How does the federal solar tax credit work?

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.

As of 2023, the solar ITC is a 30% federal tax credit.

Residential solar power projects built in 2020 and 2021 are eligible for a 26% federal tax credit, while projects built from 2022 until 2032 are eligible for a 30% tax credit. Solar energy systems built on or before Dec. 31, 2019, were eligible for a 30% federal tax credit. The residential federal tax credit expires after 2034.

Commercial solar projects with construction start dates of 2022 and later are eligible for the 30% federal ITC until 2033, but the expiration of the credit after 2033 is determined by an “applicable year,” which is defined as the later of 2032 or the year the treasury secretary determines there has been a 25% or more reduction in annual greenhouse gas emissions from power production in the U.S. compared with 2022.

The commercial credit lowers to a maximum of 22.5% in 2034 (or two years after the applicable year), 15% in 2035 (or three years after the applicable year) and 0% in 2036 (or four years after the applicable year).

Homeowners who purchase a newly built home with a solar energy system are eligible for the ITC the year they move into the house if they own the solar system. Those who lease a solar energy 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.

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How to claim the 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 $3.50 before the federal tax credit is taken into account.

This previous 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 homes.

» IS IT WORTH IT? Solar energy pros and cons

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.

The federal solar tax credit was most recently extended by the Inflation Reduction Act, which was signed into law in 2022.

Most recently, the residential solar tax credit was extended until 2034, with the amount of the tax credit dropping from 30% to 26% in 2033 and 22% in 2034. The credit is currently set to expire at the beginning of 2035.

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 — it likely knows about the incentives available in your area.

Bottom line: What to know about federal solar tax credits

The federal solar tax credit is a win for any qualifying individual or business installing a solar system on their property. The tax credit helps offset the cost of the system and can make renewable energy far more affordable and attainable to individuals who would like to live a more sustainable lifestyle.