Harnessing the Sun: A Guide to the Federal Solar Tax Credit

Explore in-depth guides on the Federal Solar Tax Credit, detailing how to maximize savings on solar energy investments, understand eligibility criteria, and navigate the claiming process effectively.

Solar energy offers advantages like minimal pollution, savings on energy, and a smaller carbon footprint. To motivate individuals to adopt solar energy in their residences, the U.S. government launched federal solar tax credits in 2006 for both residential and commercial new systems. These tax credits are designed to alleviate the financial burden of equipment and installation expenses.

What are Tax Credits? 

A tax credit represents a sum that taxpayers can subtract from the taxes they owe to the government. Unlike tax deductions, which lower taxable income and thereby reduce the amount of taxes due indirectly, tax credits directly diminish the taxes owed on a dollar-for-dollar basis. While deductions affect the final tax bill based on one's tax rate, credits offer a direct reduction in tax owed.

Both federal and state governments offer tax credits to qualifying individuals or entities as incentives for activities that positively impact the environment, economy, and other key areas.

Federal Solar Tax Credits: A Boost for Renewable Energy

The United States government initiated the federal residential solar energy credit, known as the Investment Tax Credit (ITC), back in 2006. Since its introduction, the solar energy sector has expanded significantly, comprising half of all new electricity generation capacity in the U.S. by early 2022.

Homeowners who invest in and install solar photovoltaic systems are eligible to apply for this federal tax credit. It allows for a deduction of a certain percentage of the costs associated with the installation of eligible solar power systems from their taxes, directly reducing the amount of tax owed. The credit is nonrefundable, meaning it can reduce the tax owed to zero, but it does not provide a cash refund for any credit balance remaining.

For the solar system to qualify for the credit, it must be operational within the tax year of claim and must supply electricity to a residence located within the United States. The IRS considers a system as "placed in service" once the installation is complete.

Following the Consolidated Appropriations Act of 2021, the government has extended the solar energy system tax credits but introduced a phased reduction in the credit rate. The applicable tax credit rates are as follows:

• 30% for systems operational by December 31, 2019.
• 26% for systems operational after December 31, 2019, and before January 1, 2023.
• 22% for systems operational after December 31, 2022, and before January 1, 2024.

This tax credit is set to expire after December 31, 2023, without plans for extension. Despite the tax credit covering only a portion of the installation costs, there is no cap on the claimable amount.

Typical Percentage of Cost Reduction Achieved Through Solar Energy in the U.S.

Solar energy not only reduces your environmental impact but can also lower your electricity bills. The upfront cost for solar installations may reach $17,000, yet with federal solar tax credits and reduced utility expenses, the overall savings can be significant.

On average, Americans save around $1,500 annually by switching to solar, amounting to $37,500 over 25 years. Furthermore, the 26% federal tax credit can lead to savings of $4,420 on a solar system costing $17,000, bringing the effective installation cost down to $12,180. By comparing the cost of installation with the average annual savings, it becomes clear that solar energy systems begin to generate net savings after roughly eight years.

The range of total savings can span from $10,000 to $90,000, heavily influenced by local electricity rates, the size of your roof, geographic location, state-level incentives, and your household's energy consumption.

Qualification Criteria for the Federal Solar Tax Credit

Individuals might qualify for the tax credit under these conditions:

• The solar photovoltaic (PV) system was installed between January 1, 2006, and December 31, 2023.
• The solar PV system is located at either your main home or a secondary property in the U.S., or it is part of a community solar project not on your property.
• You are the owner of the solar PV system and it is being used by you for the first time.
• Be aware that eligibility for this tax credit could be influenced by other federal or state incentives.

The federal solar tax credit is applicable to various costs including:

• Solar PV panels or cells used to power an attic fan.
• Costs related to contractor labor for the preparation of the site, assembly, or the initial installation process, which can include fees for permits, inspections, and developer charges.
• Equipment that forms part of the system, such as wiring, inverters, and mounting hardware.
• Energy storage units that are fully charged by the connected solar PV panels.
• Sales taxes on qualified expenditures.

Does It Include Expenses for Roof Replacement?

For numerous homeowners, their home's roof serves as the ideal spot for mounting solar panels. However, not every roof is suitable for this addition. The roof must have the structural integrity to support the added weight of the panels. Should your roof require repairs or enhancements before installing the panels, those expenses might be claimable.

It's advisable to discuss your specific situation with a certified tax expert, but under certain conditions, homeowners might have the ability to include the expenses for reinforcing the roof, such as the cost of new joists and sheeting, in their deductions. Additionally, the cost for installing shingles that improve energy efficiency might also be deductible.

Claim Federal Solar Tax Credit Today

To apply for the federal solar tax credit:

• Obtain IRS Form 5695 and attach it to your tax return.
• Determine the total costs of your project and record them in line 1.
• Perform the calculations required in lines 6a and 6b.
• Omit lines 7 through 12 if you're only claiming for solar energy and there are no carry-over amounts from last year.
• Sum up the amounts in lines 6b, 11, and 12 and input the total in line 13.
• Assess the limits on your tax liability as instructed in line 14.
• Finalize the process by filling out lines 15 and 16.