The Sun is Free...and a Tax Credit
Tax Credit Eligibility
To qualify for the 26% federal Residential Renewable Energy Tax Credit, you must meet all of the following requirements:
Your system must be installed by December 31, 2022.
You must own your home (renters are excluded, unfortunately).
You must pay enough taxes to the Federal Government to qualify for the 26% tax credit.
You must own your solar panels.
This last point isn’t quite as obvious as it might seem, since many homeowners today actually lease their solar systems through third party companies. While leasing may make sense in some situations, it means that the leasing company gets to claim the tax credit instead of you! By contrast, homeowners that buy their panels outright or finance them with a loan do get to claim the tax credit.
Tax Credit vs. Rebate
It’s important to understand that this is a tax credit and not a rebate. Tax credits offset the balance of tax due to the government (therefore, if you owe no tax, there is nothing to offset and you can't take advantage of it). Tax rebates are payable to the taxpayer even if they owe no tax. While most people qualify for the solar tax credit, there are some who do not. Anyone who does not owe federal income taxes will not be able to benefit from the tax credit. And, if you’re on a fixed income, retired, or only worked part of the year, you may not owe enough taxes to take full advantage of this credit.
If you do owe sufficient federal taxes the year that you finance or purchase your system, then the credit can be applied to pay off the taxes owed. If you already paid that taxes by withholding it from your paycheck, the federal government will apply the tax credit to a tax refund. This refund can be used to pay down the balance on a Financed loan. It’s important to note that the tax credit be carried forward one year, which means that you can use any remainder from this year as a credit towards next year’s taxes.
Homeowner #1 buys a $30,000 solar system. This makes them eligible for a $7,800 tax credit (26% of system costs). They are a W-2 employee of a company and have had $9,000 in federal taxes withheld from their paychecks throughout the year. If they had the correct amount withheld during the year, they should owe little if no taxes. In this example, when the solar tax credit is applied to the $9,000 in federal tax dollars withheld throughout the year, they will receive a tax REFUND of $7,800 that they can then apply to their loan - or keep if they choose.
Homeowner #2 also buys a $30,000 solar system. The homeowner only had $4,500 in taxes withheld from their paychecks throughout the year since they have a large amount of right-offs. When the $7,800 tax credit is applied, they can only claim a $4,500 tax refund because that is the maximum amount of taxes owed. In this example, the customer does not have to pay any taxes that year and gets $4,500 of the $7,800 tax credit refunded to them.
The upside is that any remaining tax credit can be carried forward and applied to next year’s taxes. In this scenario, if Homeowner #2 owes the government at least $3,300 in taxes for the following year, they can utilize the rest of the credit. You can use your tax credit for three years to collect the entire $7,800.
The 3 Steps to Claim Your Solar Tax Credit
Determine if you are eligible for the Federal ITC – make sure you credit for ownership and that federal tax liability are in order
Complete IRS Form 5965 to validate your qualification for renewable energy credits
Add your renewable energy credit information to your typical form 1040
Before You Jump the Gun: Am I Eligible for the Solar Tax Credit?
You are eligible for the Federal ITC as long as you own your solar energy system, rather than lease it. If you sign a lease agreement, the third-party owner gets the solar tax credit associated with the system. You are also eligible even if the solar energy system is not on your primary residence – as long as you own the property and live in it for part of the year, you can claim the solar tax credit.
If your federal tax liability is lower than the total amount of your ITC savings, you can still take advantage of it by carrying over any remaining credits to the following year.
How do I Fill Out IRS Form 5695?
Form 5695 calculates tax credits for a variety of qualified residential energy improvements, including geothermal heat pumps, solar panels, solar water heating, small wind turbines, and fuel cells. We’ll use the national average gross cost of a solar energy system as an example.
First, you will need to know the qualified solar electric property costs. That is the total gross cost of your solar energy system after any cash rebates. Add that to line 1.
Insert the total cost of any additional energy improvements, if any, on lines 2 through 4, and add them up on line 5.
On line 6, multiply line 5 by 30%. This is the amount of the solar tax credit.
Assuming you are not also receiving a tax credit for fuel cells installed on your property, and you aren’t carrying forward any credits from last year, put the value from line 6 on line 13.
Now you need to calculate if you will have enough tax liability to get the full 30% credit in one year.
Complete the worksheet on page 4 of the instructions for Form 5695 to calculate the limit on tax credits you can claim. If you are claiming tax credits for adoption expenses, interest on a mortgage, buying a home for the first time, or buying a plug-in hybrid or electric vehicle, you will need that information here. (For this example, total federal tax liability is $7,000.)
Enter the result on line 14 of Form 5695. Review line 13 and line 14, and put the smaller of the two values on line 15.
If your tax liability is smaller than your tax credits, subtract line 15 from line 13, and enter it on line 16. That’s the amount you can claim on next year’s taxes.
Add Credit to Form 1040
The value on line 15 is the amount that will be credited on your taxes this year. Enter that value into Form 1040, line 53 (or Form 1040NR, line 50).
The steps above outline all you need to do to have 26% of the cost of your solar panel system credited back to you. If you did energy efficiency improvements to your home in the same year, you may also need to complete page 2 of Form 5695. Either way, be sure to include Form 5695 when you submit your taxes to the IRS.