A federal tax credit for the purchase and installation costs of a residential solar system is fading away. After being 30% of the cost for several years through 2019, the credit amount drops to 26% in 2020 and then 22% in 2021, the final year of the credit.
The credit is non-refundable, meaning it can only reduce an individual’s tax liability to zero. However, the portion of credit that is not allowed because of this limitation may be carried to the next tax year and added to the credit allowable for that year. The tax code infers that any credit carryover can be added to the credit allowed in the subsequent year. However, what is unclear is whether any carryover will be allowed to 2022 once the credit expires at the end of 2021. In addition to the credit reducing the regular tax, it also reduces the alternative minimum tax should a taxpayer be subject to it.
Only the following solar power systems are eligible for the credit:
- Qualified solar electric property – property that uses solar energy to generate electricity for use in a home that is the taxpayer’s main or second residence.
- Qualifying solar water heating property – qualifies if used in a dwelling located in the U.S. that is used by the taxpayer as a main or second residence where at least half of the energy used to heat water is derived from the sun. Heating water for swimming pools or hot tubs does not qualify for the credit. The solar equipment must be certified for performance by the Solar Rating Certification Corporation or a comparable entity endorsed by the state government where the property is installed.
When Is the Credit Available?
The credit may be claimed on the tax return of the year during which the installation is completed, so if a taxpayer has purchased and paid for a system and it is completed in 2020, the credit will be 26% of the cost. But if the project isn’t completed until 2021, the credit will only be 22%. This becomes an even a bigger issue for systems being installed during 2021 that aren’t completed before 2022, when the credit rate will be zero. If you plan to purchase a solar system in 2021, the purchase should be made early enough in the year to ensure the installation is completed before 2022.
Who Gets the Credit
It may come as a surprise, but the taxpayer need not own the residence where the solar property is installed to qualify for the credit, as the taxpayer need only be a “resident” of the home. The tax code does not specify that an individual has to own the home, only that it is the taxpayer’s residence. For example: A son lives with his mother, who owns the home. The son pays to have the solar system installed; the son is the one who qualifies for the credit.
The credit is available for multiple installations. For instance, after the initial installation, if a taxpayer adds additional panels to increase capacity, these would be treated as original installations and qualify for credit at the credit rate applicable for the year the additional installation is completed, provided that the installation is done before 2022. On the other hand, if a taxpayer had to replace damaged panels or perform other maintenance on the system, these items would not be an original system and their costs would not qualify for the credit.
A battery qualifies for the credit if it’s charged only by solar energy and not off the grid. This has become popular in areas where there are frequent power outages. However, this may be more of a convenience than a necessity, so carefully consider the cost. A software-management tool—whether part of the original installation or added later (before 2022)—also qualifies for the credit in cases in which the software is necessary to monitor the charging and discharging of solar energy from a battery attached to solar panels.
Amounts paid for labor costs allocable to onsite preparation, assembly, or original installation of property eligible for the credit, and for piping or wiring connecting the property to the residence, are expenditures that qualify for the credit. This includes expenditures relating to a solar system installed on a roof or ground-mounted installations.
The term basis is generally the cost of a home plus improvements and is the amount subtracted from the sales price to determine the gain or loss when the home is sold. The cost of a solar system adds to a home’s basis, and the credit reduces the basis. This will generally create a different basis for federal and state purposes where a state does not provide a solar credit or it differs from the federal solar credit amount.
Association or Cooperative Costs
A taxpayer who is a member of a condominium association for a condominium they own, or a tenant-stockholder in a cooperative housing corporation, is treated as having paid their proportionate share of any qualifying solar system costs incurred by the condo or cooperative association or corporation.
In cases where a portion of a residence is used for deductible business use or is rented to others, the expenses must be prorated and only the personal portion of the qualified solar costs can be used to compute the credit. There is an exception when less than 80% of the property is used for non-business purposes, in which case the full amount of the expenditures is eligible for the credit.
Newly Constructed Homes
If you are planning on purchasing a newly constructed home that includes a solar system, you may be entitled to claim the solar credit. However, to do so, the costs of the solar system must be separate from the home construction costs and certification documents must be available.
Some public utilities provide a nontaxable subsidy (rebate) to their customers for the purchase or installation of energy-conservation property. In that case, the cost of the solar system that’s eligible for the credit must be reduced by the amount of the nontaxable subsidy that was received.
Solar Installations are Not for Everyone
There are TV ads, telemarketing phone calls and sales people at your front door all promoting the benefits of solar power, and one of the key considerations and a frequently mentioned benefit is the federal tax credit.
What isn’t included in the ads—and something most potential buyers are unaware of—is that the solar credit is a nonrefundable tax credit, meaning the credit can only be used to offset your tax liability. This can come as a very unpleasant surprise and is often a financial hardship when the purchaser of a home solar system finds out that the credit is nonrefundable and that they won’t benefit from the full credit.
For example, a married couple with three children, all under age 17, and an annual income of $80,000 installed a solar system costing $20,000 in 2020, expecting a $5,200 ($20,000 x 26%) credit on their tax return. Their standard deduction in 2020 is $24,800, leaving them with a taxable income of $55,200. The tax on the $55,200 is $6,229. They are also entitled to a $2,000 child tax credit for each child, which reduces their tax liability by $6,000 and results in a tax liability of $229. Since the solar credit is nonrefundable, the only portion of the credit they can use is $229, not the $5,200 they had expected.
On top of that, the family is probably financing the solar system, which significantly adds to the system’s cost. If the entire $20,000 cost were financed by a 5% home equity loan for 20 years, then the interest on that loan over its term would be $11,678, bringing the total cost of the solar system to $31,678 or a monthly cost of $132.
In lieu of purchasing a solar system, some homeowners opt to lease a system. This arrangement is not eligible for the solar credit.
As you can see, there is a lot to consider before making the final decision to install a solar system. Is it worth it, and is it the right financial move for you? Please call for a consultation before signing any contract to make sure a solar system is appropriate for you.