Is Income Generated From Solar Panels Taxable?

The adoption of residential solar panels in the U.S. has grown rapidly in recent years, with over 4 million homes now powered by rooftop solar panels as of 2022 (https://www.sempersolaris.com/unprecedented-growth-solar-panels/). This exponential growth is driven by federal tax credits, declining costs, and the ability of solar panels to reduce electricity bills for homeowners.

Solar panels generate electricity that can power a home and also be sold back to the electric grid. The income homeowners receive from their excess solar energy production is considered taxable income by the IRS and state tax authorities. Therefore, it’s important for homeowners to understand how the income generated from their solar panels will be treated for tax purposes.

Federal Income Tax Treatment

The federal tax rules for income generated from solar panels primarily depend on whether you are selling excess electricity back to the utility company. Any net income from selling electricity back to the grid under a net metering agreement is generally considered taxable income by the IRS.

When your solar panels generate more electricity than you use in your home or business, most states allow you to sell the excess back to your utility company to get a credit on your electricity bills. This arrangement is known as net metering. The value of the excess electricity sold back represents income, just like any other goods or services you sell for profit.

Specifically, the IRS considers net metering as a service being provided to the utility company. Therefore, the fair market value of electricity sold back to the grid must be reported as income on your tax return. Most utility companies will issue you a Form 1099-MISC if the income earned from net metering sales exceeds $600 for the tax year. This income will be taxed at your ordinary federal income tax rate.

However, if your solar panels are only supplying electricity for your own property’s usage, then this self-consumed solar power does not create any taxable income at the federal level. There is no tax owed on the value of solar electricity that you generate and use onsite for your home or business.

State Income Tax Treatment

Whether income from solar panels is taxable at the state level depends on where you live. Some states follow the federal tax treatment and exclude solar panel income from state taxes. Other states such as California and Hawaii do tax excess solar power generation.

For example, in California any income from net energy metering credits provided by your utility is considered taxable income. The value of these credits is reported on Form 1099-MISC and must be claimed as income. Hawaii also taxes solar panel excess generation, but uses a different mechanism. Residents must pay a “grid-supply charge” on each kilowatt-hour their system produces annually. This charge serves as a replacement for the income tax.

Massachusetts, New York, and New Jersey have income tax exemptions for residential solar power generation. So excess power credits are non-taxable in these states. Some utilities like Duke Energy in North Carolina also do not report excess generation for tax purposes at this time.

Overall there is a lack of consistency across states when it comes to income taxes on solar panel excess generation. Check your state and utility policies to determine if your income may be taxable at the state level.^[1]

[1] Homeowner’s Guide to the Federal Tax Credit for Solar PV – 2021

Property Tax Treatment

The installation of solar panels can potentially increase a home’s assessed property value, which is used to calculate property taxes in most areas. However, many states and local jurisdictions have exemptions in place to prevent or limit increased property taxes due to solar installations.

For example, in California, the added value of a solar energy system is excluded from the assessed value of a property for property tax purposes (https://esdsolar.com/installing-solar-panels-in-columbus/). This policy aims to encourage the adoption of renewable energy without penalizing homeowners with higher property taxes.

Similarly, New Jersey exempts the value added by a solar energy system from being subject to increased property taxes (https://www.ottsolar.net/federal-incentives). This exemption lasts for 15 years from the time the solar system is operational.

However, the property tax implications can vary in other states and jurisdictions. Homeowners should research their local property tax laws and exemptions when installing solar panels.

Tax Credits and Incentives

The federal government offers an investment tax credit (ITC) for residential and commercial solar installations that can reduce your taxes significantly. The residential ITC allows you to deduct 26% of installation costs from your federal taxes for systems installed in 2022 through 2032. It then drops to 22% for 2033 and expires after that (Source 1).

There are also many state and utility incentives. For example, in California there are state solar tax credits, rebates through the California Solar Initiative, and net metering programs with many utilities that can further reduce costs (Source 2). Some local governments and municipalities also offer property tax exemptions or credits for solar installations.

Researching federal tax credits along with state and local programs is important to maximize savings when installing a solar system.

