Filing for the Federal Solar Tax Credit
Congratulations! You have a solar system. Your meter is spinning backward. Your electric bill is something to brag about. You're even saving the planet.
Now it’s time to get some credit. Tax credit that is. Let’s take a look at some approaches to filing for the Federal Investment Tax Credit (ITC). Before we begin, there is the standard disclaimer. We’re not accountants. So here we go:
We’re solar gurus, not tax gurus. This guide is offered as basic instruction only and is not meant as professional tax preparation advice. For specific tax-related questions or issues, we recommend consulting a certified tax preparation specialist or CPA.
Great… got that out of the way. Let’s move on to understanding the tax credit.
First of all, technically, it’s not a solar credit. IRS form 5695 is to file for a Residential Energy Credit. More than just solar panels qualify. You can also use this for a solar hot water heater, wind power generation, geothermal, and fuel cells. There are nuances for each, but for our purposes, we’ll just focus on the credit associated with a solar panel installation.
To learn more about the solar tax credit, the US Department of Energy published a great frequently asked questions solar guide.
Credit vs Refund
The “C” in ITC is for credit. Credits are different than other tax-reducing tools and are not a refund, nor a deduction to reduce your adjusted gross income. This is a credit that you can apply to federal taxes you may owe. If you don’t owe taxes, the credit will need to carry over to another year (we’ll talk about that on line 12 of the form).
Preparing for Filling Out Form 5695
- Do all of your other taxes first. Has your 1040 already been completed? You’ll need to know your current tax liability before you can finish the form.
- As discussed above, this is a credit and not a refund. You use this credit against your tax liability. Therefore, to access the tax credit, you need to have a tax liability. Not a problem for most people, but if your income isn't taxable, or you have a significant number of deductions and credits, you may need a professional tax strategy. If you do have a tax liability, but get a refund because you overpay withholdings in your regular paycheck, you can still get the tax credit. You have two options:
- You can wait until tax time and add your credit to your refund. Note that the above restrictions apply. For example, if you have a liability of $6,000, but have paid $8,000 in withholdings throughout the year, you would normally get a $2,000 refund for your overpayment.
If you had a solar tax credit of $10,000, that's more than your $6,000 initial liability. You will apply $6,000 to your tax liability to make it zero and you will carry over $4,000 for next year's taxes.
With a new $0 tax liability, you will get all $8,000 of your withholdings as a refund, plus have $4,000 leftover to use as a credit next year.
- You can access your tax credit right away by lowering your weekly withholdings. You can safely do this knowing you have that tax credit waiting for you at tax time. Just don't forget to change your withholdings back at the beginning of the next tax year.
So the first step is understanding if your solar system qualifies for the tax credit. Unlike some of the other energy production measures, solar does not have any production or capacity restrictions to earn the credit. The Residential Energy Efficiency Property Credit is limited to your principal residence and a second home. Businesses will have a different process.
Timing is important too. In a clarifying ruling letter about solar batteries, the IRS states that "...for purposes of determining the tax year when the credit is allowed, an expenditure with respect to an item shall be treated as made when the original installation of the item is completed." This seems to equate the tax code's “placed in service” test as a completed installation independent of inspections and interconnection approval. The letter goes on to say that the system may be placed in service by January of the following year. So much is open to interpretation and that's why we have disclaimers here, but it appears that, as long as construction is complete and the interconnection approval from the utility is imminent, the credit will count. The Solar Energy Industries Association and US Department of Energy support this interpretation, saying, "There is no bright-line test from the IRS on what constitutes “placed in service,” but the IRS has
equated it with the completed installation."
Form 5695 is very simple. Of the 16 boxes, most filers will only fill out a few. You will need this form if you installed a system in the tax year OR if you have any unused portion of your credit from previous years (see line 12 of the form). Let’s dive in!
- Line 1 - This is where we enter the qualifying solar electricity costs. Generally, this is the entire purchase price of your solar system. For some solar customers, there may be additional money you can apply to the cost.
The instructions for the form say that qualifying costs, "...are costs for property that uses solar energy to generate electricity for use in your home..." Most interpreted this to mean all costs associated with providing a fully-functioning solar system. Qualifying expenses possibly include trenching, ground-mounting framing work, or even tree removal to enhance sun exposure. These expenses may be included in your solar contract or could be services provided by a third party such as a tree removal specialist.
