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Solar Tax Credit Explained: Rebates & Incentives

setting up solar

Most of us have had a solar panel sales rep knocking on our door to pitch the benefits: huge savings, low maintenance, and the satisfaction of helping the environment. Then they hit you with cost, and it suddenly becomes much less attractive.

That’s where solar tax credits can offer a tempting incentive. These credits can reduce the cost by offering a federal tax break on a portion of the system’s expenses. How do they work, and are you eligible? Let’s find out.

This article will include:

  • How to claim tax credits for solar panels.
  • The ins and outs of solar penal incentives and rebates.
  • A breakdown of commercial solar project investing.

Read more:

What Is Solar Tax Credit?

Tax credits have been around since the early 2000s, but they really kicked off as part of the Inflation Reduction Act in 2022. A tax credit directly reduces the income tax you owe, dollar for dollar — so claiming a $1 federal tax credit reduces your federal income taxes due by $1.

So what’s this got to do with solar energy? To keep things straightforward, I’ll refer to it as the solar tax credit, but its proper name is the Residential Clean Energy Tax Credit.

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Federal solar tax credit lets you claim a percentage of the costs you paid for your solar PV system on your federal income taxes, covering expenses like the installation and equipment of your solar panels.

You can also stack this federal credit with utility-funded programs and state incentives that promote clean energy to boost your savings even more.

How Does the Solar Tax Credit Work?

In simple terms: the solar tax credit lets you use a portion of your solar power system’s cost to lower your income taxes. What makes the solar tax credit so appealing? It’s a credit, not a deduction, so it directly reduces the amount of income tax you owe, dollar for dollar, rather than just lowering your taxable income.

The Office of Energy Efficiency and Renewable Energy claims you can save more than $7,500 on the average solar system through tax credits. However, the amount you claim depends on when you installed the solar PV system; here’s a breakdown:

Installation year Tax credit amount
2017-2019 30%
2020-2021 26%
2022-2032 30%
2033 26%
2034 22%

Note: Unless Congress renews it, you can say goodbye to the credit in 2035.

You should also know that this credit is nonrefundable. So, even if it reduces your tax bill below zero, you still won’t get a refund if your tax liability is under the credit amount. However, you can roll over any unused portion to the next tax year.

There’s no annual or lifetime cap on this credit (except for credit limits on fuel cell property). You can claim the credit every year you install eligible property until it starts phasing out in 2034.

What Are the Qualified Expenses for Solar Tax Credits?

The Residential Clean Energy Tax Credit covers more than just solar panels, but let’s start there. Here are all the nuts and bolts covered by the solar tax credits:

  • The cost of solar PV panels or PV cells.
  • Contractor labor costs  (installation, onsite preparation, assembly, and other fees for permits, inspections, and development).
  • Balance-of-system equipment (inverters, wiring, and the mounting equipment).
  • Energy storage devices (as long as they have a capacity rating of 3 kilowatt-hours (kWh) or more).

While solar roofing tiles or solar shingles also qualify, traditional building components for roofing or structural function don’t — so roof trusses and standard shingles used to support solar panels are a no-go.

Beyond solar panels, other renewable energy projects covered by the residential clean energy credit include solar water heaters, solar electric systems, biomass fuel systems, small wind energy systems, fuel cells, and geothermal heat pumps.

Are You Eligible for Solar Panel Tax Credit?

In most cases, the eligibility requirements are pretty straightforward: if you’ve recently installed solar panels, you can claim the tax credits. But there are a few ins and outs, so here’s the complete eligibility checklist:

  • Your solar PV system needs to have been installed between January 1, 2017, and December 31, 2034.
  • The system has to be located at one of your residences in the U.S. It doesn’t matter if it’s your primary home or a part-time place as long as it’s not a rental property or used solely for business purposes.
  • You need to own the system, so you can’t be leasing it or paying a solar company for the electricity generated. (If you bought an interest in an off-site community solar project, you’re still good to claim the credit if the electricity doesn’t exceed your home’s consumption).
  • Your system has to be new, as you can only claim the credit on the initial installation of the solar equipment.

You can’t claim the credit if you’re a landlord who doesn’t live in the property. But if you’ve made improvements to a second home that you live in part-time and don’t rent out, you might be eligible.

And for all you business owners, if your home is partially used for business (up to 20%), you can claim the full credit. If it’s more than 20%, the credit is adjusted based on the non-business portion of the expenses.

How to Claim Solar Tax Credit?

First, it doesn’t hurt to get professional tax advice to ensure you’re eligible for the credit (I’m afraid Reddit won’t cut it). Once you’re confident you meet the criteria, you must complete IRS Form 5695 and attach it to your federal tax return (Form 1040 or Form 1040NR).

Solar tax credit forms require specific details, like the total cost of your solar energy project and a certification from the equipment manufacturer confirming that the products used in your project qualify for the tax credit. This certification is key, so make sure you have it handy when filling out the form.

Solar Panel Rebates, Incentives, and Subsidies

Subsidies from your utility for installing a solar PV system are excluded from income taxes under federal law. However, payments you get from the utility for the excess electricity you produce (like net metering credits) don’t count as subsidies and won’t affect your tax credit.

Solar tax rebates are also be subtracted from your qualified expenses if they meet all the following criteria:

  • It’s based on the cost of the property.
  • The rebate comes from someone related to the sale (like the manufacturer, seller, or installer).
  • It’s not given as payment for services you provide.

