What are energy tax credits targeting home improvements?
In August 2022, the Inflation Reduction Act amended two credits available for energy-efficient home improvements and residential clean energy equipment, so that they last longer and have a greater financial impact. IRS Link
1. Energy Efficient Home Improvement Credit
Before the update and passage of the Inflation Reduction Act, the energy-efficient home improvement credit amounted to a lifetime credit of $500 through December 31, 2022. It also had a different name, the Nonbusiness Energy Property Credit.
The Inflation Reduction Act amended the credit to be worth up to $1,200 per year for qualifying property placed in service on or after January 1, 2023, and before January 1, 2033, and gave it a new name, the Energy Efficient Home Improvement Credit.
Here’s why that’s important!
Because the new credit has an annual limit rather than a lifetime limit, if you can manage to spread out your qualifying home improvements over the 10-year life of the credit, you could receive up to $12,000 back on your taxes as compared to only $500 allowed under the previous credit.
You can receive up to an additional $2,000 per year for making qualified investments in heat pumps and biomass stoves and boilers.
Which home improvements qualify for the Energy Efficient Home Improvement energy tax credit?
Beginning January 1, 2023, the credit becomes equal to:
- the lesser of 30% of the sum of amounts paid for qualifying home improvements or
- the annual $1,200 credit limit.
In addition to the total $1,200 limit, annual dollar credit limits apply to specific items including:
- Home energy audits: $150
- Exterior doors: $250 per door (up to $500 per year)
- Exterior windows and skylights, central A/C units, electric panels and related equipment, natural gas, propane and oil water heaters, furnaces or hot water boilers: $600
In addition to the $1,200 credit limit above, a separate aggregate yearly credit limit of $2,000 applies to
- electric or natural gas heat pump water heaters
- natural gas, oil, propane water heaters
- a central air conditioner
- electric or natural gas heat pumps
- biomass stoves and biomass boilers.
- an oil furnace or hot water boiler that meets the 2021 energy star efficiency criteria. (Applies if placed in service between 12/31/22 and 1/1/27)
This means you can claim a maximum total yearly energy-efficient home improvement credit amount of up to $3,200.
What is a Qualified Energy Efficiency Improvement?
A “qualified energy efficiency improvement” is an energy-efficient building envelope component that meets all of the following requirements:
- The component is installed in or on a unit located in the U.S. that is owned and used as the principal residence of the taxpayer.
- The original use of the component begins with the taxpayer (component was not previously used).
- The component is reasonably expected to remain in use for at least five years.
The building envelope component is considered energy efficient if it is specifically and primarily designed to reduce the dwelling unit’s heat loss or gain when installed.
The component also needs to meet the prescriptive criteria for that component established by the most recent International Energy Conservation Code (IECC) standard in effect as of the beginning of the calendar year. Which is two years before the calendar year in which the component is placed in service.
Examples of qualifying components include:
- Insulation material or systems
- Exterior windows
The term “residential energy property expenditures” includes expenditures for labor costs properly allocable to the onsite preparation, assembly, or original installation of the property.
2. Residential Clean Energy Credit
sidential Clean Energy Credit The second credit homeowners are eying is The Residential Clean Energy (RCE) Credit. It is a renewable energy tax credit extended and expanded by the 2022 Inflation Reduction Act. Again, this credit is worth 30% of certain qualified expenses for residential clean energy property. The Inflation Reduction Act extended and modified the existing energy credit through 2034, modified the applicable credit percentage rates, and added battery storage technology as an eligible expenditure.
The credit applies for property placed in service after December 31, 2021, and before January 1, 2033.
Starting in 2033, the credit percentage rate phases down to 26% for 2033, then to 22% for 2034, and finally to no credit being available after December 31, 2034.
Which equipment qualifies for the Residential Clean Energy Credit?
Equipment that qualifies for the Residential Clean Energy Tax Credit includes solar, wind, geothermal, and fuel-cell technology:
- Solar panels, or photovoltaics, for generating electricity
- Solar-powered water heaters for water used inside the home (at least half of the home’s water-heating capacity must be solar and water for swimming pools and hot tubs doesn’t qualify)
- Wind turbines that generate up to 100 kilowatts of electricity for residential use
- Geothermal heat pumps that meet federal Energy Star guidelines
- Fuel cells that rely on a renewable resource (usually hydrogen) to generate power for a home (minimum 0.5 kilowatts of power generation capacity)
- Battery storage technologies
How do energy tax credits work?
