There may be errors in spelling, grammar, and accuracy in this machine-generated transcript.
Jeremy Wells: Hi, I'm Jeremy Wells, enrolled agent and CPA, and welcome to Tax in Action. In this episode, we're going to look at how to handle a client who has installed some residential clean energy property at a residence. So let's get right into the situation here. You've just gotten done with a call with a client of yours. And toward the end of that call, she [00:00:30] mentioned that in the last year, she installed some solar panels on her and her husband's vacation house. This is the first time you've had a client deal with this. You know that there's some special tax benefit here, but you're not exactly sure what this is. So you made a note in the file to do some research. But as those notes tend to do, they kind of slip through the cracks. And now it's tax time. The clients come to you. They've dropped off all their tax documents, including some information about having these solar panels [00:01:00] installed. Among those tax documents, you find two invoices. One is for the actual installation of those solar panels, along with some related equipment purchases and some labor. All of that is on one invoice. On another invoice from a building contractor. You've got some charges there for some work done to her roof. So those solar panels were apparently installed on the roof. And that took two different invoices. [00:01:30] One from the solar company for the panels, one from the contractor for some work done to the roof.
Jeremy Wells: She included a note, your client explaining that the solar panel installation on the roof required some structural retrofitting to make those solar panels work on the roof. So now you're looking at these documents. It's time to start working on your tax return. And you've got some questions. How does the solar tax credit work? You've heard of it. This is your first time dealing with it? [00:02:00] What expenses qualify for the credit? How are you actually going to calculate how much credit this taxpayer is going to get? And what about these two different invoices? How should you be looking at those? One is for the actual solar panels. One is for the work done to the roof. How does the roof work into the solar panel? Uh, expenses in the solar panel tax credit. So we've got these questions, and I'm a CPA in Florida. I have clients throughout the country, [00:02:30] but I've got a lot of countries down in the South. And over the last few years especially, we've had a lot of solar panels being installed. But this also works for other kinds of property that we'll talk about clean energy property. But solar panels are one of the most common examples right now. And so for every now and then, we'll have a client come in and they've done some work usually last year without talking to us first. But we'll get the paperwork when they bring in their tax documents and we'll see That there is some expectation [00:03:00] of what's commonly known as the solar tax credit.
Jeremy Wells: So in this episode, we're going to work through how that actually works. We're going to answer some of these questions. How does the solar tax credit work. And and more broadly, how does the residential clean energy property credit work? What expenses qualify for that credit? Do all of these expenses related to the installation of those solar panels qualify? And if we have to do some work to the residence where that clean energy [00:03:30] property is installed, uh, what happens with that? Can we include all of those costs or not? So first of all, let's look at the authority that is in play here in this situation. When we're talking about authority for tax law purposes, we're always going to start with the Internal Revenue Code. For this credit in particular we're looking at Internal Revenue Code section 25 cap D. This is where we find the residential clean energy [00:04:00] credit. This code section provides a nonrefundable credit, and that's important to keep in mind. This is a nonrefundable credit, meaning that the taxpayer's tax liability cannot be paid off more than putting that client into a refund position and putting that taxpayer into a refund position with that credit. If that credit exceeds that taxpayer's tax liability, then they're going to have to carry over some of that. We'll talk about that more later on [00:04:30] in the episode.
Jeremy Wells: But that credit is for up to 30% of the expenditures on qualifying residential clean energy property. So there's a lot to unpack there. Another thing to keep in mind is that this credit is good through 2032 at 30%. For 2033, it drops down to 26%. 2034 it's going to drop down to 22%. And then after 2034, right now, the way the [00:05:00] law is worded, it goes away. But, you know, we're about ten, ten years out from that almost. And so we don't really need to worry about that today unless we're doing some really long term tax planning. But for now we're looking at a 30% of qualifying expenses, nonrefundable credit for the installation of clean energy residential property. What kind of property are we talking about here? As I've already mentioned, solar panels are one of the most common examples here, but we've got a couple others as [00:05:30] well. Another one is solar water heaters, small wind energy. So small wind turbines that could power a single home geothermal heat pumps. This is one that's relatively common, not necessarily in my area, but in other parts of the country. And then we've also got fuel cell and battery storage property. Now, there are some specific limitations on battery storage that we'll talk about. But in general, we're looking at technology, a property that can be added [00:06:00] to a residence that would offset or even generate some of the electrical capacity of, of that home.
