What is a tax credit? A tax credit is a dollar-for-dollar reduction in the amount of income tax you would otherwise owe.
It directly reduces the amount of income tax you’re required to pay, on a one-to-one basis.
To illustrate, if you are eligible for a $1,000 federal tax credit, this would reduce your federal income tax liability by the same $1,000.
Although commonly known as a federal tax credit, it’s also sometimes called an Investment Tax Credit (ITC).
However, it’s important to distinguish this from the specific Federal Tax Credit designed for businesses with solar energy installations, as the two are not the same.
- The Investment Tax Credit (ITC) is a tax credit that diminishes the federal income tax liability by a percentage of the cost of solar panels installed during the tax year.
- The Production Tax Credit (PTC) is a tax credit per kilowatt-hour (kWh) for electricity generated by solar and other eligible technologies during the initial 10 years of a system’s operation. It lowers the federal income tax liability and is annually adjusted for inflation.
Tax credits are more beneficial than tax deductions, which only reduce the amount of income that is subject to taxation rather than directly lowering your tax bill.
Different types of federal tax credits are available, including those for education expenses, energy-efficient home improvements, and childcare, among others.
In this article, we will focus on the Solar Investment Tax Credit (also known as the solar tax credit).
What Is Solar Tax Credits?
The federal residential solar energy credit offers taxpayers the ability to claim a percentage of the cost of their solar panels as a tax credit on their federal income taxes.
Although there are similar credits for other forms of renewable energy, they are not covered in this discussion.
To qualify, the solar PV system must be fully installed within the tax year.
For systems installed in 2020 and 2021, a 26% tax credit is available.
However, an extension passed by Congress in August 2022 increased this rate to 30% for installations completed between 2022 and 2032. Systems installed by the end of 2019 were also eligible for a 30% credit.
The credit will be reduced to 26% for installations in 2033 and further decline to 22% for those completed in 2034. Unless renewed by Congress, the tax credit will expire starting in 2035.
Importantly, there is no cap on the amount that can be claimed for this credit.
The absence of a maximum claim limit makes this tax credit particularly advantageous for those installing more expensive systems.
- 30% for equipment placed in service in tax years 2017 through 2019
- 26% for equipment placed in service in tax years 2020 through 2021
- 30% for equipment placed in service in tax years 2022 through 2032
- 26% for equipment placed in service in 2033
- 22% for equipment placed in service in 2034
After 2034, the credit is scheduled to end.
How Does the Solar Tax Credit Work?
If you finance a solar panel system within a given tax year, you qualify for a Federal Solar Tax Credit, which can be applied as a percentage of the system’s cost against your federal income tax liability.
For example, if you invest $20,000 in a solar system that becomes operational in 2023, as certified by a city inspector, you would be eligible for a $6,000 federal tax credit.
You would claim this on your 2023 federal income tax return, which you’d typically file in 2024.
Here’s how the credit applies based on your tax liability:
- If your 2023 tax liability exceeds $6,000: You can utilize the entire $6,000 tax credit to offset your tax bill for that year. This provides immediate financial relief, making your solar investment more economical.
- If your 2023 tax liability is less than $6,000: The remaining balance of the tax credit can be carried forward to offset your federal taxes in subsequent years. For example, if your tax liability for 2023 is $4,000, you can apply the full $4,000 against that liability and carry forward the remaining $2,000 to the next tax year.
It’s crucial to understand that this credit can only be claimed once.
If the credit amount surpasses your tax liability for that year, the excess credit will be carried over to the next tax year.
Additionally, it’s important to clarify that the credit acts as a reduction in your tax liability; it is not a refundable amount.
What Qualifies for Solar Tax Credit?
- Solar skylights
- Solar generators
- Solar batteries
- Solar water heaters
- A rental property
- Roof replacement. But there can be a gray area here.
Is the Solar Tax Credit Refundable?
The solar tax credit is non-refundable, meaning it can lower your owed taxes but won’t result in the IRS giving you a refund if the credit is more than your tax liability.
In simpler terms, the credit can bring your tax bill down to zero, but it won’t go into negative territory, meaning you won’t get money back from the IRS.
However, you do have the flexibility to “carry forward” any unused credit to the following tax year.
This credit is particularly impactful because it directly reduces your tax liability, unlike a tax deduction which merely lowers your taxable income.
