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How Does The Federal Solar Tax Credit Work?

Solar for Homeowners | 7 min read
How Does The Federal Solar Tax Credit Work

Billed as “the most aggressive action on tackling the climate crisis in American history,” the US government passed the Inflation Reduction Act (IRA) in August 2022. This sweeping bill has a significant impact on those interested in solar energy.

Superseding the waning Solar Investment Tax Credit from the 2000s and 2010s, the new solar panel tax credit in the Inflation Reduction Act helps sweeten the deal for those looking to save on the installation cost of a solar energy system.

Where We Came From: The Solar Investment Tax Credit

From 2006 to 2022, the Solar Investment Tax Credit saved Americans thousands on their solar systems. This incentive began as a credit equal to 30% of your system’s installation costs on federal income taxes. It was available as long as they (1) owned their system and (2) had tax liability. In 2020, the ITC dropped to 26% as it began its phase-out. 

In 2021, the credit was supposed to drop to 22% but was pushed to 2023 due to COVID-19. In 2024 it would have dropped to 10% for commercial systems and go away entirely for residential systems.  

However, the Inflation Reduction Act changed all this by introducing a new solar tax credit. 

The Inflation Reduction Act's Solar Tax Incentives

With the last ITC, Americans saved less and less on solar installations each year. The Inflation Reduction Act’s federal solar tax credit of 2022 sets a new standard for ten years (until 2032). And it benefits many solar customers. 

While the IRA offers tax incentives for solar across the board, benefits differ depending on the size of your system and the type of customer you are (residential vs. commercial vs. non-profit). 

Inflation Reduction Ac Solar Tax Incentive Overview

Below, we’ll explore how the Inflation Reduction Act will impact anyone looking to install a solar system. But a word of caution: as of the writing of this blog, things are still in flux. 

It’s not yet 100% clear how these incentives will apply. Once the IRS issues guidelines and the Department of Treasury define specific metrics, things will be more certain. Until then, here’s how the industry interprets solar’s federal tax credit in 2022.

Systems Under 1 Megawatt (MW) AC Power (Homes, Businesses, Farmers)

Anyone installing a solar system smaller than 1 MW of AC power will receive a tax credit of 30%. This will be the case for homeowners until 2032. For businesses of most sizes and agricultural producers, this rate is guaranteed until 2025.

Systems Over 1 Megawatt (MW) AC Power (Solar Developers, Utilities, XL Industrial)

For now, systems larger than 1 MW will receive the full 30% tax credit. But once the IRS issues their guidelines, the rate will vary based on how well the project meets a series of metrics.

The tax credit begins at 6% across the board but can increase to 70% if certain conditions are met:

  • The 6% can increase to 30% if the project meets apprenticeship (requirement of the installation company) and prevailing wage requirements.
  • An additional 10% tax credit is added if the project is built on a brownfield site or community with coal plant closures.
  • An additional 10% tax credit is added if the project uses at least 40% domestically-produced system components and 100% domestically-produced steel and iron components. There are still guidelines that need to be issued to define the 40% measurement.
  • An additional 10% tax credit is added if the project is installed in a low-income area or on tribal land (and is under 5 MW).
  • An additional 20% tax credit is added if the project energizes a low-income residential building or economic benefit system (and under 5 MW).
  • The tax credit will cover interconnection costs for projects under 5 MW.

These large systems can also choose a production tax credit (PTC) over the ITC. This credits system owners based on how much electricity the system produces. The current rate is $0.026/kWh but will increase with inflation. 

What Happens if you don’t have the tax liability to use the tax credit?

The new bill allows homeowners and businesses that don’t have tax liability the option to sell (transfer) their tax credit. For example, you could sell your solar tax credit for $0.90 on the dollar. You’d be able to cash in on 90% of the tax credit you wouldn’t otherwise be able to. The organization or person that bought your credit gets a 10% savings for whatever portion of their taxes your solar credit covers.

There are still a lot of details that need to be defined, but here's what we know as of now:

  • The tax credit can only be sold (transferred) once
  • The credit can not be piecemealed into multiple sales
  • It must be a cash transaction
  • It's not taxable to the seller or buyer

Can you carry the tax credit forward to future tax years?

The solar tax credit can be carried forward to be used in future tax years. 

The commercial tax credit can be used to recoup taxes from the prior three years. It can also be carried forward for 22 years. 

The residential tax credit can be carried forward for 10 years.

How Do These Tax Credit Changes Impact Recent & Current Solar Installations?

If you’ve gone solar since January 1, 2022, have a project in the works or are planning to get the ball rolling soon, you will qualify for the 30% credit.

Systems Under 1 Megawatt (MW) AC Power 

If you’ve installed a solar system in 2022, the 30% tax credit will apply to you retroactively. That means you’ll get an extra 4% added to the 26% tax credit you expected. 

While it’s not 100% clear at the moment how the IRS defines “a system installed in 2022,” most policies apply to the date the system becomes operational. Assuming that’s the case, if construction on your project started in 2021 but was completed in 2022, you’d be eligible for this extra 4%.

If your system hasn’t yet been completed or installed, you’ll receive the 30% tax credit.

Systems Over 1 Megawatt (MW) AC Power 

For systems of this size, the tax credit amount depends heavily on the prevailing wage and apprenticeship metrics. However, these metrics are not yet defined.

