Solar Tax Credits & Deductions
Many people, including solar salespeople, are confused about tax credits and tax deductions for solar systems. This article explains both and the differences between them. Credits are the federal ITC (Investment Tax Credit). Deductions can be both federal and state, and are for interest you pay on a solar loan.
This is the place that Solar Consumer Advisor must protect itself by stating that it is not a Certified Public Accountants (CPA), so you should not rely on the statements on this website or in the Solar Buying Guides about tax matters, but should instead consult your own CPA. This is partly because there are many unusual tax circumstances which might affect you, but few other people, and all of them can't possibly be covered here.
This is the place that Solar Consumer Advisor must protect itself by stating that it is not a Certified Public Accountants (CPA), so you should not rely on the statements on this website or in the Solar Buying Guides about tax matters, but should instead consult your own CPA. This is partly because there are many unusual tax circumstances which might affect you, but few other people, and all of them can't possibly be covered here.
The Difference Between Income-Tax Credits & Deductions
An income-tax credit is a reduction of your taxes while an income-tax deduction is a reduction of your taxable income.
For example, if your total federal income-tax for 2016 (before subtracting estimated tax payments and withholding) would have been $16,000, but you got a $8,000 tax credit from purchasing the example solar, photo-voltaic (PV) system, your tax would only be $8,000; the credit comes off the tax.
But if your 2016 taxable income were between about $75,000 and $152,000, and you suddenly found an extra $8,000 tax deduction somewhere, it would only reduce your taxable income by this $8,000, so your tax would decrease by only $2,744. Credits are worth a lot more than deductions.
For example, if your total federal income-tax for 2016 (before subtracting estimated tax payments and withholding) would have been $16,000, but you got a $8,000 tax credit from purchasing the example solar, photo-voltaic (PV) system, your tax would only be $8,000; the credit comes off the tax.
But if your 2016 taxable income were between about $75,000 and $152,000, and you suddenly found an extra $8,000 tax deduction somewhere, it would only reduce your taxable income by this $8,000, so your tax would decrease by only $2,744. Credits are worth a lot more than deductions.
Federal Income-Tax Credits: The ITC
The only tax credit for residential PV systems is the federal Investment Tax Credit (ITC).* It applies only to purchased systems, not to leased or PPA, although you get indirect benefits of the ITC in those cases too. But it is a big deal: 30% of your total system price, including related necessary improvements to your home's electrical or roofing. The ITC is scheduled go down to 26% in 2020, 22% in 2021, and disappear in 2023. There are no California state income-tax credits for solar.
All tax credits are further divided into two types: refundable and non-refundable. You get a check for a refundable tax credit even if you have no tax at all that year. But for a non-refundable credit, if your total 2016 tax were the $16,000 mentioned earlier, you could take a credit on your 2016 tax return for up to that amount, but not more. The ITC is a non-refundable-type credit. That means you only get the credit if your tax in the year you buy the system is at least as much as the credit amount. If you have some tax that year but it is less than the credit, the credit will wipe out the tax, but you won't have used all the credit.
There is one way around this limitation: it is called a carry-forward. For example, if you had a $8,000 solar credit in 2016 but only $5,000 in taxes, you could wipe out your taxes and carry the remaining unused $3,000 forward to 2017 or beyond to offset taxes you incur in future years. You cannot carry it back to previous years, however.
You claim the ITC on the tax return for the year in which you acquired the PV system. If, for example, you acquired a system in January 2017, you would file your 2017 return sometime between February 2018 and October 2018, and that's when you would claim the credit. If you have overpaid your taxes through withholding and/or estimated tax payments during that time, you would subsequently receive a refund of the credit amount. Alternatively, you could reduce your withholding and/or estimated tax payments during 2017 so that you came out even at the end of the year. That would reduce your waiting time to get the benefit of the credit.
If you sell your house sooner than 5 years after your solar system is turned on, you must "recapture" a proportional part of the ITC and return it to Uncle Sam. For example, if sold after 3 years, you would have to return 2/5 of the credit or 40% of the credit.
