How Does the Investment Tax Credit (ITC) Work?
Navigate the Investment Tax Credit (ITC). Understand its structure, how to qualify, calculate, claim, and manage this federal incentive.
The Investment Tax Credit (ITC) is a federal tax incentive designed to encourage investment in specific types of property. It allows taxpayers to reduce their federal tax liability by a percentage of the cost of eligible investments. This credit primarily aims to stimulate the adoption of clean energy technologies, though it can also apply to other qualified business improvements. The ITC helps to lower the upfront financial burden for individuals and businesses.
Understanding Eligibility and Qualified Investments
Eligibility for the Investment Tax Credit varies depending on the taxpayer and the type of property. For businesses, under Section 48, the credit applies to investments in eligible renewable energy projects and other designated property. The equipment must be new, meaning its original use must begin with the taxpayer, or the system must be constructed by the taxpayer.
Solar energy equipment (photovoltaics, solar water heating)
Geothermal electric and heat pump systems
Fuel cell property
Small wind energy property
Energy storage technology
Combined heat and power systems
For individuals, the Residential Clean Energy Credit, found in Section 25D, provides a similar incentive for clean energy installations in their homes. The property must be installed in a dwelling unit located in the United States and used as a residence by the taxpayer.
Solar electric property
Solar water heating property
Qualified fuel cell property
Small wind energy property
Geothermal heat pumps
Battery storage technology
A common requirement for both business and residential property is that it must be “placed in service” during the tax year the credit is claimed. This generally means the property is in a condition or state of readiness and availability for its specifically assigned function.
Determining Your Credit Amount
The Investment Tax Credit amount is calculated as a percentage of the eligible basis of the qualified property. The “eligible basis” refers to the cost of the property, including equipment and installation expenses.
For many qualified energy properties, the base credit rate is 6%. This rate can increase to 30% if prevailing wage and apprenticeship requirements are met. For residential clean energy property, the credit is generally 30% of qualified expenditures.
Additional bonus credits can further increase the total credit amount. Projects located in “energy communities” or those meeting domestic content requirements can receive an additional 10% bonus. Another bonus may apply for projects benefiting low-income communities. The credit amount directly reduces the taxpayer’s overall tax liability.
Reporting the Credit on Your Tax Return
Once the Investment Tax Credit has been calculated, it must be properly reported on the tax return. Businesses typically use IRS Form 3468, “Investment Credit,” which is then attached to their tax return.
Individuals claiming the Residential Clean Energy Credit report it on IRS Form 5695, “Residential Clean Energy Credit,” attached to Form 1040. Taxpayers should retain all supporting documentation, such as purchase invoices and installation records.
Important Considerations After Claiming
After claiming the Investment Tax Credit, taxpayers must be aware of certain ongoing rules and potential implications. One significant concept is “recapture,” which means a portion of the previously claimed credit may need to be repaid if certain conditions are not met within a specific period. This typically occurs if the qualified property is disposed of or ceases to be used for its intended purpose within five years of being placed in service.
Another consideration is the reduction in the property’s basis. For many investment credits, the tax basis of the property must be reduced by a portion of the credit amount. This basis reduction affects future calculations, such as depreciation deductions and the gain or loss upon sale of the property.
If the credit amount exceeds the taxpayer’s tax liability in the year it is claimed, any unused portion of the credit may be carried forward. This allows the taxpayer to apply the excess credit to reduce tax liability in future years.