Jeremy Wells: The residential energy efficiency improvements credit is a completely separate credit. We're not talking about that, although I am planning a future episode of this show on that. But those that credit includes new windows insulation or HVAC systems such as air conditioners that all falls under the IRC section [00:06:30] 25 cap C credit. So those residential energy efficiency improvements to a residence are covered under a completely separate credit. That's a separate discussion. What we're talking about here is energy producing property such as solar panels, solar water heaters, geothermal energy production. If we're talking about those kinds of installations, then we're looking at the 25 cap D [00:07:00] credit. The interesting thing about this particular credit in this section of the code is, unlike most sections of the code, we really don't have much guidance beyond what's in the code section itself. We don't have any Treasury regulations related to this code section, which is which is not very common. Usually we get a lot of extra guidance from Treasury from IRS. In this case, there are no Treasury regulations to turn to. [00:07:30] Pretty much everything we need to know as far as authoritative guidance comes straight out of the code. Section 25, cap D. Uh, there has not been much litigation on this. There are not really any important court cases, uh, whether in the Tax Court or in the federal court system on this. Again, what we're looking at is pretty much just what comes straight out of the code section.
Jeremy Wells: Now, that said, the IRS has issued some clarification [00:08:00] on this, particularly in the form of a notice, which is not necessarily authoritative, although it's always helpful to get some published guidance from IRS to understand how IRS is interpreting, uh, tax law and how IRS might, uh, make a determination in a specific taxpayer's case. But again, we have to be careful relying on these non authoritative publications even from the IRS. But we've got notice 20 [00:08:30] 1370, which is essentially a a question and answer. It's a long Q&A on both the 25 cap C energy efficient home improvement credit and the 25 cap D residential clean energy credit, which is what we're talking about today. So again, uh, planning a future episode on that 25 C credit. But for now we're just focusing on the residential clean energy property credit. We also have a few Pls or private letter [00:09:00] rulings. Again, Pls are not authoritative except for the taxpayer that that letter was directly addressed to. They are helpful in understanding where IRS is thinking how IRS is interpreting tax law. But beyond the taxpayer, those letters were directly addressed to. We can't really use them as precedent or as authoritative guidance. They can be helpful for thinking about what might and might not qualify [00:09:30] under, uh, 25 cap D for this credit, though. Aside from the actual code section, though, we really just don't have much to work with.
Jeremy Wells: So most of what I'm going to be discussing in this episode is going to come straight out of that code section. Uh, and so we usually have some additional guidance in this case not so much. That said, let's think about what we have here from the taxpayer and what's still missing and [00:10:00] what the code section tells us that we need to know from the taxpayer. So now that we're familiar with where to look, let's actually break it down. So one of the first things that 25 cap D starts talking about is a qualifying residence. Usually when we're talking about taxpayers and their residents, we're concerned with their primary residence. If you have worked with a taxpayer who has recently sold their primary residence, you might be familiar with section [00:10:30] 121, which talks about being able to exclude some or all of the gain from the sale of that primary residence. In this case, though, when we're talking about section 25 D, we're not talking necessarily about the primary residence of the taxpayer. We're actually talking about any residence of the taxpayer. So it's a little bit looser than other code sections such as section 121. So the property has to be installed at a dwelling unit. And that's that's [00:11:00] sort of the technical phrase that comes from tax law. Dwelling unit. This is a place that the taxpayer actually lives, uh, in the United States, used by the taxpayer as a residence that comes from 25 D, subsection D, the home doesn't have to be the the taxpayer's primary residence unless the property is a fuel cell.
Jeremy Wells: Now, this is one of the exceptions. And like I said earlier on, we've got to be careful with the fuel cells and the batteries. There's a little bit of extra, uh, limitations and requirements [00:11:30] for those types of properties. But when we're talking about the solar panels or the geothermal or the solar water heaters, we're just talking about the taxpayer's residence. Now, to call it the taxpayer's residence means that we're actually not talking about investment properties or rental properties. 25 D Cap D does not apply to rental properties. So if a taxpayer comes to you and says that they installed solar panels on a rental property of theirs, there is a different code section that we [00:12:00] can look to, but we're not going to be looking at section 25 cap D. And so that's not part of what we'll talk about on this episode. We'll have a future episode on that credit as it applies to installing this kind of property on a on a rental property. But for now it has to be a taxpayers residence. It doesn't have to necessarily be their principal or primary residence, but it has to be the taxpayer's residence. It can be a second home, a vacation home, a summer home, something like that. [00:12:30] But they've got to be using it personally. It can't be a property that they're renting out or using as an investment.
