Installations of residential solar roofs have increased steadily over the past few years. Purveyors of solar system installations tout that the projects “pay for themselves” after federal and state tax incentives and energy savings. But is it really worth it? Maybe, maybe not. There are many variables to consider to determine whether a solar installation will result in savings for you. Even if you do realize savings, it often takes longer than anticipated to recoup the costs.
What are the up-front costs?
Costs will vary by location, sun exposure, and size and complexity of the system. Most of the solar installations I have seen fall in the $25,000 to $30,000 range. Since this is an expensive project, be sure to obtain multiple quotes if you are considering installing solar (or “photovoltaic” by its technical name).
You can pay for the project up-front in cash or finance the project. Many installation outfitters will give you information on financing, but you might be able to find less expensive financing on your own—such as through a home equity loan or line of credit—so it is worth exploring options beyond those provided by the installation company. Be sure to factor any financing cost into your computations when analyzing whether you will realize savings.
A third option is to lease a solar system instead of purchasing one. There are fewer up-front costs, but since you do not own the system it does not increase the value of your home and you may not be eligible for tax incentives. When the lease expires, the owner of the solar system removes it if you decide not to renew the lease.
What tax incentives are available?
At the federal level, you are eligible for a nonrefundable tax credit of 30% of qualified solar electric property costs in 2023. If your solar system costs $27,500, this means your federal tax liability is reduced by $8,250. (Whether you pay for the system up-front or finance the project costs is irrelevant. You still receive this tax benefit.) If your federal tax liability for the year is less than $8,250 before the credit, your liability is reduced to zero, and any unused amount is carried forward to the following year.
The credit is called the Residential Clean Energy Credit, and is claimed on Part I of Form 5695. Besides solar electric property costs, the credit is also available if you incur qualified property costs for solar water heating, small wind energy, geothermal heat pump, biomass fuel, and fuel cell. There is no limit to the amount of the Residential Clean Energy Credit available (before applying the per-year limit based on overall tax liability).
Another federal tax incentive is the Energy Efficient Home Improvement Credit, which is claimed on Part II of Form 5695. The Energy Efficient Home Improvement Credit generally targets smaller projects (like insulation, exterior doors and windows, and certain types of heating and cooling systems) and has a $500 lifetime limitation.
Some states also offer similar incentives for solar installation, but they often come with additional requirements. Utah, for instance, offers a Renewable Residential Energy Systems Credit that largely mimics the federal version, and Utah residents must receive advance approval before claiming it on their taxes. (As of the time of writing, the Utah credit will not be available for systems installed on or after January 1, 2024.)
How would solar save me money on a monthly basis?
Solar works by reducing your reliance on the electrical grid, thus reducing your monthly electric bill.
If net metering is available, the electric company effectively buys electricity from you when your home produces more electricity than it uses. When your home consumes more than it produces, you buy from the electric company. You only pay an electric bill at the end of the month on the net (hence the name)—i.e., if you use more electricity than your home produces. While this makes a lot of sense for an individual homeowner, net metering has become a controversial practice because of the various external factors involved. (Do a simple Google search for “net metering controversial” to get an idea!)
Most solar installations nowadays include a solar battery, so you can use the electricity generated by the sun during the day to power your home at night. Battery storage is becoming progressively more efficient in terms of cost and storage capacity, so this will be an exciting development to watch. Storage is a vital aspect of clean energy development.
Knowing how much your electric bill should be after installing a solar system is a fairly straightforward computation. First, calculate your monthly average electricity usage. Examine your electric bills for the past twelve months, write down your kilowatt-hours (kWh) consumed per month, and take the average. Next, subtract the kilowatt-hours that your solar system will generate. The vendor should be able to provide this information. (Remember that they are trying to sell you a product. Take their estimate with a grain of salt, and perhaps discount it somewhat. Averages are better than claims like “your system may generate as much as” a certain amount.) The difference between these two is your new average electricity usage. Use this to calculate your expected monthly electric bill based on applicable rates. For example, if your expected net usage is 250 kWh, and your electricity cost is $0.07 per kWh, your new bill would be $17.50 (i.e., 250 × $0.07).