Depreciation

One of the biggest tax benefits of installing solar panels is the ability to depreciate the cost of the solar installation over time. The IRS allows solar panels to be depreciated over 5 years for residential installations and over 6 years for commercial installations using the Modified Accelerated Cost Recovery System (MACRS) (source). This allows businesses and homeowners to deduct a percentage of the total installation cost from their taxes each year.

For example, a homeowner who installs a $30,000 solar system would be able to deduct $6,000 (20% of the total cost) from their taxes in the first year. In the second year, they could deduct $5,400 (32% x original cost), followed by $3,240 in year 3 (19.2% x original cost) and so on according to the MACRS depreciation schedule until the full installation cost has been deducted (source). This tax benefit helps offset the upfront cost of installing solar panels.

Businesses that install solar can benefit even more from accelerated depreciation. Commercial solar systems are eligible for a 100% first-year bonus depreciation deduction, allowing the full cost to be deducted in the first year. The depreciation deduction, combined with other incentives like the federal Investment Tax Credit (ITC), can lead to very favorable tax treatment and short payback periods for commercial solar projects (source).

Tax-Advantaged Solar Investment

Investors can gain tax advantages by investing in solar bonds, securities, and real estate investment trusts (REITs). Solar bonds allow people to invest directly in solar projects. Major companies have issued over $3 billion in solar bonds. Institutional investors have bought solar bonds; publicly listed companies like SolarCity have issued solar bonds on public exchanges. Solar bonds provide steady returns and tax benefits.

Real estate investment trusts (REITs) allow investors to gain exposure to large-scale solar projects while receiving tax advantages as a REIT shareholder. Solar REITs own and operate solar energy systems across a distributed portfolio of properties. They generate income by selling clean electricity to customers. According to experts, implementation of solar REITs will be challenging but provides a promising opportunity.

Sale of Excess Power

One way for homeowners to benefit from installing solar panels is through net metering programs, which allow them to sell any excess electricity generated back to the grid and receive credits on their utility bill. According to the Department of Energy, net metering is available in over 40 states.

The IRS considers the sale of excess power through net metering to be a trade or business activity taxable as ordinary income (Internal Revenue Code § 61(a)(2)). Any net income received from selling power back to the utility would need to be reported on Schedule C and subject to both federal and state income taxes.

For example, if a homeowner sells $200 worth of electricity back to the grid over the year, that $200 would be considered taxable income. Depending on their tax bracket, federal and state taxes could reduce the net benefit they receive. Proper tax planning is important when utilizing net metering programs.

According to this CNET article, some states like California are transitioning net metering programs to less favorable rate structures, which could impact the economics. Homeowners should research the net metering policy and rates in their specific area.

Tax Planning Strategies

There are several ways homeowners can minimize the taxes owed on income generated from solar panels:

Install the solar array on a rental property rather than a primary residence. The income from solar energy can be counted as business income instead of residential rental income, allowing for more deductions and depreciation (U.S. Department of Energy).

Claim depreciation on the solar system over five years to lower taxable income. Homeowners can deduct 85% of the cost of installing solar panels on their taxes in the first year via the Modified Accelerated Cost Recovery System (NerdWallet).

Offset solar income by increasing pre-tax retirement contributions, donating to charities, or maximizing other deductions. Contributing more to certain accounts like a 401(k) or IRA can reduce taxable income from solar power (Forbes).

Consider leasing rather than buying solar panels to take advantage of tax incentives and avoid capital gains taxes. Solar leases allow homeowners to claim the ITC and avoid paying taxes on excess electricity sold back to the grid (Forbes).

Sell excess solar energy to the utility company instead of applying net metering credits. The income from selling electricity is taxable, but the overall tax burden may be lower compared to claiming credits.

Consult a qualified tax professional to develop a customized solar tax minimization strategy based on your individual circumstances.

Conclusion

The tax implications of generating income from solar panels can be complex. The main takeaways are:

– Income generated from selling excess solar power back to the grid is generally taxable as ordinary income on your federal taxes. Many states also tax this income.

– Property tax exemptions for solar installations vary widely by location. Some areas offer partial or full property tax exemptions while others provide none.

– Upfront tax credits and ongoing tax incentives can help offset the costs of installing solar. These include federal and state investment tax credits, accelerated depreciation, and property tax exemptions.

– Work with a tax professional to maximize tax benefits and develop an optimal solar investment strategy for your situation. Careful planning can yield substantial tax savings.