Solar Tax Credits and Incentives Explained

The federal solar tax credit, also known as the Investment Tax Credit (ITC), represents one of the most valuable incentives for homeowners considering solar energy adoption. Through the Inflation Reduction Act of 2022, this credit has been extended and enhanced, providing significant financial benefits for those transitioning to clean energy.

This article aims to help homeowners understand how to qualify for, calculate, and maximize solar tax credits and other incentives, ultimately making solar energy more accessible and affordable.

The Residential Clean Energy Credit: Overview

The Residential Clean Energy Credit, commonly referred to as the federal solar tax credit or Investment Tax Credit (ITC), allows homeowners to deduct 30% of the total cost of installing a solar energy system from their federal taxes.

This credit was extended through the Inflation Reduction Act of 2022, which restored the credit to 30% after it had been scheduled to decrease from 26% in 2022 to 22% in 2023 before expiring completely for consumers in 2024.

Under the current legislation, the 30% credit will remain available until the end of 2032, after which it will decrease to 26% in 2033 and 22% in 2034, before expiring completely in 2035.

Unlike a tax deduction that reduces your taxable income, the solar tax credit is a dollar-for-dollar reduction in your tax liability. For example, if you installed a solar system for $20,000, you could claim a tax credit of $6,000, directly reducing what you owe in federal taxes by that amount.

The credit is nonrefundable, meaning it can’t reduce your tax bill to less than $0, but any unused credit can roll over to subsequent tax years if the value exceeds your tax liability.

Eligibility Requirements

System Ownership Requirements

To qualify for the federal solar tax credit, you must own the solar system outright. This means you must have purchased the system either with cash or through a loan.

If you’ve acquired solar panels through a lease or power purchase agreement (PPA), you are not eligible for the tax credit since you don’t own the system.

Additionally, the credit applies only to the original installation of the equipment—you cannot claim the credit for used solar panels or for moving panels from one property to another.

Property Requirements

The solar system must be installed on a property in the United States that you own and use as your primary or secondary residence.

The IRS specifically requires that solar installations contribute to the energy needs of a domestic home, reinforcing the government’s commitment to promoting sustainable energy practices at the individual homeowner level. Rental properties do not qualify for the Residential Clean Energy Credit, though they may be eligible for commercial solar incentives.

For properties with business use, there are important considerations. If you use up to 20% of your home for business purposes, you can claim the full credit. However, if business use exceeds 20%, the maximum available credit is based on the share of expenses allocable to non-business use.

For example, with a home office occupying 25% of your residence, you could only claim the solar tax credit for 75% of the qualifying costs.

Timeline Requirements

The solar tax credit should be claimed on your tax return for the year the system receives Permission to Operate (PTO) from your utility company, not when the system was purchased or when you made payments.

This is an important distinction—if your solar panels were purchased in December but your utility didn’t provide PTO until the following year, you would claim the tax credit on the following year’s tax return.

Qualifying Expenses

Eligible Costs

The federal solar tax credit covers a wide range of expenses associated with installing a solar energy system. Eligible costs include:

Solar photovoltaic (PV) panels and cells.
Labor costs for on-site preparation, assembly, and original installation.
All system equipment such as wiring, inverters, and mounting hardware.
Energy storage devices with a capacity of at least 3 kilowatt hours that are charged exclusively by the solar panels.
Sales taxes on eligible expenses.
Permitting fees, inspection costs, and developer fees.

Ineligible Costs

Not all expenses related to solar installation qualify for the tax credit. Ineligible costs include:

Roof repairs or replacements (unless the roof itself is an integrated solar component).
Structural upgrades not directly related to supporting the solar system.
Ongoing maintenance costs for cleaning and repairs.
Financing charges, such as interest on loans used to pay for the system.
Extended warranties.
Property taxes.

How to Calculate Your Credit

Calculating your solar tax credit is relatively straightforward. Multiply the total eligible costs of your solar installation by 30%. For example, if your total qualified solar costs amount to $20,000, your tax credit would be $6,000 ($20,000 × 30% = $6,000).

However, utility rebates can affect this calculation. In most cases, if you receive a rebate from your utility company, the value of that rebate must be subtracted from your total costs before calculating the federal tax credit.

For example, if you install a $20,000 system and receive a $1,000 utility rebate, your tax credit would be based on $19,000 ($19,000 × 30% = $5,700).

State tax credits, on the other hand, generally don’t impact the value of your federal tax credit. You can claim both federal and state solar tax credits, though claiming a state credit will change the amount of taxable income you report on your federal taxes.

Claiming the Solar Tax Credit

Required Documentation

To claim the solar tax credit, you’ll need to maintain proper documentation, including:

Receipts and contracts showing the cost of the system and installation.

Manufacturer certifications for qualifying equipment.
Proof of when the system was placed in service, such as utility connection approval or permission to operate.