Calculating your electric bill will probably not be as simple as multiplying the expected usage by the cost per kWh. For example, we have tiered rates based on our overall electric usage for the month plus some fixed costs that apply regardless of our actual usage. As a result, if we tried to short-circuit (pun intended!) these steps by multiplying the expected energy produced by a solar system by our marginal energy rate cost, the resulting figure would be an inaccurate estimate of our expected monthly savings.
What else impacts my overall savings?
If the reduction in your monthly electric bill is more than the total monthly financing cost, your solar system literally pays for itself from day one. (For example, paying $30/month for electricity and $150/month to finance your solar system is less than paying $210/month for electricity.) But if you sell your home before paying off the solar loan, you will have to pay off the solar loan from the sales proceeds, so you might end up losing money on the solar installation. Do not finance your solar installation if you do not expect to own your home long enough to pay off the loan.
If you finance your solar installation project, know that the total cost over time includes the interest paid, not just the project cost minus tax incentives. Additionally, the potential deductibility of interest paid on your solar loan is of no use if you take the standard deduction when filing your taxes.
If you choose to pay upfront, the computations are easier. Your total outlay is the project cost minus tax incentives. (Keep in mind that you must pay the full project cost out of pocket, and you do not receive the benefit of the tax incentives until you file your tax return the following year.) Simply divide your after-tax project cost by the average monthly savings in your electric bill—over an entire year to account for seasonal fluctuations—to gauge how long it will take to recoup your costs. This is typically five to fifteen years. Will you own the home for that long? Consider also that the recoupment period will probably be longer in reality because cost savings rarely seem to materialize as much as you hope.
Even if you recoup your costs on an absolute dollar-for-dollar basis, do not ignore the time value of money. Recouping your costs means that you had a 0% return on your investment for that amount of time, and only after that will you be actually saving money. Use the Rule of 72 to figure your average annual savings you will realize after the recoupment period: simply divide 72 by the number of years it will take to recoup your costs.
To know whether a solar installation makes long-term financial sense, you must also consider how long you expect to own the home.
Calculate your recoupment period.
Divide 72 by the result (expressed in years) from step 1. This tells you your average annual savings, expressed as a percentage of your initial investment, after the recoupment period.
Estimate the length of time (in years) you will continue to own the home after completing the installation project.
Subtract your step 1 result from your step 3 result. (In other words, step 3 minus step 1.) This gives you the number of years that you will actually be saving money after recouping your costs.
Divide step 4 by step 3, and then multiply the result by step 2. This gives you the net annualized return on your investment while you expect to continue to own the home. After all, once you no longer own the home, you will not realize any savings from the reduced monthly electric bill.
Compare the result from step 5 to the rate of return you would expect to receive by investing the (after-tax) funds for your solar project costs, based on how you would invest the money if you did not spend it on a solar system. Which path—solar system or passive investing—will leave you better off by the time you expect to no longer own the home?
Notice how I framed this in terms of “owning the home” rather than “living in the home.” Given that many folks will move out of a home, retain ownership, and rent it out, the difference is not simply semantics. However, the above calculations only work if you bear the effective responsibility for the electric bill. If you rent out your home and your tenants pay utilities directly or reimburse you for the amounts billed each month, they bear the effective responsibility for the bill. In that scenario, you are no longer saving money on electric costs, so you should replace “owning the home” with “living in the home” in making your cost comparison.
Does installing solar increase my home value?
Maybe. Whether solar installation increases your home value, and by how much, is very dependent on local conditions. Even if it applies, you will not realize this benefit until you sell the home. By then, the impact of solar on your home value may be vastly different or nonexistent than it was when first installed. In the meantime, if solar increases your home value, expect an uptick in your property tax bill.
Put this all together for me. Is solar with it?
Maybe, maybe not. If you can afford to pay for your project without borrowing money, will actually recoup your costs in relatively few years, and live in the home for a long time after recouping the costs, then perhaps it makes financial sense over time. But more often than not, the project goes over budget, the expected savings do not quite materialize, you end up moving sooner than expected, and/or other variables come into play that leave you financially worse off in the long run than if you had just passively invested the money at the outset.
In short, do not invest in solar if your primary justification for doing so is financial.
Comments