Solar Investment Tax Credit: everything you need to know (2021 update)
The latest extension gives homeowners and business more time to take advantage of large savings on a solar photovoltaic system
Big news! The federal tax credit for homeowners and businesses that install solar, which was previously set to expire, has been extended for two years.
This tax credit, often called the Solar Investment Tax Credit, gives homeowners and businesses a break on their federal taxes worth 26% of the gross price of a solar photovoltaic system. Set at 26% in 2020, it was previously going to drop to 22% in 2021, then to 10% for businesses and zero for homeowners at the end of 2021.
Fortunately, a federal spending package passed on Dec 28, 2020 included a two year extension of the 26% tax credit on solar installations. This gives homeowners and businesses more time to take advantage of the big cost savings this program offers.
Here’s the new schedule for the tax credit and when each tier of the credit will expire:
|Date installation completed||Tax credit amount|
|up to 12/31/2022||26%|
|calendar year 2023||22%|
|after 2023||0% for residential solar, 10% for businesses|
How does the solar tax credit work?
After you install a solar energy system on your home or business, you apply for the tax credit the next time you file your federal taxes. For example, if you get a home solar system installed this summer, you would apply for the credit the next time you file your taxes (normally due next April).
Individuals and businesses use different forms to file their taxes, but the credit is available to both. For homeowners, it’s officially called the Residential Energy Credit, and it’s Form 5695.
If you’re a business owner, you’ll be looking for the Investment Credit and Form 3468.
Important detail: You get the credit as a reduction of your tax bill. It is not paid out to you directly in full. For example, if your credit is $5,000, but your tax bill is only $4,000, you get a maximum benefit of $4,000. You can’t claim more than the taxes you owe. However, you can carry forward any unused credits to the next year.
This means that if you are someone with a low tax bill, such as a retiree, you may not be able to fully benefit from this tax credit. This is one of the few cases where a solar lease may make sense for you. (Although we recommend getting your lease from a smaller local installer, rather than one of the huge national companies such as Sunrun.)
How is the solar tax credit calculated?
The tax credit is calculated on the total system price. “Total system price” means the gross invoice price billed by your solar installer, before other rebates. That includes labor costs and all the components of a photovoltaic system, including solar panels, racking, wiring, and the inverters. All of those costs are eligible for the credit.
If you’re doing a ground-mounted system, the foundation work and mounting system are eligible too.
However, some work that may be required to install solar on your home cannot be included in the credit. For example, if your roof requires repairs before you install solar, you generally can’t claim that repair work for the credit.
One great thing about this credit is that it can be combined with other rebates, such as state tax credits or utility rebates. For example, New York state offers a 25% state tax credit on solar that’s worth up to $5,000. This means New Yorkers can potentially get solar for roughly half the cost. Many other states have solar tax credits too.
What technologies are eligible for the solar tax credit?
While the focus of this article is solar photovoltaic systems, other technologies are eligible, including solar hot water, small wind turbines, and geothermal heat pumps.
Solar storage batteries are also eligible, with some caveats. There’s a section below that discusses this in detail.
Here’s a complete list of tech that qualifies for the credit:
Solar photovoltaics. This means good old solar panels and their supporting equipment. In the IRS instructions for the tax credit, photovoltaics are described as solar electric property. They also make a point of including solar shingles, such the Tesla Solar Roof.
Solar water heating. There are types of solar collectors that use the sun’s energy to directly heat hot water, which can then be used to supply hot water for the home or used for space heating. Supporting equipment, like racking, is included in the eligible costs. The equipment must be rated by the Solar Rating Certification Corporation or an equivalent agency to qualify.
Small wind turbines. While not nearly as popular as solar panels in urban settings, in more rural areas using small wind - also known as micro wind - turbines to generate electricity is gaining in popularity. Unlike for other technologies, the IRS doesn’t have much in the way of restrictive language about what qualifies. In practice, “small” wind turbines that a homeowner would install are going to top out at around 25 kW in size.
Geothermal heat pumps. Also known as ground-source heat pumps, you could think of these devices as backwards air conditioners: they draw heat from the outside and pull it inside your home. They can work as air conditioners too. Air source heat pumps are more popular, but geothermal pumps that use coils buried up to a few hundred feet underground are more energy efficient. They’re also significantly more expensive, so this tax credit is a big help.
