Tax Treatment for Solar Panels: Business vs Individual Use

Solar panels are becoming increasingly popular as both individuals and businesses are looking to maximize energy efficient activities while enjoying tax breaks. This means that your clients are more likely to inquire about the tax treatment for solar panels and other systems, making it critical to differentiate between the Federal tax credits for homeowners and commercial entities.

Tax Credit for Homeowners

The Federal Investment Tax Credit (ITC) for homeowners and the Inflation Reduction Act recently signed by President Biden are tax credits for eligible solar photovoltaic (PV) systems. This credit can be applied for other energy efficient improvements as well.

Eligibility Requirements

Eligible solar PVs must be placed in service during the tax year and generate electricity for a dwelling located in the United States. Your clients must also meet the following requirements:

• The solar PV system was placed in service between January 1, 2006 and December 31, 2023.
• The solar PV system is at their primary or secondary residence in the United States and the electricity generated does not exceed the home consumption.
• The homeowner must own the solar PV system. Financed systems qualify, but leased systems do not.
• The solar PV system is new or in use for the first time.

Eligible Expenses

Eligible expenses include:

• Solar PV panels used to power an attic fan
• Contract labor for install, assembly, permit fees, etc.
• Wiring and mounting equipment
• Energy storage devices charged by solar panels
• Sales tax on panel purchases

The Claiming Process

For tax years 2020 and 2021, homeowners can claim a credit of 26% of qualifying costs. The Inflation Reduction Act expands the credit for tax years 2022 through 2032 to a credit of 30% of qualifying costs. This tax credit is unique in the fact that there is no maximum credit amounts or threshold limitations. Form 5695, Part I, must be completed with the Federal Form 1040 in order to claim the credit.

In some cases, state governments offer rebates and tax credits that follow the Federal credit. When state credits are claimed, it reduces the amount of the state income tax deduction on Schedule A. This may result in a higher tax liability, making the two credits not additive. Be sure you check into rebates, certificates, and credits in the state your client files in to maximize tax savings.

Depreciation

There is no depreciation deduction available unless your clients have a qualifying business where the solar panels are installed.

Unused Tax Credits

This credit is nonrefundable, meaning your clients won’t get a refund for credit amounts that exceed their tax liability. However, the credit will carry forward into the next tax year.

Other Key Information

• Solar panels don’t need to be located on the roof to qualify.
• If your client has a home office, the credit computation becomes more difficult. If less than 80% of the solar PV system cost is a residential expense, the IRS only allows the percentage that relates to the residential spending to be used in the credit calculation. The portion that is a qualifying business expense follows commercial ITC rules on Schedule C, which are be discussed below.
• Your client doesn’t necessarily need to be a homeowner to claim the credit. This commonly arises in a tenant-stockholder relationship in corporations and for condo-owners.

Tax Credit for Commercial Entities

Businesses are also able to take the Federal Investment Tax Credit and the 30% credit in the Inflation Reduction Act. However, they must follow different regulations. This applies to all Schedule C, Schedule E, and business tax return clients.

Eligibility Requirements

To take the ITC or credit in the Inflation Reduction Act, businesses must meet a few different requirements:

• The solar PV must be used by a business that is required to remit Federal income taxes. Charities are disallowed from the credit.
• The business must be based in the U.S.
• The solar PV system must be new or applicable used equipment.
• The solar PV system must not be used to heat a swimming pool.
• The solar PV system construction must have commenced before the end of the tax year, which means significant work has been performed or integral expenses will be incurred within 3 ½ months after payment.

Eligible Expenses

The eligible expenses for businesses are similar to those of individual tax clients, including:

• Solar PV panels, racking, equipment system, and sales tax
• Installation costs
• Step-up transformers and other electrical work
• Energy storage devices that are charged by the solar system more than 75% of the time

The Claiming Process

The business must have begun or hired a company to begin the construction of a solar PV system before year-end to take the credit. Businesses will need to file Form 3468 on the tax return to claim the credit. Just like individuals, businesses are also able to take the 30% credit from the Inflation Reduction Act to boost tax savings.

Like individuals, businesses can receive state rebates and credits as well. These are usually one-time rebates that occur when the solar PV system is purchased. Businesses may be entitled to receive revenue from the sale of energy credits, payments for state performance-based incentives, property tax exemptions, nonprofit grants, and energy financing.

Depreciation

Since solar PV systems are considered assets of the business, depreciation deductions can be taken. Businesses may take a combination of bonus depreciation and Modified Accelerated Cost Recovery System (MACRS) to write off the solar PV system. The depreciable base is the total cost of the solar PV system less one-half of the credit amount.

For example, your client placed a $500,000 solar PV system in service in 2022. Since the ITC credit rate is 30%, 15% of $500,000 cost is $75,000, making the basis for depreciation $425,000.

Between 2019 and 2022, businesses can take 100% of bonus depreciation on qualifying solar systems, while the deduction drops 20% each year after 2022. This means if your client placed a solar PV system in service during 2022, they would be able to take the entire $425,000 in bonus depreciation. However, if they place a system in service during 2023, they would only be able to immediately expense 80% of the depreciable base, with the remaining 20% depreciated under MACRS.

Unused Tax Credits

Unused ITC can be carried back one year and forward for 20. After the 20-year mark, half of the remaining credit can be deducted while the other half expires.

Other Key Information

• Buildings that hold a solar PV system may be a qualifying expense.
• Nonrecourse financing brings additional restrictions and can delay the claiming process.
• The business claiming a credit must retain ownership of the solar PV system for 6 years. If the business sells the system before the 6-year mark, recapture rules go into place.

Summary

Understanding the difference between the Federal Investment Tax Credit for individuals and businesses is critical to filing accurate returns for your clients. This credit is a great opportunity for your clients to take steps towards renewable energy while enjoying the tax benefits.

Sources

U.S. Department of Energy. “Homeowner’s Guide to the Federal Tax Credit for Solar Photovoltaics.” U.S. Department of Energy, Jan 2021,  Accessed 15 August 2022.

U.S. Department of Energy. “Guide to the Federal Investment Tax Credit for Commercial Solar Photovoltaics.” U.S. Department of Energy, Jan 2020,  Accessed 15 August 2022.

H.R.5376 Inflation Reduction Act of 2022. https://www.congress.gov/bill/117th-congress/house-bill/5376. Accessed 22 August 2022.

By Rich Walden,  CPA
University of Illinois Tax School Instructor