Can You Get a Tax Deduction for a Solar Loan?

Installing solar panels can help you save money on energy costs for years to come, but the initial expense can be overwhelming. According to Homeadvisor, the average cost to install solar panels on your roof is $21,429.

Fortunately, the federal government offers some help, giving you a 30% tax credit on the installation costs through 2019, after which it drops to 26% in 2020, 22% in 2021, and nothing after that. This credit allows homeowners who purchase solar systems outright to deduct a percentage of the costs as a tax credit. A tax credit is a dollar-for-dollar reduction of the income
taxes you would pay to the IRS. If you’re considering an investment in solar energy, you could save nearly a third of the cost with this tax credit.

How do you apply for a solar installation tax deduction?

  1. Check you’re eligible for the Federal tax credit
  2. Complete IRS Form 5965 to validate your qualification for renewable energy credits
  3. Add the renewable energy credit information to your form 1040

But the IRS solar tax credit isn’t the only way to get a tax break on your solar energy system.

How to get a tax deduction for a solar loan

Because of the high cost of installing solar panels, it’s likely that you’ll need to finance them. There are several ways to do that, but only two make it so that you can deduct the interest you pay when filing your taxes.

A home equity loan and home equity line of credit (HELOC) are special loans because they’re tied to your house. For example, a home equity loan is often called a second mortgage.

Essentially, you’re borrowing from the equity in your house when you use one of these options. And because mortgage interest is deductible, so is interest you pay on a home equity loan and HELOC.

“Using a home equity loan, we got a better interest rate and tax deductibility of the interest,” says Michael Dinich, a financial advisor from Pennsylvania.

That’s a big benefit. But it’s not necessarily the best option for everyone.

3 things to know before you get a home equity loan or HELOC

1. You might not get enough

“Not everyone will have enough equity in their home to consider a home equity loan,” says Dinich. Because a home equity loan and HELOC are based on the equity in your home, you have to have sufficient equity to borrow against.

Not everyone will have enough equity in their home to consider a home equity loan”

For example, say your home is worth $300,000, and your mortgage balance is $280,000. This means that you have $20,000 in equity. Just because you have that equity, though, doesn’t mean you can borrow $60,000.

Some lenders won’t allow you to go above a certain loan-to-value ratio. If that number is 80%, you’ll only be able to borrow $16,000.

2. Home equity loans and HELOCs are expensive to set up

Again, the amount you can borrow on these loans is tied to the value of your house. So, just as when you got your mortgage, you have to pay to have an appraisal done, which costs $328 on average.

You may also have to pay other fees, like an origination fee, title fees, document preparation, an application fee, and more. All in all, the fees can be as high as 2% to 5% of the loan amount.

3. You’re putting your home at risk

Once you get a home equity loan or HELOC, the lender now has a financial interest in your home. This means that, if you default on the loan or line of credit, the lender can repossess your house. As such, only apply for one of these if you know for sure that you’ll be able to pay it off.

Is getting a tax deduction for a solar loan worth it?

Using a home equity loan or HELOC to finance your solar panels comes with a nice tax break. “Compared to a personal loan, home equity loans generally have better interest rates and longer repayment terms,” says Dinich.

He adds, “The longer repayment term can be important in renewable energy projects as it can take a number of years to recoup expenses.”

But because of the upfront costs and risks involved, you might want to consider other options.

Getting a personal loan, for example, means that your debt is unsecured and you don’t lose the house if you default. The process is usually smoother, and you can often find lenders who don’t charge an origination fee. Interest rates on personal loans can be high, though, especially if your credit isn’t stellar.

Another option is to get a Title 1 FHA Loan. These loans are designed specifically to help you finance home improvements that boost the home’s energy efficiency.

Final thought

Carefully consider all of your options before getting a solar loan. If getting a tax deduction is worth the extra costs of setting up a home equity loan or HELOC, go for it.

But if you think the costs outweigh the benefits, consider a personal loan or Title 1 FHA Loan to help you cover the costs of installation.

The important thing is that you do your research so that you know for sure you’re making the right decision for your situation.

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