The instructions go on to say, “No costs relating to a solar panel or other property installed as a roof (or portion thereof) will fail to qualify solely because the property constitutes a structural component of the structure on which it is installed” (Bolding added for emphasis).
Leave it up to the IRS to give us a double negative saying that “no cost… will fail”. Many have interpreted this to be any improvements needed to make solar viable may be included in the cost of the system.
So, what does that mean? As a practical example, let’s say to get solar, you need to redo your roof. The roof cost was $10,000. Again, this is a general consensus, but most tax professionals indicate that the portion of the roof affected by solar would qualify. So, if solar panels cover 40% of your roof, then you may consider adding $4,000 (40% of $10,000) to the “Qualified solar electric property costs” in Line 1. To be clear, many tax professionals say to go ahead and throw the whole roof cost in there, while others say to put nothing in there. Consult your tax professional on that (and everything else… which is why we started with the disclaimer and keep repeating it).
- Line 2-4 - are similar and apply to other energy-saving and production measures. Most solar customers will leave these blank.
- Line 5 - This is a total of the above lines. In most solar cases, this will simply be copying what you put in the first line.
- Line 6 - Multiply line 5 by 0.30 to calculate 30% of project costs. 30% is the 2022-2032 tax credit amount. In 2033, the federal ITC begins stepping down. If you are not able to use all of the tax credit for the filing year, in future years, you may use Line 12 to carry over any unused credit. This is a dollar amount and not a percent, so even if it takes you multiple years, you will still be using your original credit from the year you first filed for the credit.
Put another way, if you have a $9,000 credit in a 30% credit year, you can get all $9,000 regardless of how the rate might step down for the next tax year.
- Line 7 - Doing anything crazy with fuel cells? Didn’t think so. For most solar customers, check “No” for 7a and leave 7b blank. If you did do something with fuel cells, check “Yes” and give us a call because we want to check it out.
- Line 8-11 - We can skip these unless you did something with fuel cells. Again, we’d love to know about it if you did!
Just like that, we’re on Line 11 and we’ve only filled in 4 things and did one easy math problem.
- Line 12 - We keep talking about this line. We only need to worry about this line if you could not capture the whole tax credit for the year you installed this solar system. For most solar customers, this will be blank. If this is your first time with the form, it will be blank. If we need to carry forward, we’ll add that later on Line 16.
- Line 13 - Time for some math again. It’s really easy though. We take Line 6 (your tax credit), add Line 11 (which should be zero and that’s easy math), and add Line 12 (which, in your first year, should also be zero and is still math we can handle).
- Line 14 - Just when we brag about how easy this is through Line 13, Line 14 comes up. Line 14 is all about applying the credit to your tax liability. For that information, the IRS gives you a worksheet in the form instructions called i5695. This worksheet gives us a way to calculate Line 14. It’s a pretty easy worksheet, so let's dive in!
- Form i5695, Line 1 - We want to enter the total taxes you owe. That’s as simple as looking at your 1040 form and entering in the information from line 12b (Or line 45 in you are using 1040-NR).
- Form i5695, Line 2-9 - These lines talk about other credits. For most solar customers, this would be zero.
- Form i5695, Line 10 - Yea! More easy math. Add Line 2 through 9 together which will most likely be zero.
- Form i5695, Line 11 - This math is harder. We’ll have to subtract zero (likely the Line 10 number) from the Line 1 number and put it here. This number goes in Line 14 on the original form.
- Line 15 - Now that we’re done with Form i5695, we’ll look at line 13 (the credit) and line 14 (the tax bill) and write in the number for whichever is lower.
- Line 16 - If Line 15 is less than Line 13, then we subtract Line 15 from Line 13 (the tax credit) to find out how much of the credit will carry over to next year’s taxes.
Done! Most of the math involved zeros so that news is almost as good as the big credit you have with the IRS. The last step is to take the amount on Line 15 of Form 5695 and copy that to Line 53 of Form 1040 - Schedule 3.
Let’s do that disclaimer again for fun. Please check with a tax professional. There are so many variables. This guide is only intended to show you some of the more common approaches to claiming the tax credit.
Now, go outside and watch your beautiful solar panels soak up free energy and save you money. You’ve earned it!