For now, all projects of this size will receive the 30% credit. 60 days after the IRS issues guidelines, systems of this size will need to comply, or their credit will be reduced.

Remember that all commercial projects can still take advantage of the depreciation benefits of a solar investment

Non-Profits, Municipalities, Local Government Agency, & More: Tax Liability Is No Longer Required To Use The Solar Tax Credit

With the previous ITC, solar owners needed tax liability to take advantage of the savings. This made going solar more difficult for non-profits, government buildings, and other organizations without tax liability.

Thankfully, the IRA changes this.

For non-profits and state and local governments, the IRA allows for the direct payout for all of or a portion of the solar tax credit. Here are the conditions:

  • The system is completed after 1/1/2023 (the direct payout is not retroactive to 2022 installs)
  • For systems under 1 MW, tax-exempt entities will receive 100% of the 30% tax credit. Systems larger than 1 MW will receive the 30% if they meet the domestic manufacturing requirements (which have not been defined at this time).
  • Starting in 2024, if the domestic manufacturing requirements are not met on 1MW+ systems, they’ll receive: 90% of the ITC in 2024, 85% in 2025, and 0% in 2026
  • These organizations are eligible for the bonus add-ons ( 10% for domestic content, 10% for installing in an energy community, and 10% if installed in a low-income area)

Filing for the direct payment must be completed at the end of the next tax deadline, which for 501(c) non-profits is in May of the following year. It could take up to one year or more to receive the direct payment. 

The selling (or transferring) of the tax credit is a benefit only available to organizations that do not qualify for the direct payment option. 

What Year's Taxes Does The Solar Tax Credit Apply To?

With the previous ITC, you could claim the solar tax credit in upcoming years and in some cases, the previous year. This is still the case with the IRA, but some slight changes exist.

Commercial Solar Tax Credit Carry Forward Rule 

Under the ITC, commercial organizations could apply their ITC tax credit to last year’s taxes or any year for the next 24 years. With the IRA, the periods changed slightly. Now, you can take the tax credit for taxes owed from the past three years and/or to taxes for 22 years after.

IRA Solar Tax Credit Commercial Carry Forward Rule

Residential Solar Tax Credit Carry Forward Rule

The IRA allows homeowners to carry the tax credit forward ten years until its fully used

IRA Solar Tax Credit Residential Carry Forward Rule

Energy Storage & Solar Batteries: Use The Tax Credit With or Without Solar

Previously, the ITC only applied to battery backup systems that were installed within one year of a solar energy system. 

With the IRA, you can take full advantage of the tax credit if you install a battery system regardless of when — or if — you install solar. So whether you installed solar years ago or never have, you can still save a significant amount. 

To qualify, energy storage systems must be over 5 kWh. This credit is also dependent on the US Department of Treasury’s energy reduction goal. This credit isn't available for residential and commercial systems until 2023.

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No More Safe Harboring The Solar Tax Credit

Since 2019, the ITC has been waning. This gradual phase-out pushed the practice of safe harboring into the spotlight at the end of each year. Solar installers would rush to get their customers’ systems started in the year when the tax savings were the highest. 

The good news is that the IRA brings some much-appreciated regularity back to solar incentives. 

Unlike in the late 2010s and early 2020s, the federal tax credit for solar is set at a specific rate for ten years. That means a system installed in 2024 will receive the same benefits as a system installed in 2030.

The exception to this is whether or not the Department of Treasury’s 2025 goal is met. Otherwise, we’ll see a step down in commercial credits, where a safe harbor situation would likely come into play. 

Should You Wait If You're Thinking About Installing Solar Panels?

The IRA has ushered in what is perhaps the biggest change for renewable energy in history. And no matter how you slice it, things are in a state of flux until the IRS releases clear guidelines on the application of this bill. In light of this, it’s completely valid to question whether or not it’s better to wait things out. 

Full disclaimer: we’re solar installers, so even with the very best intentions, we have an implicit bias to say it’s always a good time to go solar. But consider this:

  • The federal government has made it clear that systems installed since January 1, 2022, are going to get the 30% tax credit for at least the next few months.
  • Energy prices continue to increase across the country at a dizzying pace.
  • For the first time in history, the cost to install solar increased in 2021. This is due to continued supply chain issues, inflation, and demand outpacing supply. We expect this could continue to be an issue as demand created by the IRA ramps up. 
  • Each day you go without solar is a day you have to pay the utility company for each kilowatt-hour you use. 

Given those conditions, we’d advise those interested in going solar to get the ball rolling as soon as possible. The IRA is likely to increase the demand for solar energy, but the already-low supply of solar components won’t change anytime soon. That could mean increases in the cost to go solar would outpace the potential savings from a more ironed-out IRA (if that’s even the case).

However, there are exceptions.

If you’re a non-profit or government organization, you can start the process, but your installation can not be completed until after 1/1/2023 to get the tax credit payout.

If you’re installing a system larger than 1 MW of AC power, you may want to press the gas if your system doesn’t qualify for any of the additional conditions listed above, especially if you’re not meeting the IRA’s apprenticeship or prevailing wage requirements. This could knock your tax credit down to 6%. But here’s the good news: these requirements are waived for any project that started between January 1, 2022, and 60 days after the rules are implemented.

Overall, a day with solar energy saves you more money than a day without solar energy. Request your free quote to learn how solar will help you Save With Every Sunrise

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Originally published December 7, 2016, updated September 2, 2022.

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