Jeremy Wells: So that's what it takes to qualify as a residence. We also have to look at what's going on inside of that residence, meaning is there any business use of that home? I work with a lot of self-employed individuals, and so they are often running their businesses out of their home. And we take account of that by getting something like a [00:13:00] home office deduction. Or maybe if it's an S corporation, we have an accountable plan to make sure that they're able to deduct some of that business use of home, uh, expense. But in the case of this credit, we have to be very careful and take that into account. If there is any business use of the home, such as a home office, we need to understand exactly how much of the home's square footage is used for that. If [00:13:30] more than 20% of the property's square footage is used for business, such as a home office, or maybe renting a portion of that home out, then we're going to have to make some adjustments to the amount of credit that this taxpayer can get. The taxpayer can only apply the percentage of the expenditures, the qualifying expenditures that we'll talk about in a minute allocated to the non-business portion of that residence. [00:14:00] So imagine, for example, that a taxpayer owns a home. That taxpayer uses 25% of that home square footage as a home office.
Jeremy Wells: Now we can only look at 75% of the expenses for that improvement property. Uh, we can only look at 75% of that or the remaining portion of the home after we exclude that business use of home [00:14:30] portion. And then we're going to calculate the credit on that. Now, as long as that non personal or business use of the home is less than 20% of the square footage of the home, if it's less than 20% we don't have to make that correction. So anything up to 19% of the home square footage, we're fine. We can take 100% of those expenses and use that to qualify the credit as soon as we go over 20%. Now we have to start allocating. [00:15:00] In that case, we're going to look at the difference and the remaining personal use, and then we're going to reduce those qualifying expenses in order to calculate the credit. Now what do we mean by qualifying expenditures. And this is really the main question we have to think about when we're talking about figuring out the amount of this credit. So what costs actually qualify to calculate this [00:15:30] credit. Usually from our perspective the taxpayer is going to hand us at least one, if not a couple of invoices that are going to have hopefully some things itemized out, a breakdown of how much was actually spent or paid to install this property, and there might have to be some adjustments to the residence to the structure in order to allow for this property to be installed.
Jeremy Wells: So we need to be very careful about what all [00:16:00] we're looking at as far as including in the expenses we're using to calculate this credit. So the eligible expenditures include the cost of the property, as well as any on site labor costs to prepare, assemble and install that property. So it's not just the cost of the solar panels themselves or the geothermal unit itself, but also if there's any labor that is needed to [00:16:30] prepare to assemble or to install that property as well. Also, if we're talking about property that needs to be wired or piped into the property, such as a solar water heater, we're going to have to plumb that into the property. Or if we've got solar panels, we're going to have to add some wiring to connect that up to the home's electrical system. All of that counts as well. So we've got the property itself and the cost of that. We've [00:17:00] got the labor cost to prepare, assemble and install. And then if we need to connect that property to the house's systems, either plumbing or electrical, we've got the cost of that as well. This all comes from 25 cap D, subsection E one for solar, electric and water heating. Though we have some exceptions that are built into the code section. So the panel or the other property that's installed as a roof [00:17:30] or a portion of a roof that is treated as qualified property, even if it's a structural component of the dwelling unit.
Jeremy Wells: Stay with me for a second, because this this is going to get a little a little confusing. And it's it's going to require us to go back and really carefully read the documentation and the invoices and maybe lead us to ask some more questions of the taxpayer when we start trying to figure out how much the total cost, uh, eligible for the credit, all of this [00:18:00] was. So if the panels actually become a structural part of the roof, then we can include that cost. That's different from saying that we had to do some work to the roof to be able to install those panels. So make sure you keep those points clear. Again, you might have to go back to the taxpayer and ask some more questions. When you had these solar panels installed, were they installed as part of the roof, or did you have to do some work [00:18:30] to the roof to be able to install them? Those are going to the answer to that question. Whether it's the the one or the other is going to determine how much of that cost is actually eligible for calculating the credit. If there's any other normal roofing work done, the material installed, or the labor to work on the roof to be able to make those solar panels able to be installed, then that's not [00:19:00] going to qualify for the credit.
