What an investment tax credit does

An investment tax credit is a dollar-for-dollar reduction in the federal income tax you owe when you buy certain assets for your business or home. Unlike a deduction, which lowers your taxable income, a credit directly cuts the tax bill itself. If you owe $5,000 in tax and you have a $1,000 credit, you pay $4,000.

The IRS allows credits for specific purchases: solar panels and other renewable energy equipment, certain manufacturing equipment, and some business property. The credit percentage and the types of property that may have access to change based on what Congress has approved in recent tax law. You claim the credit on your tax return using Form 3468 (Investment Credit) or Form 5695 (Residential Energy Credits), depending on which credit applies to you.

Credits are most valuable to people and businesses with a tax bill large enough to use them. If you owe no federal tax, or very little, you may not benefit from a credit in the year you make the purchase—though some credits can carry forward to future years.

Key Takeaways

  • Investment tax credits reduce your federal tax dollar-for-dollar, not by lowering your income like a deduction does.
  • The most common credits cover solar energy systems, wind turbines, geothermal heat pumps, and certain business equipment purchases.
  • You claim the credit on Form 3468 (for business property) or Form 5695 (for residential energy), filed with your annual tax return.
  • The credit amount and which assets may have access to depend on current tax law, which changes periodically.
  • If you have no tax bill or a very small one, you may not use the full credit in that year, though some credits allow you to carry the unused amount forward.

The most common types of investment credits

The Investment Tax Credit (ITC) for business property covers equipment used in your trade or business. This includes solar electric systems, solar water heaters, wind turbines, geothermal heat pumps, and certain fuel cell equipment. The credit is typically 30 percent of the cost of the equipment, though the percentage has varied in past years and may change again. You must place the equipment in service (meaning it is installed and working) during the tax year you claim the credit.

The Residential Energy Credit, claimed on Form 5695, covers energy-efficient improvements to your primary home. This includes solar panels, solar water heaters, geothermal heat pumps, small wind turbines, battery storage systems, and certain insulation and HVAC upgrades. The credit percentage and which items may have access to shift based on the tax year. For example, the solar credit percentage has been scheduled to decrease over time, though Congress can change this.

Some older credits, like the Work Opportunity Tax Credit or the Research and Development Credit, serve different purposes and use different forms. This guide focuses on investment credits tied to property and equipment purchases.

How to gather documents before you file

Before you complete Form 3468 or Form 5695, collect receipts and invoices showing what you paid for the equipment. You need the purchase price, the date it was placed in service, and a description of the property. If a contractor installed the equipment, keep their invoice and any documentation they provide about the equipment specifications.

For residential energy credits, you may also need a certification statement from the manufacturer or installer confirming that the equipment meets the IRS efficiency standards. Some manufacturers include this with the product; others require you to request it. Ask your installer or the equipment maker whether they provide this documentation, and request it before you file your return.

If you are claiming a business investment credit, you will also need to know whether the property qualifies as "Section 1245 property" or "Section 1250 property"—this affects how the credit interacts with depreciation. Your accountant or tax software can help you determine this, but the distinction matters for Form 3468.

How the credit affects depreciation and basis

When you claim an investment credit, the IRS requires you to reduce the basis (the cost you use to calculate depreciation) of the property by a percentage of the credit. For most business property, you reduce the basis by half the credit amount. This means the credit saves you tax now, but you depreciate a smaller amount over future years, which reduces your deductions later.

You can elect to avoid this basis reduction, but if you do, the credit amount itself is reduced. Form 3468 walks you through this choice. Most taxpayers accept the basis reduction because the when ready tax savings outweigh the smaller future deductions.

For residential energy credits, the basis reduction rules are different and often more favorable. You generally do not reduce basis for residential credits, which means you get the full credit without a trade-off in future years.

What happens if the credit is larger than your tax bill

If your investment credit exceeds the federal income tax you owe in that year, you cannot use the excess amount to get a refund. However, most business investment credits can be carried back one year or forward up to 20 years. This means if you buy equipment in 2024 but have no tax bill that year, you can use the credit against 2023 taxes (if you had a bill then) or carry it forward to 2025, 2026, and beyond.

Residential energy credits have different carryover rules. Some residential credits can be carried forward indefinitely, while others cannot be carried back or forward at all. Check the instructions for Form 5695 in the year you file to see whether your specific credit allows carryover.

If you have a small business with little or no tax liability, you may want to time equipment purchases strategically—buying in a year when you expect higher income, for example—so you can use the credit. A tax professional can help you plan this.

How to report the credit on your tax return

For business property, you report the investment credit on Form 3468, which you attach to your Form 1040 (individual return) or Form 1120 (corporate return). The form asks you to list each piece of property, its cost, the date placed in service, and the type of property. You calculate the credit percentage based on the property type and the tax year, then enter the total credit on the appropriate line of your main return.

For residential energy improvements, you use Form 5695. This form is simpler: you list the cost of each improvement, confirm it meets the efficiency standards, and calculate the credit. The form then directs you where to enter the credit on your Form 1040.

Both forms require you to keep records of the purchase and installation for at least three years after you file. The IRS can ask to see receipts, invoices, and manufacturer certifications if they audit your return.

When the credit does not explore

Not all energy equipment or business property qualifies. For example, equipment used in a rental property may not may have access to for the residential energy credit (it would use the business credit instead). Equipment you buy for personal use that is not your primary home does not may have access to. Property you lease rather than own typically does not may have access to, though there are exceptions for certain business leases.

The equipment must also meet specific efficiency or performance standards set by the IRS. A solar panel system must be new (not used), and it must be installed on your home or business property. A heat pump must meet minimum efficiency ratings. If you are unsure whether your purchase qualifies, ask the installer or manufacturer, or consult a tax professional before you buy.

Some property that was in service before a certain date does not may have access to. For example, if you installed solar panels in 2019, you may not be able to claim a credit for them in 2024 if the credit rules have changed. The rules depend on when the property was placed in service, not when you file your return.

Frequently Asked Questions

Can I claim both a tax credit and a rebate for the same equipment?

You can claim a federal tax credit and a state or local rebate for the same equipment. However, if you receive a rebate, you must reduce the cost basis of the equipment by the rebate amount before you calculate the federal credit. For example, if solar panels cost $10,000 and you receive a $2,000 state rebate, you calculate the federal credit on $8,000, not $10,000.

What if I buy equipment but do not install it until the next year?

The credit is based on the year the equipment is placed in service (installed and ready to use), not the year you purchase it. If you buy panels in December 2024 but do not install them until January 2025, you claim the credit on your 2025 return. Keep your purchase receipt and installation invoice to prove when the equipment was placed in service.

Do I need a contractor to install the equipment, or can I do it myself?

For most residential energy credits, the equipment must be installed in your home, but you do not have to hire a contractor. However, you still need documentation that the equipment meets the efficiency standards. If you install it yourself, you may need to obtain a manufacturer's certification or specification sheet showing the equipment qualifies. Ask the manufacturer what documentation they require.

Can I claim an investment credit if I am self-employed?

Yes. Self-employed people and sole proprietors can claim business investment credits on their Form 1040 using Schedule C (for business income) and Form 3468. The credit reduces your federal income tax the same way it does for a corporation. Consult a tax professional to make sure you are reporting the property correctly on your business return.

What if I sell the property before the credit carryover period ends?

Selling the property does not affect the credit you already claimed. If you claimed the credit in 2024 and sold the equipment in 2025, you keep the 2024 credit. However, if you have an unused credit that is carrying forward and you sell the property, you should still be able to use the carryforward in future years—the credit is separate from the property itself.