Energy tax credits are incentives offered by the government to encourage citizens to invest in energy-efficient products and services. Credits are typically applied to a taxpayer’s income tax liability and thereby can offset the cost of energy-saving improvements such as insulation, windows and doors, solar panel systems, or other qualifying renewable energy sources.
Are energy tax credits refundable?
Energy tax credits aren’t refundable tax credits. This means that you can reduce your total tax to zero if you have a large enough credit. But, you can’t get any excess credit amount as a payment to you on your tax return if you have more energy credit than your total tax. Any unused energy tax credit claimed on your tax return can roll forward to future years and offset tax liability in those years.
Will these energy efficiency tax credits make home improvements more cost-effective?
Generally, yes. Not only can energy efficiency home improvements lower the cost of heating and cooling your home, but these credits also help to lower the cost of purchasing them. As a result, these tax credits can prove cost-effective if used in combination with home improvements that also lower your cost of living.
Some other good news about the Energy Efficient Home Improvement Credit is there is no phase-out for higher-income taxpayers, and a taxpayer who qualifies for both the energy efficient home improvement credit and the residential energy efficient property credit can claim both.
How can I maximize my tax credits?
Given the way the annual aggregate limits are structured, it can work out better to spread your improvements over a few years.
If your heating or cooling system is old, and you are considering a new air source heat pump, it is always wise to optimize your attic insulation first, so you don’t pay for more heating and cooling than you actually need.
Making these upgrades together in one year would allow you a tax credit of up to $1,200 for the insulation and up to $2,000 for the heat pump.
Similarly, you could combine a heat pump installation with window/door replacements. In that scenario, the $2,000 credit for the heat pump could be combined with tax credits up to $600 total for the windows/skylights plus $500 for two or more doors.
If you replace your water heater the following year, you would be eligible for another 30% tax credit, up to$2,000 plus up to $600 if you need an electric panel upgrade to accommodate the new water heater.
High-Efficiency Electric Home Rebates
Although not a tax credit, the High-Efficiency Electric Home Rebate Program will also help American families go green. The program, which was added by the Inflation Reduction Act, will provide rebates to low- and middle-income families who purchase energy-efficient electric appliances. To qualify for a rebate, your family’s total annual income must be less than 150% of the median income where you live.
Qualifying homeowners can get rebates as high as:
- $840 for a stove, cooktop, range, oven, or heat pump clothes dryer;
- $1,750 for a heat pump water heater; and
- $8,000 for a heat pump for space heating or cooling.
Rebates for non-appliance upgrades will also be available up to the following amounts:
- $1,600 for insulation, air sealing, and ventilation;
- $2,500 for electric wiring; and
- $4,000 for an electric load service center upgrade.
There are limits on the amount certain families can get, though. For instance, a rebate can’t exceed 50% of the cost of a qualified electrification project if the family’s annual income is between 80% and 150% of the area median income. Each qualifying family will also be limited to no more than $14,000 in total rebates under the program.
The $4.5 billion to be allocated for rebates will be distributed to families through state and tribal governments that establish their own qualifying programs. The funds will be available through September 30, 2031.
Note: Tax credits for home improvements that expired in 2017 were retroactively extended through December 31, 2021. Those currently in place might change in the future. In other words, a tax credit that exists today for, say, replacing your hot water heater with a solar water heating system, might not exist in a few years or, if it does exist, might not be for the same dollar amount.
Although the tax credits for energy-efficient home improvements expire at the end of 2021, you always have the option to refile your return from a previous year you made a qualifying home improvement, going back to 2017. If you are just learning about the available tax credits and did not claim them in 2017, 2018, 2019, or 2020, you are eligible to refile.
It is recommended that you consult your tax adviser about your individual tax situation. This guide is meant to provide general information only.
Here are some more resources to help you find out exactly what you can get in terms of tax credits or rebates.
- Save More on Green Home Improvements – Kiplinger
- Homeowners’ Guide to Energy Tax Credits and Rebates – Constellation
- Federal Tax Credits – Rheem
- Water Heater Incentives – Rheem (pdf)
- Federal Income Tax Credits and Incentives – Energystar
- Clean Energy For All – White House
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