Jeremy Wells: If we're preparing the roof, or if we're changing the structure of the roof to be able to support those solar panels. That work is not going to qualify, and the cost for that work is not going to qualify for calculating the amount of expenditures eligible for the credit. If it's a solar water heater. It has to be certified by the Solar Rating Certification Corporation or by a comparable entity endorsed by your state. This [00:19:30] is another point that we're going to have to maybe ask the taxpayer for some more information. Maybe ask them for some more documentation. Some of this property, there are strict substantiation requirements in terms of making sure that the property actually qualifies and is actually certified as clean energy and eligible for the credit. In the case of a solar water heater, that's going to come from the Solar Rating Certification Corporation or a [00:20:00] comparable entity endorsed by the taxpayer state. So you may have to find out on a state by state basis where that certification is actually going to come from for the property installed at that taxpayer's residence. For geothermal heat pumps, we similarly have a requirement. This one is going to come from Energy Star. Energy star is much more widely known certifier of this clean energy and energy efficient [00:20:30] home improvement property. A lot of the energy efficient home improvement property is going to have to be Energy Star certified.
Jeremy Wells: In the case of geothermal heat pumps and geothermal property, that is also going to have to meet Energy Star requirements in order to qualify for this credit. Then there is battery storage. Battery storage has to have a capacity of at least three kilowatt hours. I'm not an electrical expert. I'm a tax professional. I don't know what that really means. What I'm going [00:21:00] to ask the client for is something some piece of paper coming from the installer or the seller of that property, showing me that it has a capacity of at least three kilowatt hours. Um, and so at this point, as a tax professional and someone who's not an expert in clean energy property, we're going to have to, uh, make sure we've got the documentation in place in our files. Uh, and not necessarily in [00:21:30] order to protect ourselves, but to make sure that our client, the taxpayer, actually has the paperwork they need to. I've had situations where I've gone back and I've asked taxpayer for some of this documentation, and the taxpayer realized they didn't have anything showing this, and they had to go back to the seller or the installer of this property and get it. So sometimes by way of making sure that we're not necessarily enforcing, but helping make sure that our clients are compliant with these requirements, we're actually helping [00:22:00] them make sure that they've gathered all the documentation that they might need in the future.
Jeremy Wells: So again, it's important to not feel like you're, uh, bothering or unnecessarily requesting these documents from the taxpayer. Sometimes taxpayers just they don't know what they don't know. Um, and they don't know to ask for this documentation from, uh, the companies that are selling them, uh, this property. So, again, for battery storage capacity of at least three kilowatt hours. [00:22:30] Again, that that's a relatively meaningless phrase to me, except I just know that I need to make sure that if a taxpayer has this kind of property and they want it to be eligible for the credit. I need to make sure that they have documentation showing this for fuel cells. The eligible cost are limited. It can't exceed $1,667 per half kilowatt of capacity. Again, I'm not an electricity expert. I don't know why this is defined in [00:23:00] terms of a half kilowatt. That's just the way the code section is written. So I'm not sure why they didn't say $3,333 per kilowatt of capacity, but this is the way they that Congress chose to write this code section. So again, I would go to the taxpayer. I would make sure somewhere in the documentation that the taxpayer gave me something showing how many kilowatts of capacity that this property actually [00:23:30] has. And then I would make sure that we have taken that into account when we're looking at the total eligible costs here. Seer if there is any sort of additional energy storage medium, which is the phrase that the code section uses, energy storage medium that serves an additional function.
Jeremy Wells: Now the examples in the code section here are a swimming pool or a hot tub. Then the cost of that property is not eligible. [00:24:00] So what I'm imagining happening here is that we've got some sort of solar energy production going on, and we're using that to heat a swimming pool or a hot tub. And that's where some of that energy storage is happening. Obviously, there's a personal benefit to the taxpayer here. Uh, they get a new swimming pool or they get a new hot tub by way of installing this new energy production. We're not going to allow that to factor in to the [00:24:30] eligible expenses for the credit. The credit is specifically on the clean energy property. It's not for the ancillary installations that are going to go along with that. If you get a tax payer that is really wants their new pool or hot tub to be included in the credit, you just have to tell them, sorry, that's not allowed, but I hope you enjoy your new pool or hot tub. Uh, I've had to tell a couple taxpayers that before. It's it's [00:25:00] annoying to have to tell them that part of what they were sold. Uh, isn't going to qualify for that. But they got, you know, when we look at the the amount of the credit that they're going to get, we just tell them it's going to offset part of the cost of their new pool or hot tub.
