Residential Energy Credits
So that the United States can wean itself off of foreign sources of energy, the American Recovery and Reinvestment Act was enacted to provide tax credits to offset the cost of installing energy efficient improvements to residences. However, not all products that are designated as ENERGY STAR products that can be used in home improvements qualify for the credit.
Tax law distinguishes between 2 types of improvements, which differ as to whether the property credit can be applied to the installation costs. The nonbusiness energy property credit can be applied to energy efficiency improvements, such as energy-efficient windows, doors, roofs, and added insulation, but not the installation costs. On the other hand, the residential energy-efficient property credit for residential energy property, such as water heaters and stoves that use biomass fuel, and high-efficiency heating and air-conditioning systems, can also be applied to the installation costs. The residential energy-efficient property credit covers investments in alternative sources of energy, such as solar, wind, geothermal, and fuel-cells. The calculation for the credits, with detailed instructions, is on Form 5695, Residential Energy Credits. Both credits are added together and listed on Form 1040.
Because the nonrefundable residential energy credits are the last credits listed in the Tax and Credits section of Form 1040, all credits listed earlier — such as the foreign tax credit, the credit for child and dependent care expenses, education tax credits, the retirement savings contributions credit, and the child tax credit – that are claimed by the taxpayer may reduce the amount of residential energy credits that can be claimed, since the total credits in this section cannot exceed the taxpayer's ordinary income tax liability. However, any unused amount credit can be carried forward to the next tax year. Moreover, the residential energy credits can be used offset both regular and AMT liability.
The tax basis of the home must be adjusted downward by the amount of any residential energy credits claimed. So if a taxpayer owns a home with an adjusted basis of $100,000 and claims $3,000 worth of residential energy credits for the home, then the adjusted basis of the home will be $100,000 – $3,000 = $97,000.
Nonbusiness Energy Property Credits
The nonbusiness energy property credit can only be used for improvements to a principal residence within the United States and only if the improvements are placed in service before 2021. (This tax credit has been extended several times.) Owners of cooperatives or condominiums can split the cost of installing the equipment with other unit owners. The taxpayer must be the original user of the equipment, which must be expected to last at least 5 years.
The credit = 10% of the cost of exterior windows and skylights and 100% of the cost of other qualified improvements, with a total lifetime aggregate limit of $500, so if you already claimed $500 of this credit in prior years, then no additional credit can be claimed.
Specific maximum dollar limits apply for specific improvements:
- $200 for exterior windows, including storm windows and skylights;
- $300 for water heaters, heat pumps, central air conditioners or other energy-efficient building property;
- $150 for a furnace or boiler;
- $50 for an advanced main air circulating fan used in a furnace.
The nonbusiness energy property credit is only available for those improvements that are approved by the IRS. The improvements must meet energy efficiency standards approved by the IRS to qualify for the credit. Qualified energy efficiency improvements are any energy efficient building envelope component that satisfies the energy conservation criteria set by tax law. A building envelope component is any material or system designed to reduce heat loss or gain.
The taxpayer can rely on the manufacturers' written certification that its products qualify for the credit. The certification does not have to be attached to the tax return, but it should be retained by the taxpayer as a record.
Residential Energy-Efficient Property Credit
The residential energy-efficient property credit can be claimed for up to 30% of the cost for qualified residential solar panels, solar water heating equipment, wind turbines, and geothermal heat pumps, including on-site preparation, assembly, and installation. However, heating equipment for a pool or hot tub does not qualify for the credit. If the heating equipment heats both a home and a pool or hot tub, then only the prorated cost allocated to the home is deductible.
There is no dollar limit on the credit, and most residences qualify, even if it is not the taxpayer's principal residence. However, the credit is limited depending on when the property was placed in service:
- If the property was placed in service after 2016 but before 2020, then the credit is 30%.
- For property placed in service after 2019 but before 2021, the credit is 26%.
- For property placed in service after 2020 but before 2022, the credit is 22%.
The new Consolidated Appropriations Act for 2021 (H.R. 133), signed into law on December 27, 2020, allows a 26% rate to apply to property placed in service during 2021 and 2022, then decreases to 22% in 2023. Also qualifying for this credit is a biomass fuel property with a 75% efficiency rating.
There is also a qualified fuel-cell property credit that can cover the cost of up to 30% of the fuel-cell, but it must be installed in a principal residence within the United States, and is subject to a limit based on kilowatt capacity. The fuel-cell must have at least 1/2 kilowatt of electrical capacity and the credit cannot exceed $500 for each additional half-kilowatt.