U.S. Department of Energy Energy Efficiency and Renewable Energy

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February 22, 2013
Q.

Are there any federal incentives available for residential rental properties? More specifically, can any residential rental property qualify for the Federal Business Energy Tax Credit? (I understand rental properties don't qualify for the Residential Renewable Energy Tax Credit.) - Jefferson

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A.

This response is written in the context of solar-electric or PV property. Different definitions pertain to solar thermal systems, but the general issues discussed herein are similar. The federal residential renewable energy tax credit contained in 26 USC 25D defines a qualified solar electric system expenditure to be: “an expenditure for property which uses solar energy to generate electricity for use in a dwelling unit located in the United States and used as a residence by the taxpayer.” [emphasis added]. Consequently, you are correct that in most circumstances a residential rental property would fail to meet this requirement.

The federal business energy tax credit contained in 26 USC 48, sometimes referred to as just the “ITC”, employs a somewhat more inclusive definition. For the purposes of the business ITC, qualifying solar property includes “equipment which uses solar energy to generate electricity…excepting property used to generate energy for the purposes of heating a swimming pool”. The law contains additional language that limits the credit to property for which “depreciation (or amortization in lieu of depreciation) is allowable…”. Other requirements exist as well, but the two quoted above are likely the most relevant to the question posed.

With respect to the first, PV equipment falls within this definition, and in most cases will not fall prey to the exclusion for pool heating. With respect to the second, IRS Publication 527 provides guidance on tax issues associated with residential rental property, including that related to depreciation claims. In summary, a taxpayer can depreciate property if he or she owns the property, it is used in an income-producing activity (i.e., renting it), the property has a determinable useful life, and it is expected to last more than one year. The exceptions to this are land, property placed in service and disposed of in the same year, and equipment used to build capital improvements. None of these exceptions should prevent PV system from being considered property eligible for depreciation.

Thus, neither of these requirements presents a general bar to the business ITC being claimed for systems located on a residence. In fact, arrangements where a third-party solar service provider owns a system located on a residential rooftop are increasingly common, and allow the system owner to claim the business ITC as well as depreciation on the system.

Readers should note that many other complications may exist with claiming the business ITC or depreciation. For instance, the sale of ITC property before the credit has fully “vested” (which it does at 20% annually over five years) will trigger recapture of unvested portion of the tax credit, and cost basis for depreciation must be reduced by half of the value of the ITC (i.e., to 85% of the ITC basis).. The numerous details and potential pitfalls cannot be fully summarized here, and in any case are best evaluated in the context of individual circumstances with the services of a qualified tax professional.

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Disclaimer: The information presented does not constitute professional tax advice or other professional financial guidance. It should not be used as the only source of information when making purchasing decisions, investment decisions or tax decisions, or when executing other binding agreements.

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