Jeremy Wells: The taxpayer can include any sales tax that's paid in the eligible cost of the property. So again, when you're looking at the invoice, if you're looking at it itemized and on that invoice, [00:25:30] some of the costs are eligible and some are not. Be sure to not take the actual list price. Be sure to also include some of that sales cost back in uh, sales tax cost back in. So, uh, this is something that, uh, you know, I've seen happen before. I've actually done it before is we're looking at an invoice and this is true of this credit as well as other, uh, things that we report on tax returns. We're looking at what all the [00:26:00] eligible costs are. We know that some of the line items on an invoice are not eligible. So we just take the list prices of all the individual items. Don't forget to go back and allocate the sales tax to those. Sometimes it's not a whole lot of money, but you know, calculating a credit on an extra 5000 to $200, it might make a little bit of a difference. If the taxpayer finances [00:26:30] the purchase of the property through the seller, then you can calculate that credit based on the actual cost. That is part of that obligation to pay. This is a question that I see come up quite a bit, actually, when I see tax professionals in online forums asking questions about solar tax credit.
Jeremy Wells: Again, this is something that's been fairly common over the last few years, relatively. Uh, what if the seller finances [00:27:00] the the cost of that the taxpayer isn't actually out any money yet to install this property? Uh, do they get to take the full credit? And actually, yes, they do. This is coming out of that IRS notice 20 1370. This is question answer 13. Uh, in that document, if the seller finances the property, the taxpayer is eligible to count those expenses as [00:27:30] paid whenever the taxpayer would otherwise be able to claim this credit? Had he or she paid cash up front for it? Uh, so don't get hung up on how the taxpayer is paying or financing for the property. Just focus on the timing of when the credit should actually be taken. And we'll talk about that here in a few minutes. And then finally, [00:28:00] if the taxpayer does finance the cost, then the interest is not included in the eligible costs. So sales tax is eligible. And if the seller finances those costs, then the taxpayer can include all of those eligible costs. But interest on that financing is not going to be one of the eligible parts of that cost. We also [00:28:30] need to look at what this property is going to be able to do relative to the needs of the home.
Jeremy Wells: What do I mean by that? Does this property generate electricity in excess of the home's needs? This is an important question to ask. It's really easy, especially with solar panel installation, to get the invoices. Look at it, look at the costs. Figure out which costs are eligible, calculate the credit and then we're done. However, there is [00:29:00] a cliff here that again, I'm not an electrical expert. I'm a tax professional. But I am supposed to ask the taxpayer what is the actual electrical need of the house relative to the capacity to produce energy that you've now installed on this residence? So for solar electric property, the taxpayer can only take the portion of the cost that is related to the electricity [00:29:30] generated for the taxpayer's home. So in other words, if the new property is going to be able to produce electricity in excess of the home's needs, which usually results in the taxpayer selling electricity back into the grid, then the portion in excess of the home's needs is not eligible for the credit. Again, this is IRS notice 20 1370. This is now Q&A 27. So let's think about what might [00:30:00] actually happen here. Let's say our taxpayer comes in. They say last year they installed some solar panels on their roof. They live in a particularly sunny area. They installed enough solar panels to be able to create more than enough electricity to run the entire household. And now they're able to sell some electricity back to the grid.
Jeremy Wells: They're going to get an economic benefit from that. And in effect, they installed more solar electric generation capacity than [00:30:30] the home actually needs The IRS does not want taxpayers claiming a credit on that excess capacity. And I think that makes sense, right? Otherwise, we would all be installing solar farms, selling it all back, and then just taking a huge saying it was for our homes use and then selling all of that extra electricity back into the grid. And we'd have a pretty good result from all of that. We don't want to be able to to let taxpayers do that. We [00:31:00] don't want taxpayers to be able to do that. So what IRS says is that we have to figure out what portion of the cost is actually going to be able to generate electricity to sell back to the grid. Now, there's not a lot of detail here of how to do this. Do we allocate this based on the actual electricity generated and over what period of time? Because we have to claim this credit the for the year that it was installed. But what if it's installed late in the year. [00:31:30] Do we actually know no. Should we be using data from the from the home's electrical usage prior to the installation? What if their electrical usage significantly changes after that installation? These are all unanswered questions as far as the guidance that we have now.
Jeremy Wells: But in effect, if the solar energy generating improvement is able to generate more electricity [00:32:00] than the home actually needs, we've got to have some reasonable way of allocating the expenditures for that property to the excess electricity. And we've got to reduce the eligible costs by that much. And from that, we'll actually calculate the credit. This is only going to be an issue if the taxpayer installed a lot of excess capacity, uh, on their home to the point at which now they're selling back. I think there are a lot of homes in the southwest, uh, particularly, [00:32:30] that are able to do this. They're just they got some 99% of the days. Uh, and so they're generating way more electricity than they actually need. They're selling a lot of it back to the grid. I'm not sure we have that as much in the southeast where I am, but in general, be sure to take that into account. Ask the taxpayer. Look, are you selling any of this electricity back to the grid from these solar panels that you've had installed? If they say no, you should be good. If they say, yeah, we're getting a check back from the electric company every month. You [00:33:00] might need to dig a little bit further and figure out just how much of those costs need to be offset from the excess that's being generated and sold back to the grid. If the taxpayer got some sort of monetary incentive as part of the purchase of this property, then we need to be careful here as well.
