How Does the Federal Solar Tax Credit Work?

What is the federal solar tax credit?

The federal solar tax credit reduces your income tax liability by 30% of what you spent installing solar panels on your home. It’s nonrefundable, meaning you can only claim a credit up to the amount of tax you owe for the year. In other words, you won’t get the excess amount refunded if the credit exceeds your tax bill. However, any unused portion of the credit can carry over to reduce the taxes you'll owe in future years.

History of the solar investment tax credit

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.

The new bill doesn’t affect solar leases or commercial solar projects.

In the early days of solar energy, residential systems were far more expensive than they are now. 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 to $3.50 before the federal tax credit is taken into account.

By many homeowners’ standards, however, solar panels are still expensive today. The tax credit made solar more accessible to middle-class households. The ITC was set to drop to 26% in 2033 and 22% in 2034, then expire in 2035 — but those future step-downs have been eliminated under the new law.

What was the old rule?

Before this new bill, if you wanted to put solar panels on your roof, the government would basically say, “Hey, nice job helping the planet. We’ll pay for 30% of it by giving you that money back when you do your taxes!”

So, for example, if your solar panels cost $30,000, you would get about $9,000 back, making it way cheaper.

How does the federal tax credit work now?

You can still claim the 30% tax credit only if your system is installed, paid for and activated by the end of the year. You must own your solar energy system to receive the ITC, though it’s fine if you’re financing it.

Next year, if you put solar panels on your house, you will have to pay the full price and won’t get a tax credit. Before, a $30,000 solar system effectively cost $21,000 after considering the tax credit. Now it costs the full $30,000. That’s almost like paying for a whole extra new car.

Leases and PPAs

The new bill does not affect solar leases or power purchase agreements (Section 48E). Previously, buying was often much better financially because you’d get that huge 30% tax credit, plus bigger long-term savings.

Now, with the federal tax credit going away after 2025, the gap between leasing and buying shrinks (because nobody gets the tax credit anymore). A lease or PPA might look slightly more attractive for homeowners who prefer no upfront costs, while buying still wins for people wanting maximum control and savings over decades.

» MORE: Lease or buy solar panels?

Tax credits vs. tax deductions

Kelly McCann, an attorney at a law firm specializing in real estate and construction law in Portland, Oregon, said these tax credits can be a huge bonus for taxpayers. But only 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.”

“Suffice it to say, tax credits are better for the taxpayer than are tax deductions,” McCann added. He 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.

How to claim the solar tax credit

Those who are eligible 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.

Are there other solar energy incentives?

Some places, like California, are trying to make their own initiatives to help households adopt solar. But in a lot of places, people will likely just stop buying solar panels because they are too expensive now. On the bright side, there are still some 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 a local solar installer — they likely know about the incentives available in your area.

How much do solar panels cost?

A standard solar panel system costs around $15,000 to $30,000. 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 also cheaper now than in those early days. However, it's unclear if these prices will continue to decrease.

The averages below do not consider the federal solar tax credit. You might be eligible for local incentives that make the system cheaper, depending on where you live.