How Does Bonus Depreciation for Solar Work?

Bonus depreciation is a federal tax incentive that permits businesses to deduct a large percentage of the cost of qualifying assets, including solar energy systems, in the first year they are placed in service. This accelerated depreciation method improves cash flow by reducing a business’s taxable income sooner than standard depreciation schedules allow. Initially set at a 100% deduction by the Tax Cuts and Jobs Act of 2017, this provision is now in a phase-down period.

Eligibility Requirements for Solar Bonus Depreciation

To qualify for bonus depreciation, a solar energy system must be used for business or income-producing activities, as personal use systems are not eligible. This includes solar panels, inverters, racking, and energy storage devices like batteries if charged by the solar array. A primary requirement is the “placed-in-service” rule, meaning the deduction is taken in the tax year the system becomes operational. The property must also have a recovery period of 20 years or less under the Modified Accelerated Cost Recovery System (MACRS), and solar property qualifies as five-year property.

Interaction with the Investment Tax Credit

Before calculating bonus depreciation, a business must account for the solar Investment Tax Credit (ITC). The ITC is a separate and distinct incentive that provides a dollar-for-dollar reduction in federal tax liability. For systems placed in service between 2022 and 2032, the credit is generally 30% of the total project cost, assuming certain labor requirements are met or the project is under one megawatt in size. The credit then reduces to 26% for systems placed in service in 2033 and to 22% for systems placed in service in 2034.

When a business claims the ITC, a mandatory basis reduction rule applies. The depreciable basis of the solar asset—the amount on which depreciation deductions are calculated—must be reduced by one-half of the value of the ITC claimed. For a 30% ITC, this means the depreciable basis is lowered by 15% of the system’s cost, resulting in a final depreciable basis of 85% of the original cost. This adjustment is not optional and must be made before any depreciation.

This basis reduction directly impacts the total amount of depreciation that can be claimed over the life of the asset. It ensures that a business does not receive a duplicative tax benefit on the portion of the investment covered by the tax credit.

Calculating the Bonus Depreciation Deduction

For example, consider a solar project with a total cost of $500,000 placed in service in 2025. First, calculate the 30% ITC, which amounts to $150,000 ($500,000 x 0.30). Next, determine the required basis reduction, which is half of the ITC, or $75,000 ($150,000 x 0.5). Subtracting this reduction from the total cost gives a final depreciable basis of $425,000 ($500,000 – $75,000).

The bonus depreciation percentage is then applied to this adjusted basis. For property placed in service in 2025, the bonus rate is 40%, so the first-year bonus depreciation deduction would be $170,000 ($425,000 x 0.40). This amount is deducted from the business’s taxable income in the first year. The bonus rate is scheduled to decrease to 20% for property placed in service in 2026 before phasing out. The remaining basis of $255,000 is then depreciated over the standard five-year MACRS schedule.

Claiming the Deduction and State Tax Implications

To claim bonus depreciation for a solar asset, a business must file IRS Form 4562, Depreciation and Amortization, with its federal income tax return. The special depreciation allowance is reported in Part II of this form. The form requires the taxpayer to enter the total cost of the eligible property and calculate the deduction based on the applicable percentage for the year the asset was placed in service.

A business must also consider how its state treats bonus depreciation, as not all states conform to the federal tax code. Some states automatically adopt federal changes, while others have “fixed date” conformity and may not recognize current bonus depreciation rules. In states that decouple from the federal provision, a business may be required to add back the bonus depreciation amount on its state tax return.

This creates a separate depreciation schedule for state tax purposes, where the asset is depreciated according to state law. This difference between federal and state tax treatment necessitates careful record-keeping and an understanding of specific state tax regulations. Businesses should verify their state’s conformity status to ensure accurate tax filing.