Consequently, tax credits usually offer more substantial financial benefits compared to deductions, which need to be itemized and only recoup a fraction of your expenses.
How Do You Qualify for the Federal Solar Tax Credit?
To be eligible for the federal solar tax credit, there are several criteria you must meet:
- The project must be located in a U.S. residence where you lived during the tax year for which you’re claiming the credit. The IRS’s definition of a “residence” is fairly broad and includes houses, houseboats, mobile homes, cooperative apartments, condominiums, and manufactured homes. Importantly, for solar, wind, and geothermal projects, the property doesn’t have to be your primary residence.
- You must own the system outright; To qualify for solar tax incentives, you typically need to own the solar system. A solar loan allows you to purchase and own the system, as opposed to a solar lease or Power Purchase Agreement (PPA) where a third party retains ownership.
- The project must have been put into service in 2017 or later. Systems activated prior to the inception of the energy credit program will not qualify.
- While many costs related to the project are covered, not all are included. The program covers installation expenses but excludes costs that only serve a structural function and don’t directly support the system.
How to Claim Solar Tax Credit? What Documents Do You Need?
To take advantage of the solar tax credit, you’ll need to complete IRS Form 5695, which is designated for residential energy credits.
This form will require specific details, both about your general tax situation and your energy project.
For your overall tax situation, you can refer to your Form 1040, which will provide necessary information such as your tax liability for the year.
In addition, you’ll need to provide comprehensive details about your energy project, including its costs.
Furthermore, a certification from the equipment manufacturer confirming that the installed products are eligible for the tax credit is usually required.
What Expenses Qualify for Solar Tax Credit?
Solar Water Heaters
These systems are an eco-friendly and efficient means of producing hot water for your residence.
Utilizing solar collectors along with a storage tank, solar water heaters capture the sun’s thermal energy to heat the water in your home.
There are various designs available, and these systems can be an excellent long-term investment to lower your energy bills.
Solar Photovoltaic (PV) Systems
These are the solar panels that are commonly seen on rooftops. They transform the sun’s light energy, specifically photons, into electricity that powers your home.
Not only do these systems significantly cut down on your monthly electricity bill, but they can also make you more self-reliant in terms of energy.
Does the Solar Tax Credit Work With Other Incentives?
You can still claim the federal solar tax credit even if you benefit from other clean energy incentives for the same project.
However, it’s important to note that such additional financial incentives could reduce the system’s net cost that’s used to calculate your federal tax credit, potentially resulting in a smaller credit amount.
State Solar Incentives
State-level incentives for solar projects can differ considerably, so it’s prudent to research the regulations and opportunities specific to your state.
If you’re looking for a starting point, N.C. State University’s NC Clean Energy Technology Center provides a comprehensive directory of programs across the nation.
Generally, state-level tax breaks or rebates won’t restrict your eligibility for federal solar credits.
Conversely, financial help from your utility company could have different implications.
According to IRS guidelines, the total cost basis for calculating your federal tax credit must factor in any incentives received from a public utility, unless you’ve accounted for these incentives as income on your federal taxes.
The IRS has several mechanisms to verify the legitimacy of claims made for the solar tax credit.
Is the Solar Tax Credit a One-time Credit?
The Solar Tax Credit is not a one-time credit in the sense that you can claim it for multiple solar projects or for various phases of a larger solar project, provided they are completed in different tax years.
However, for a single solar installation, you claim the credit only once in the tax year the system is placed into service.
If the tax credit exceeds your tax liability for that year, the excess amount can be “carried forward” to reduce your income taxes in subsequent years until the credit is fully used up.
Is There an Income Limit for the Solar Tax Credit?
The absence of an income limit for the federal Solar Tax Credit makes it available to taxpayers across all income levels.
However, it’s important to have sufficient tax liability to make full use of the credit in a given year. If your tax liability is less than the credit amount, you can carry over the remaining balance to offset your taxes in subsequent years.
Can You Claim Solar Tax Credit on Second Home?
Yes, you can claim the federal Solar Tax Credit for a solar system installed on a second home, provided the property meets certain criteria outlined by the IRS.
Specifically, the second home must be in the United States, and you must have lived in it for at least part of the year for which you are claiming the credit.
How Many Years Can You Roll Over Solar Tax Credit?
You can continue to roll over unused portions of your credit for as long as the solar tax credit is in effect.