Things get trickier when it comes to state incentives. Generally, state energy efficiency incentives aren’t subtracted from your qualified costs unless federal tax law considers them a rebate or purchase-price adjustment.

And in some states, you won’t be taxed on the added value from your solar panels due to property tax exemptions. Let’s take California – solar energy is entirely excluded from tax assessments, meaning your property tax bill won’t rise due to installing solar panels. These property tax incentives often come with sales tax exemptions which differ across states.

Note: Receiving a state tax credit could mean you report higher taxable income on your federal taxes since you’ll have less state income tax to deduct.

Investing in Commercial Solar Projects

Moving onto commercial solar project investing. I recently had the pleasure of tuning into the “Tax Benefits of Energy Investing” webinar with the founder of Carry, Ankur Nagpal, and Valur founder and CEO, Mani Mahadevan. Let’s dive into some of the key takeaways.

How Much Income Can Commercial Solar Projects Generate?

Commercial solar projects typically produce an income of 3% to 7% of the project’s value. This income usually comes from selling the electricity generated by the solar panels to an off-taker, a commercial entity that agrees to buy the power.

Offtakers often buy electricity between 50% and 80% of the grid’s rate from the solar project owner. This means they get a discount on their electricity, which is where your income as the solar project owner comes from.

So, what’s the risk? While the odds of live and functioning solar panels not generating income are low, the main risk is if the off-taker goes bankrupt after the project is up and running.

But even if this happens, you’re still in luck. In most states, net metering programs allow the grid to buy electricity from you, albeit at a lower rate than the off-taker would pay.

How Do Investment Tax Credits Work?

You can use investment tax credits to reduce your tax liability. Typically, they amount to 40% of a project’s value. If your solar project is valued at $1 million, you could earn $400,000 in investment tax credits, meaning you can directly offset $400,000 of your federal tax liability, dollar for dollar.

Here’s an example: If your project is worth $1 million, your federal depreciation basis is adjusted by subtracting half of the tax credits from the project value. In this case, you’d subtract $200,000 (half of $400,000) from $1 million, leaving you with an $800,000 federal depreciation basis.

Regarding state depreciation, investment tax credits don’t have an impact. State depreciation usually follows its own schedule, typically spread over the first five years.

What to Watch Out for When Getting Started?

Start by asking developers if they need any permits or regulatory approvals to move forward. Also, get a clear timeline from them so you know exactly when they expect to complete the project.

Check the track records of both the developers and the off-takers. The developer’s experience and reliability are essential for the project’s success. Equally important is the off-taker, as they directly impact your income, so you need confidence in their stability and experience in handling such agreements.

To maximize tax benefits, you must purchase the assets or the business before developers complete the project. However, to lower your risk, it’s best to buy closer to the project’s completion — the more work left to be done, the higher the risk.

What Are the Requirements for Material Participation?

To be a material participant, you must spend at least 100 hours per tax year running the business. If there are multiple owners, say five, each person needs to put in at least 500 hours to qualify as active participants.

So, what should you spend these hours on? Solar projects are pretty self-sufficient, but there are plenty of tasks to keep you busy.

You can work closely with developers and off-takers, visit the project sites, and handle your due diligence with accounting and legal teams. Plus, you can regularly monitor the business’s performance and revenue to ensure everything is running smoothly.

Another great way to fulfill these hours is by furthering your education. Attend industry conferences and learn more about solar energy and how to improve your business operations. It’s a good idea to diversify your activities across different categories — treating it like a regular business can help you pass audits.

Is It Worth Moving to Solar Energy?

Now for the big question, are solar panels worth it? Let’s start with the obvious. Switching to solar energy has a ton of benefits — you can save on energy bills, reduce your carbon footprint, and potentially boost your property value.

But even with tax credits, the installation costs can be high, especially for those with fixed or low incomes. On average, a 5-kilowatt system costs around $16,000, and some can go beyond $35,000. Of course, the price tag depends on several factors, like the size of your home, where you live, the size of the system, and the rates of your solar installer.

Remember: Federal tax incentives go to the system’s owner, so if you pay cash or finance the solar panels, the incentives are yours. And don’t skimp on quality — invest in highly-rated panels and inverters for better performance and reliability.

While the federal tax credit can lower your upfront costs, the real value of solar extends beyond just the tax benefits. Think about the long-term economic and environmental perks. Once you know your system’s initial investment and energy production capacity, you can estimate your annual savings on energy bills.

FAQs

How does the IRS verify solar credit?

The IRS verifies solar tax credits through documentation. You’ll need to complete and attach IRS Form 5695 to your federal tax return, detailing the cost of your solar project and providing certification from the equipment manufacturer. Keep all receipts and documents related to your solar installation in case the IRS requests proof.

How does the solar tax credit work if you don’t owe taxes?

You can’t claim the solar tax credit for the year you install your solar system if you don’t owe federal taxes. However, the credit can be carried forward to future tax years, so if you don’t use the full credit amount, you can apply it to your tax liability in upcoming years until it’s fully used.

Will the government pay for solar panels?

The government won’t directly pay for your solar panels, but it offers incentives like the federal solar tax credit to reduce costs. Some states and local utilities also provide rebates and incentives to help offset the initial investment, making solar panels more affordable.

What’s the solar tax credit income limit?

The solar tax credit doesn’t have an income limit. Anyone who installs a qualifying solar energy system on their property can claim the credit, regardless of their income level. The key requirement is you must owe federal income taxes to take advantage of the credit. You can carry the unused portion to future tax years if your tax liability is under the credit amount.

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