Jeremy Wells: Some incentives, such as direct or indirect rebates from public utilities, reduce those eligible costs. So there are some [00:33:30] public utility companies that in order to encourage, uh, local citizens to install this kind of property, they're actually going to incentivize some of that, uh, cost. So, uh, you might get a rebate back from your local energy company for installing some solar panels, for example, uh, for an incentive to be a rebate, it has to be based on the cost of the property, come from someone reasonably related to the transaction, such as a manufacturer, distributor, [00:34:00] seller or installer. Um, and it's not given as a payment for services provided. So this comes from notice 20 1370 Q&A 11 and 12. We need to understand whether this is in fact a rebate, and we need to make sure that we account for that. When we're looking at the eligible costs. Those rebates will actually reduce the eligible costs for the credit. If they're coming from one of those reasonably related parties, such as a manufacturer, [00:34:30] distributor, seller or installer. So it's important to review those invoices. Again, I can't emphasize this enough. We have to get all of that documentation from the client. Sometimes they're going to throw in the brochures and the sales ads and all that stuff. We can kind of filter all of that out, but we need to look at what was actually paid for, and we need to look at the math of how they arrived at the final cost to the taxpayer and all of the different inputs that went into that.
Jeremy Wells: So what's the price of all the different units of property? What is the labor cost? And [00:35:00] then what, if any, incentives were attached to that to offset some of that cost? We need to ask the taxpayer questions. Um, if you see any possible financial incentives pop up in these invoices, and we need to go back to the taxpayer and make sure that we're clear on what those incentives were and where they came from. That said, if the taxpayer lives in a state that offers tax credits or other incentives to purchase and [00:35:30] install residential clean energy property, then those we do not account for in the eligible costs if they come from a state government. Now some states will actually call their incentives rebate. They're not actually rebates. They're incentives from a state government that were not going to reduce the eligible costs by if the taxpayer is eligible for a state tax credit based on the costs of that property. [00:36:00] We're also not going to worry about that when we're looking at the eligible costs for the property. Now, that might have an effect on the taxpayer's tax liability in another way, that state tax credit would reduce that taxpayer's state tax liability and therefore reduce their state and local tax deduction on schedule A if they itemize.
Jeremy Wells: But other than that, we're not going to worry about factoring in any sort of state government, either [00:36:30] tax credit or quote unquote, rebate. Uh, in the eligible cost for figuring out how much the credit is, we're generally not going to take those into account. Now, the timing question when can the taxpayer actually take the credit? This is an issue that I've seen trip up more taxpayers than I, uh, really want to deal with. I've had so many taxpayers, uh, [00:37:00] the ones that I work with, the ones that I've seen other tax professionals working with, and they'll ask about so many, uh, will have this property installed in one year, or they'll start the work and they'll start paying some of the costs out. Or maybe they'll sign the contract and they'll make the first payment or the deposit in one year, and then the installation doesn't actually happen until the next year, or the [00:37:30] system is installed toward the end of the year, and it doesn't actually become operational the next year. Or maybe there's some sort of certification that needs to happen, and the installation is done in one year, and the certification doesn't arrive until the next year. I've seen these kinds of questions pop up pretty regularly over the last couple of years. When is the actual timing of the credit meaning? In which tax year do we actually take the credit? And really, the [00:38:00] answer again, there's not much guidance besides the actual code section.
Jeremy Wells: And the answer is right there in the code section. So for installations to an existing residence the taxpayer report the expenditure when the property is completely installed. And that's the actual wording that comes from the code section when that property is installed on an existing residents and its completed. The work. Crews are [00:38:30] done. They packed up, they're gone. The property is ready to be put into service. Whatever date that falls on, whatever tax year that date is in, that's the tax year that the taxpayer can take that credit. It's slightly different if this property is being attached to a new construction or reconstruction. And this is another difference between the residential clean energy credit and some other credit, such [00:39:00] as the residential energy efficient improvement credit. But for this credit, we can take this credit for eligible property that is installed on a new construction or a reconstruction. And in that case, it's reported when the taxpayer begins using the dwelling unit. Now, this is different from when it's, uh, a, an existing residence. So if it's an existing residence, then we're talking about when it's installed, [00:39:30] when the property is installed, finished, ready to go, when it is a new construction or a reconstruction, a complete rehab. In that case, then we're only going to take that credit once the taxpayer has actually moved into and started using that dwelling unit.
