To encourage investment in alternative energy sources, the Code provides various incentives, including a 30% credit for the cost of energy-efficient property such as solar electric property and solar water-heating property. Although most people know that this credit is available for qualifying solar property installed in their homes (called the residential energy credit), they may not realize that the 30% credit is also available for these improvements in rental properties they may own.
The residential energy credit is nonrefundable—if the credit is more than a taxpayer's tax liability, it can be carried forward to next year's tax return under Sec. 25D(c). Taxpayers who take the 30% credit for solar energy property installed in their principal residence or vacation home must reduce their basis in the property by the amount of the credit. A home includes a house, houseboat, mobile home, cooperative apartment, condominium, and a manufactured home (Instructions to Form 5695, Residential Energy Credits).
Qualified solar property for residential energy credit purposes includes property that uses solar energy to produce electricity for the home. Costs for solar panels or related property that are installed as a roof or portion of a roof will not fail to qualify for the credit because they constitute a structural component of the roof (Form 5695 Instructions).
For the business energy credit, solar energy equipment qualifies if it is equipment that uses solar energy to generate electricity, to heat or cool (or provide hot water for use in) a structure, or to provide solar process heat, except property used to generate energy to heat a swimming pool (Sec. 48(a)(3)(A)(i)). Unused credit amounts are carried back one year or forward 20 years under Sec. 38.
Nonetheless, there continues to be confusion about whether the 30% solar energy tax credit on the cost of installing solar panels is available when the panels are used in residential rental properties the taxpayer owns. At least part of the confusion is because solar energy tax credits are available under two separate Code sections, Sec. 25D and Sec. 48.
Residential solar credit
Sec. 25D provides a solar tax credit to an individual taxpayer when the panels are installed for use in the taxpayer's residence. Under Secs. 25D(d)(1) and (2), solar water-heating panels and solar electric (photovoltaic) panels must be installed for use in a dwelling located in the United States and used as a residence by the taxpayer. Thus, Sec. 25D does not allow a credit when solar panels are installed for use in a residential rental property the taxpayer owns.
In Notice 2013-70, which provides guidance on Sec. 25D, the IRS further clarified this issue. Question 6 in the notice asks whether the credit is available for improvements made to a second home, for example, a vacation home or an investment property. In its answer, the IRS specifically states that while the credit may be taken for solar panels installed for use in a vacation home, the taxpayer may not claim the Sec. 25D credit for expenditures for improvements made to an investment property, such as rental property, that is not also used as a residence by the taxpayer.
While Sec. 25D does not allow a solar tax credit for the cost of installing solar panels for use in residential rental property, Sec. 48 is more favorable. Sec. 48 provides for a solar energy tax credit for the installation of solar panels as part of the general business credit under Sec. 38. Under Sec. 48(a)(5)(D), property that is eligible for the general business credit is tangible property for which depreciation is allowable. Solar panels installed for use in residential rental property meet this requirement.
This is not quite the end of the story, however. Under Sec. 50(b)(2), business credits are generally not available for property that is used predominantly to furnish lodging. At first glance, this subsection would appear to prevent solar panels installed for use in residential rental property from being eligible for a business credit.
A further reading of Sec. 50(b)(2), however, indicates that the restriction on the availability of the general business credit for property used to furnish lodging does not apply to "any energy property" (Sec. 50(b)(2)(D)). Sec. 48(a)(3)(A)(i) defines equipment that uses solar energy to generate electricity or to heat or cool a structure as energy property, as long as it is not used to heat a swimming pool.
The result is that solar panels installed on residential rental property the taxpayer owns should be eligible for a solar tax credit under Sec. 48, assuming other requirements for the credit are met. This is good news for taxpayers hoping to take advantage of the 30% tax credit for the cost of solar panels installed on residential rental property.
Kenton D. Swift (Kent.email@example.com) is a professor of accounting in the School of Business Administration at the University of Montana who teaches undergraduate and graduate tax courses.