How do I write off solar panels for sole proprietor business?
-Don, TX
Hello Don,
Thank you for submitting your question regarding writing off the purchase of solar panels for your sole proprietorship. Your question can be complicated, but we will try to highlight some of the options for you to consider. Since we don’t have particulars regarding your business, it would be a good idea to consult with a tax professional so they can review your specific situation and make a determination of what you qualify for and is the most beneficial.
First of all, if the solar panels are exclusively serving your business (they are not connected to your primary residence, second or vacation home), the cost of installing the solar panels would be eligible for writing off as a business expense like any other business asset. While you could choose to take them as a depreciation deduction, they would be subject to the normal rules for purchasing capital assets in your business. Depending on your facts and circumstances, the cost and installation of the solar panels may qualify for a Section 179 deduction or bonus depreciation. Any remaining cost may need to be written off over five years as it would be classed as energy property. However, there is also a solar credit available for businesses as well which may be more beneficial.
If the system is used exclusively for business (and not part of your home) you may be better off claiming the cost for the Energy Investment Credit, which is only available for rental property and to businesses. For small business taxpayers, which is defined as a system that produces less than 1 megawatt, this credit would also be 30% of the cost of installation and was enhanced by the Inflation Reduction Act of 2022 (IRA ’22) back to 30% for the 2022 tax year. This credit enhancement was not retroactive to years before 2022. If the system produces 1 megawatt or more, the rules become much more complicated for taxpayer to claim a full 30% credit, as there is a base credit amount of 6% with ways to increase that to 30%. However, that would be an involved discussion beyond the scope of our answer here. Generally, tax credits have a more beneficial impact on your tax return than write-offs, as they result in a dollar-for-dollar reduction in taxes. However, this credit will not reduce your self-employment taxes that are generated by your self-employment income, as it can only be used to reduce income taxes.
For individuals, there has been in existence for some years the Residential Energy Efficient Property credit (or REEP) that provided for a tax credit for the installation of solar electric property on the taxpayer’s residence. The Inflation Reduction Act of 2022 recently enhanced this credit. This law extended the credit through 2023 and bumped the reduced rate (which had been in effect for 2020 and 2021) back up to 30% for property placed into service after December 31, 2021. After December 31, 2023, the credit rate will reduce to 26% for 2033, and then to 22% for 2024. You don’t mention what year you purchased and placed the panels into service. If it was during 2021 or 2020, keep in mind the credit is limited to 26%. The Inflation Reduction Act of 2022 has changed the name of this credit to the Residential Clean Energy Credit.
The credit is not refundable, so you must have a tax liability to offset with the credit. If your credit is higher than your tax liability, the credit can be carried over to subsequent tax years until it is fully used.
For purposes of this blog, we’re going to assume you are talking about a home office situation where you want to install solar on the roof of your residence but treat it as a business expense. And here is where the answer gets tricky.
When you have a “mixed use” property, such as a home where you are also operating your business, you generally must allocate costs that impact the entire home between your personal residence portion and the business portion. For example, the home mortgage interest paid on your mortgage would be allocated to both the business expenses and personal itemized deductions, based on the allowable square footage of the business versus the entire home. For solar energy property, the IRS has indicated that if your business use of the property is 20% or less, then the entire cost of the system should be treated as a personal residence expense, and it would then qualify for the Residential Clean Energy Credit as if there was no home office. In other words, the credit would be calculated like it would be for any taxpayer who does not run their business from their home.
If business use exceeds 20% of the home, then the cost of the system must be allocated. Only the portion of the home used as a personal residence would be eligible for the Residential Clean Energy Credit. For example, if you have been claiming 25% of your home as a home office, only 75% of the cost of the system would be eligible for the Residential Clean Energy Credit.
Would the remaining portion be eligible for the business version of the credit? This is not entirely clear from the guidance issued by the IRS so far, and they continue to issue new guidance on a near-daily basis, so we may not have the answer to that question immediately. It is possible that the remaining cost basis would qualify under the Energy Investment Credit, but the ability to take a “partial” credit under that credit’s provisions was limited by the IRA ’22, so it may not qualify. We simply do not know, exactly, at this time.
However, the remaining cost might qualify as a business deduction, but again this would need to be allocated between the portion used to claim the residential credit and the business portion. Only the portion that represents the business use may qualify as a deduction and, as we stated earlier, it is better to use this cost for a tax credit than as a business deduction, as this will generally result in a larger reduction of your taxes. A tax professional could do the math using several scenarios of credit versus deduction and give you the best options for your particular set of circumstances.
Sincerly,
Carolyn Richardson, EA, MBA