If you lease a PV system instead of purchasing it, the vendor gets to take the ITC, but they usually pass the credit (or part of it) on to you in the form of a reduced price for the system. This applies to any applicable rebates as well.
All tax credits are further divided into two types: refundable and non-refundable. You get a check for a refundable tax credit even if you have no tax at all that year. But for a non-refundable credit, if your total 2016 tax were the $16,000 mentioned earlier, you could take a credit on your 2016 tax return for up to that amount, but not more. The ITC is a non-refundable-type credit. That means you only get the credit if your tax in the year you buy the system is at least as much as the credit amount. If you have some tax that year but it is less than the credit, the credit will wipe out the tax, but you won't have used all the credit.
There is one way around this limitation: it is called a carry-forward. For example, if you had a $8,000 solar credit in 2016 but only $5,000 in taxes, you could wipe out your taxes and carry the remaining unused $3,000 forward to 2017 or beyond to offset taxes you incur in future years. You cannot carry it back to previous years, however.
You claim the ITC on the tax return for the year in which you acquired the PV system. If, for example, you acquired a system in January 2017, you would file your 2017 return sometime between February 2018 and October 2018, and that's when you would claim the credit. If you have overpaid your taxes through withholding and/or estimated tax payments during that time, you would subsequently receive a refund of the credit amount. Alternatively, you could reduce your withholding and/or estimated tax payments during 2017 so that you came out even at the end of the year. That would reduce your waiting time to get the benefit of the credit.
If you sell your house sooner than 5 years after your solar system is turned on, you must "recapture" a proportional part of the ITC and return it to Uncle Sam. For example, if sold after 3 years, you would have to return 2/5 of the credit or 40% of the credit.
If you lease a PV system instead of purchasing it, the vendor gets to take the ITC, but they usually pass the credit (or part of it) on to you in the form of a reduced price for the system. This applies to any applicable rebates as well.
Federal and State Income-Tax Deductions - Only for Interest
Interest you pay on loans to purchase or pre-pay a lease can usually be taken as an itemized deduction on your federal** and state*** tax returns. Since it is a deduction from your taxable income, how much it saves you depends on what is called your "marginal tax bracket." For example, if your taxable income were between about $75,000 and $152,000 (for couples), you would be in the 3rd marginal tax bracket (called the 25% bracket), because you'd pay 25% tax on the highest portion of your income - the part above $75,000).****
The Solar Panel Cost & Savings Calculator assumes marginal tax brackets that would apply to average solar shoppers: 25% federal and 9.3% California. For these brackets, you'd save $3,734 in taxes on a 20 year loan on the example $18,440 system at an interest rate of 4.74%.
At the next higher bracket, the 20-year savings would go up another $435, and up by $1,089 two brackets higher. At the next lower bracket, your savings would drop by $1,230. Of course, the savings would be higher if the interest rate were higher.
The Solar Panel Cost & Savings Calculator assumes marginal tax brackets that would apply to average solar shoppers: 25% federal and 9.3% California. For these brackets, you'd save $3,734 in taxes on a 20 year loan on the example $18,440 system at an interest rate of 4.74%.
At the next higher bracket, the 20-year savings would go up another $435, and up by $1,089 two brackets higher. At the next lower bracket, your savings would drop by $1,230. Of course, the savings would be higher if the interest rate were higher.
Local Tax Benefits
Your city or county may offer additional tax benefits, such as credits on your real-estate property taxes, but these vary widely from locale to locale, so please check yours.
* See IRS Instructions for Form 5695.
** “Instructions for Form 1040,” www.irs.gov
*** “Instructions for Form 540, California Resident Income Tax Returns,” www.ftb.ca.gov/forms
**** Or see “1040 Tax Tables,” IRS form i1040tt.pdf for federal and “2016 California Tax Rate Schedules,” in Instructions for 540 Form, California Resident Income Tax Returns, www.ftb.ca.gov/forms, p. 80.
