Increased non-linear residential loads in today’s distribution system is a concern due to the harmonics related power quality issues. The situation gets worsened by the harmonic resonance introduced by the installation of power factor correction (PFC) capacitor banks in the distribution network. At the same time, more and more renewable energy-based distributed generation (DG) units are being installed in the residential area. These DG systems can be used as an effective way to mitigate the harmonic related power quality problems introduced by the nonlinear residential loads. In literature, very limited work has been done to identify harmonic compensation priorities that should be assigned to different DGs operating at different locations of the distribution system for improved compensation performance. This issue is addressed in this paper. A selective harmonic compensation scheme based on modal analysis is developed to assign compensation priorities on DGs operating at different distribution system nodes for improved compensation performance. A modeled residential distribution system containing distribution components such as distribution line, PFC capacitors, transformers, and household appliances along with DG units is used to verify the improvement of compensation performance. Experimental verification of the proposed method is also provided.