Jeremy Wells: Note that that might be a later date. Uh, we might have more rehab, more renovation going on with that property. Uh, and so it's going to take longer than when [00:40:00] that, uh, clean energy property is actually installed and ready to be turned on. It might take some more time, and that might cause a difference. You might have that clean energy property installed toward the end of one year, and the taxpayer doesn't actually move into that residence until the following year. If this is a new construction or a reconstruction, then we have to wait until the taxpayer actually moves into and starts using that dwelling unit. This is this is a little bit interesting. Uh, generally when [00:40:30] we talk about when property is eligible for either a deduction or a credit, we're usually thinking about when it's put into service. That's not necessarily the case for this property with an existing residence with an existing residence. We can take that credit when it's completely installed, whether it's actually been switched on yet or not. But with a new construction or a reconstruction, we have to wait until the taxpayer is actually living in that unit. And at that point, we might say that it's been put into [00:41:00] service. So for new construction, taxpayer can, uh, might be in a situation where they can't actually pinpoint the explicit costs of that property if it's been rolled up into the overall cost of that residence.
Jeremy Wells: In that case, the taxpayer can request a reasonable allocation of expenditures from the builder, or she can use any reasonable method to allocate the cost of the eligible property. That [00:41:30] comes from Q&A 21 out of that notice 20 1370. So in that case, if the taxpayer tells you they just built a new house, they had some solar attached, they send you the closing statement. Uh, or maybe the developer sent them, uh, some sort of document saying this is how much the property cost, but there's nothing there explicitly itemizing out the cost of that property, that clean energy property. You might either have to tell the taxpayer to go back and get [00:42:00] some more information from the developer actually breaking out those costs. Or, uh, you might be able to come up with some sort of reasonable method, uh, to allocate those costs. But either way, you're going to have to get some more information from the taxpayer for a new construction. If it's not explicitly stated what the cost of that property are. Okay. That's that's a lot. Let's let's summarize some of this up and think about where we're at with our taxpayer. Right. So what do we actually need from the taxpayer. [00:42:30] Let's sum this up. I think we can sum this up into a few bullet points. So first of all we need the taxpayers personal usage of the residence. And if there's any business use we need to be clear on that.
Jeremy Wells: We need to make sure that taxpayers actually using this residence personally and that if there is any business use, meaning if there's a home office in there or a part of it is being rented out, we need to understand the actual, uh, non personal use of this property so that we can allocate that [00:43:00] for later on. We need to know what all of the costs paid were. So we need the receipts, we need the invoices or we need some sort of financing agreement that's going to list all of this out if it was financed. And we need to see if there were any rebates or other incentives that were offered, uh, as part of the sale of this property. For solar electric property, we have to ask the taxpayer if they're selling any of that electricity back into the grid, because we need to be able to allocate for [00:43:30] that. If we've got excess capacity above and beyond what the home actually needs, and then we need to know when the property was either completely installed for an existing residence or in the case of a new construction, when the taxpayer actually moved into that residence. At minimum, that's the information we need from the taxpayer. So in terms of our client, remember we we had a phone call with a client uh, back before tax season. Now it's tax [00:44:00] time. We've got a couple of invoices here.
Jeremy Wells: One to install the solar panels and to actually pay for those solar panels, and then a separate one to do some work to the roof to be able to retrofit that and make sure it's structurally sound, to be able to install those panels. So in terms of thinking about our client situation. We need to make sure one that this is actually their personal residence. So it's eligible. As far as we know. We might want [00:44:30] to ask a few questions just to make sure that there's no rental usage here. Or if there is, we need to be ready to allocate that. Uh, it's a vacation home, but there's always a possibility of maybe there's some business use here. Again, probably not, but we need to make sure. We just need to make sure we understand the total usage of this property, this residence. Um, and once we know that, we'll know how to allocate those expenses. Now, again, back to the two invoices that she [00:45:00] had. One is to install, to purchase and install the panels. The other one is the work done to the roof. The cost for the solar panel installation, those seem to qualify. We'd want to break that down, see if there's any rebates offered in there. Uh, but other than that, uh, we're pretty sure that most of those costs are going to qualify. There may be some things in there we've got to account for, but in general that's going to qualify.