Tax Forms

Claiming the tax credit requires completing IRS Form 5695, Residential Energy Credits. Here’s a step-by-step process:

Fill out line 1 of IRS Form 5695, labeled “qualified solar electric property costs,” with the total cost of your solar system
If you’ve installed energy storage or other qualifying equipment, list those costs on the corresponding lines
Calculate the total credit value by multiplying the total qualified costs by 30%
Add any other credits you’ve earned, such as the energy-efficient home improvement credit
Complete lines 14 and 15 to determine if you have any solar tax credit roll-over for next year’s return
Add the final tax credit value to IRS Form 1040 to calculate your final tax liability

Timing Considerations

The credit must be claimed for the tax year in which the system was “placed in service”—typically when it receives permission to operate from your utility company. If you can’t use the entire credit in one year because your tax liability is less than the credit amount, you can carry the unused portion forward to future tax years.

If you missed claiming the credit in previous years, you may be able to file an amended return, though time limitations apply.

Additional Federal Incentives

Beyond the solar tax credit, homeowners can take advantage of the Energy Efficient Home Improvement Credit. This credit allows you to claim 30% of the cost of energy-efficient home upgrades, up to a maximum credit of $1,200 per year. Specific improvements have their own limits:

Home energy audits: maximum of $150 per year.
Residential energy property (air conditioners, furnaces, water heaters): up to $600 per item.
Exterior doors: $250 per door with a total limit of $500.
Exterior windows and skylights: $600 total limit.
Insulation and air sealing materials: no additional limit beyond the general $1,200 maximum.

Additionally, homeowners can claim up to $2,000 per year for qualified heat pumps, heat pump water heaters, biomass stoves, or biomass boilers. These credits can be combined with the solar tax credit to maximize your overall tax benefits, though each has its own qualification requirements and limitations.

State and Local Incentives

Types of State Incentives

Many states offer additional incentives that can be combined with the federal solar tax credit:

State tax credits: Several states offer their own solar tax credits, including Arizona (25% of costs, up to $1,000), Hawaii (35% of costs, up to $5,000), and New York (25% of costs, max of 50% of tax liability in any given year, roll over unused credit for up to 10 years).
Property tax exemptions: Many states exempt the added value of solar systems from property tax assessments.
Sales tax exemptions: Some states offer exemptions from sales tax on solar equipment purchases.

Utility Programs

Local utility companies often provide additional incentives:

Net metering: Many utilities offer net metering programs that credit homeowners for excess electricity their solar panels produce, typically at retail rates.
Net billing: Similar to net metering but credits excess energy at wholesale rates rather than retail rates.
Rebate programs: Some utilities offer direct cash rebates for solar installations.

How to Find Local Incentives

To discover available incentives in your area, check the Database of State Incentives for Renewables & Efficiency (DSIRE) website or contact your utility provider directly. Many states and municipalities have unique programs that can significantly reduce the cost of going solar.

Special Situations and Considerations

Community Solar Participation

The Inflation Reduction Act extends and expands tax credits for community solar projects, which allow people to buy or lease a share of a solar installation without installing panels on their own property. These projects enable participants to earn credit off their electric bills based on the electricity their share generates.

The IRA enables community solar projects to benefit from the same commercial credits as other businesses, which should result in more community solar projects being built.

Home Office or Mixed-Use Properties

For properties with mixed residential and business use, special rules apply. If your home office occupies more than 20% of your residence, you can only claim the solar tax credit for the percentage of the system allocated to residential use.

For example, with a home office occupying 25% of your total residence space, you could claim the solar tax credit for 75% of the qualifying costs on Form 5695. The business portion may be eligible for depreciation as a business expense.

Maximizing Your Solar Investment

Strategic Timing

To maximize your solar investment, consider these strategies:

Know your energy needs before installing solar to properly size your system
Invest in high-quality solar panels with good efficiency ratings
Ensure proper placement of panels to maximize sunlight exposure
Choose high-efficiency inverters to increase system performance
Consider adding battery storage to maximize self-consumption of solar energy
Monitor your system regularly to ensure optimal performance
Take advantage of all available government incentives
Connect to the grid to sell excess electricity where net metering is available

System Sizing Considerations

Right-sizing your solar system is crucial for maximizing tax benefits. Too many or too few panels can reduce your overall energy savings and return on investment.

Calculate the number of panels you need based on your roof size, energy requirements, and budget. Consider future energy needs when sizing your system to avoid costly expansions later.

Conclusion

The federal solar tax credit, along with state and local incentives, significantly reduces the cost of transitioning to solar energy, making it more accessible and affordable for homeowners across the United States.

By understanding eligibility requirements, qualifying expenses, and proper documentation, you can maximize these financial benefits while contributing to environmental sustainability.

While the current 30% federal tax credit is secured through 2032, the long-term benefits of solar energy—including reduced utility bills, energy independence, and increased property value—extend far beyond these incentives.