Solar Leases can be complex to navigate and are often misunderstood. If you are a business or farm looking to understand more about leasing, here is what you need to know. There are two types of leases for solar energy - Capital Leases and Operating Leases. They function very differently and understanding your financial situation is important when choosing which one will work best for you. Here's a look at how the two options compare.
Capital Lease
With a capital lease, the lessee is able to capitalize on all the tax and depreciation benefits that come with solar. However, the monthly payments are typically higher than an operating lease option. At the end of the lease term, the lessee has the option to buy the system from the bank.
Operating Lease
With an operating lease, the Lessor owns the solar system and the Lessee makes a monthly payment to the Lessor. In this scenario, the Federal Tax Credit would go to the Lessor. This is lease option is best for a business that cannot utilize the tax and depreciation benefits that come with a solar system. The Lessee can decide to purchase the solar system or renew the lease terms when the operating lease expires.
Both Lease Options at a Glance
| Capital Lease | Operating Lease |
|---|---|
| Ownership conveys to the Lessee | Ownership conveys to the Lessor |
| Federal Income Tax Credit goes to the Lessee | Federal Income Tax Credit goes to the Lessor |
| Financed by a note payable | Entire monthly payment is an expense and thus tax deductible |
| The equipment is capitalized as an asset | Does not show as an asset or liability on the balance sheet |
| Depreciated which reduces taxable income | Can not be depreciated |
| Counted as debt | Off-balance-sheet financing |
Tax Implications for Capital and Operating Leases
A capital lease is treated like owning an asset. An operating lease is an expense that remains off the balance sheet. One way to think of it is owning vs renting a piece of equipment. A capital lease is owning the equipment and an operating lease is like renting the equipment from a tax perspective. That being said, typically at the end of the life of an operating lease, ownership will transfer to the Lessee.
Final Thoughts
It should be stated that operating leases for solar are rarely used. If a business or farm is looking at an Operating Lease because they can not take advantage of the Federal Income Tax Credit, they probably are not showing enough profit to qualify for an Operating Lease.
We're here to provide guidance as you learn which solar financing option is best for you. Gives us a call or complete a contact form to have your questions answered.
