In August 2022, the Inflation Reduction Act revised two credits available for energy efficient home improvements and residential clean energy equipment. The credits are now worth more and extended further than under previous legislation. Let’s find out how you can take advantage of these credits on your 2023 tax return.
The Home Energy Credits should be looked at under two buckets:
- Energy Efficient Home Improvements
- Residential Clean Energy
Energy Efficient Home Improvement Credit
Prior to the passage of the Inflation Reduction Act, the Energy Efficient Home Improvement Credits were known as Nonbusiness Energy Improvement Credits and were limited to a $500 lifetime credit. Not terribly generous under the old rules. But thankfully the new rules allow for a credit up to $1,200 per year, with no lifetime maximum.
So which home improvements can qualify for the credit?
- 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
The credit is computed as:
- The lesser of 30% of your purchase price,
- The annual limit of $1,200, or
- The per item limit listed above
In addition to the items above, there is a credit for electric or natural gas heat pump water heaters, electric or natural gas heat pumps, and biomass stoves and biomass boilers up to $2,000.
Solar water heaters and heat pumps must generally meet Energy Star requirements in order to qualify for the credits.
Therefore, the total maximum Energy Efficient Home Improvement Credit is $3,200 provided that you purchased items from both categories during the year.
Residential Clean Energy Credit
Prior to the passage of the Inflation Reduction Act, the Residential Clean Energy Credits were known as Renewable Energy Credits and were being phased out slowly. These credits were for a maximum of 22% of the purchase price before the passage of the Inflation Reduction Act.
The new rules restore the original 30% credit rate until 2033 when they ratchet down to 26%. The rate is reduced to 22% in 2034 and then is set to expire in 2035.
The following equipment qualifies for the credit:
- 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
It’s important to note that the cost of installation for these items can generally be included in the credit computation. The caveat here is that roof materials may NOT be eligible depending on the type of work being done. If you reshingle a roof while installing solar panels, it is unlikely that the shingles count towards the credit.
Both the Home Energy Credits are considered nonrefundable credits which means that you must have a gross tax liability of at least the credit amount in order to qualify to take the full credit. Taxpayers can, however, carry forward excess unused credit and apply it to any tax owed in future years. The credit is claimed on IRS Form 5695, “Residential Energy Credits.”
Also, keep in mind that the credit reduces your tax basis in your home and must be excluded when figuring out the potential taxable gain on the sale of your home.
The Home Energy Credit rules have been greatly expanded so it’s worth taking another look if it has been some time since you last considered them. Careful tax planning can help optimize your tax credit over the life of home ownership.