Fuel cells. Fuel cells turn hydrogen directly into electricity. There was a time when hydrogen fuel cells were a really promising technology, but they haven’t panned out. Instead, lithium-ion batteries have filled that role. Only a few of these devices were sold for the home market in Japan. I’m not aware of any currently available for sale in the US.
Are home batteries eligible for the tax credit?
The Solar ITC was introduced in 2006, before lithium-ion home energy storage batteries like the Tesla Powerwall came onto the market. Back then, hydrogen fuel cells were the technology that a lot of people were betting on.
Because of this, in the IRS instructions for the tax credit, there’s no language that addresses home storage batteries, even though they currently fill the same role that fuel cells were intended to.
Thankfully, the IRS has issued a clarification and the news is good: home solar batteries are eligible for the tax credit.
However, there is an important caveat. In order to qualify, the battery can only be charged with electricity generated by the solar panels. Any use of grid electricity to charge the battery disqualifies you from claiming the credit.
In practice, this is difficult to enforce. Home solar systems are grid-connected, and batteries like the Tesla Powerwall can be charged with either solar or grid electricity by selecting different operating modes. However, solar homeowners will usually want to charge their battery with midday solar electricity that they “spend” during peak hours in the early evening because of the effect of time-of-use rates.
There’s more to know about rebates and tax credits for solar batteries, including local rebates, so we wrote an extensive article that tells you everything you need to know.
How do you apply for the solar tax credit?
It’s actually pretty simple. The form is only 2 pages long, but when applying for credits for solar panels or the other technologies mentioned above, you only need to pay attention to the first page.
The second part of the form, somewhat confusingly labelled Nonbusiness Energy Property Credit, is used when you have energy efficiency improvements to claim, such as insulation or high efficiency appliances.
This means you only need to pay attention to Part I of the form, and that form only has a couple lines to fill out. The first is simply the invoice price of your system, and the second bit is to figure out if you need to carry forward any unused credits.
What happens with unused credits?
When you fill out the form, line 14 of the form asks you to figure out if your ITC credit is greater than the tax you owe. If it is, don’t worry. The credit won’t be wasted because you can carry forward any unused credits to the next year.
To figure out line 14, there’s a little worksheet included in the instruction booklet for the form - it’s part of the form itself.
Can the solar tax credit be taken on a second home?
Yes. The equipment doesn’t have to be installed on your primary or main home. If you’re the homeowner, you’re eligible for the credit.
The instructions in the IRS form are slightly confusing because there’s a section that defines what a “main home” is. However, only the tax credit for fuel cells restricts you to claiming the credit for your main home. All other technologies, including solar panels, don’t have this restriction.
Can I take advantage of the ITC in addition to state or local credits?
In all cases that we are aware of - yes. Taking the ITC does not prevent you from also receiving rebates offered by your state, municipality, or utility.
What are the deadlines for taking advantage of the solar tax credit?
You apply for the credit in your tax return after the system is placed into service.
The date that the system is placed into service is also relevant if you’re on the cusp of a year in which the credit steps down. Due to the federal spending bill, the tax credit drops to 22% in 2023. This means that your system needed to be switched on and generating electricity on December 31, 2022 in order to claim the 26% credit.
Which are the relevant IRS forms?
Use Form 5696 for residential (home) solar.
Use Form 3468 for commercial solar.
Will the Solar ITC be extended again?
The Biden administration has set a goal for the United States to be net zero carbon by the year 2050. This would require a massive investment in renewable energy. Biden’s platform also specifically calls out solar. Because of this, there’s a good chance that the administration will seek to extend the tax credit again.
Has the Solar ITC been a good thing for solar?
It absolutely has. While we can’t know for sure what would have happened to the solar industry if the ITC wasn’t in place, we do know that the solar industry has grown by a staggering total of 10,000%, or more than 50% every year since the ITC was enacted in 2006.
While solar costs will likely continue to drop even after the ITC expires, there’s little doubt that losing the credit will slow the growth of solar. You can read more from the Solar Energy Industries Association, an industry advocacy group.
Where can I learn more?
Follow the links above for the relevant IRS form and read the associated instructions. It’s worthwhile reading because in addition to solar electric, many other renewable energy technologies are covered, as well as energy efficiency improvements such as insulation and windows.