
- The new-construction home I bought last year came with solar panels; can I get the credit?
You can claim the credit as long as the builder didn’t already claim it (the credit belongs to the homeowner, so they shouldn’t have). Contact your builder for a reasonable allocation of costs in order to claim your credit.
- Can I claim even if I finance my solar installation project?
You can claim your solar project for the tax credit even if you take out a solar loan — as long as the contract requires you to pay for the full cost of the system.
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