Jeremy Wells: If there is some excess generation of electricity, we might need [00:45:30] to allocate for that. So that's a question we would need to ask the taxpayer as well. Are they using all the electricity generated by those panels or is some of that being sold back to the grid? The parts and labor from the solar invoice are all going to be included in the calculation of the of the credit here, but the cost for the structural retrofitting of the roof, that's probably not going to qualify. So again, if we're talking about installing solar panels that are [00:46:00] that are going to be become a structural part of the roof, then those are eligible according to the code section. But if we're just retrofitting the roof to be able to install those solar panels, that's not going to qualify. So we can take the first invoice for the purchase and the installation of the solar panels we're going to have to set aside the invoice for the roof work. Now, depending on how much that roof work is, the client may or may not like that. Unfortunately, that's just how it's going to have to be. So we're going to need to be able to explain that to the taxpayer. [00:46:30] Now then reporting this. This is all going to get reported on form 5695 residential energy credits. This is all going to go in part one. We're going to start with the address of the residence.
Jeremy Wells: And then in lines one through six, we're going to calculate the credit for the various kinds of property. There's a separate line for each one of the kinds of property here. We're just going to focus on the qualified solar property line seven through 11. If we're talking about any sort of fuel cell [00:47:00] property, that's where we're going to include that here. In the case of our client, that's not relevant. But for one of your clients, if they had some fuel cell property, it might be line 12 is going to be any credit carry forward from the prior year. Now remember this is a nonrefundable credit. So it's entirely possible that the taxpayer is eligible for this credit and a tax year, but can't actually take it because they don't have enough tax liability to need to use it in that year. In that case, [00:47:30] it will carry forward. And eventually, if the taxpayer has enough uncovered liability, then they'll be able to use it in that future year. Then on line 13, we're going to add those amounts together to calculate the maximum credit amount for the tax year. Line 14 we're going to calculate the limitation based on the tax liability. There's a worksheet in the form 5685 instructions. That's going to show you all of the things we need to add [00:48:00] back to the tax liability, to actually find out the amount that we can apply this nonrefundable credit to line 15.
Jeremy Wells: We're going to take the smaller of the maximum and that liability limited amount. Hopefully in the case of this taxpayer we can take the full amount. Otherwise, they're going to have a carry forward into future years. And then line 16 is simply going to give us the amount of credit for the current year. Um, and then if it's limited, line 16 is going to give us the carry over into [00:48:30] the next year. And the calculation is relatively straightforward. Once you correctly account for the eligible cost, that's really going to be the most difficult part of this entire process, is making sure that you're focusing solely on the actual eligible costs for the taxpayer. This is a nonrefundable credit, again, so it can't reduce tax liability below zero. However, there is that carry forward. Uh, this can also offset uh alternative minimum tax AMT. [00:49:00] So if you have a taxpayer that's in a situation where they're paying AMT, this credit is good to offset that as well. Any taxpayer residence again, not just the primary residence qualifies for the credit. I've seen this question a lot. It does not need to be the taxpayer's primary residence. However, if it's a secondary residence, especially if it's a vacation home, we need to especially ask if there's any non-personal use there, such as some short term rental activity or something like that going on. In that [00:49:30] case, we're going to need to offset some of the costs and allocate them just to that personal use.
Jeremy Wells: The taxpayer does have to reduce her basis in the property for the amount of the credit allowed. This is going to be important, especially if this is a secondary residence where we're not going to have that section 121 exclusion. That's going to reduce the basis in that property by the amount of the credit they'll get, an increase from the remainder of the cost of the property, but they're not going to get an increase to the full extent [00:50:00] of the cost, whatever that credit is. If it's that full 30%, then we're only going to be able to apply 70% of those costs to the basis of that property. It's important to track that and include that in the client's file somewhere, so that down the road, when they actually do sell that property, we account for that correctly, uh, in their net gain from the sale of that property or potentially net loss. So that is [00:50:30] the residential energy credit. Clean energy credit in a nutshell. This has been tax in action. I'm your host, Jeremy Wells. I hope you found this episode informative. And I'm looking forward to more episodes where we break down and help you understand how to go from the complicated tax law into how that can be used to actually help your clients and get their tax returns prepared and filed. Be sure to subscribe to the show on [00:51:00] YouTube and your podcast platform of choice. Thanks to my producers, Zach Frank, and to you for listening.
