Energy Efficient Home Improvement Credit

In this week’s post, I explain the basics of the Energy Efficient Home Improvement Credit.

Last week, a reader asked a question about the new tax credits that are available for certain HVAC equipment. This post will explain the basics of the Energy Efficient Home Improvement Credit, which includes credits for certain HVAC improvements. As I have mentioned, if you have a tax topic that you would like to learn about, please let me know and I can write a post about it.

Before we get started, it is important to remember the basics of tax credits. Tax credits reduce tax liability dollar-for-dollar. A credit is different from a deduction, because a credit reduces tax and a deduction just reduces taxable income. In order to review these fundamentals, see our post from several weeks ago, Basic Income Tax Formula.

What is the Energy Efficient Home Improvement Credit?

The Energy Efficient Home Improvement Credit was part of the Inflation Reduction Act, which was passed last year. It provides tax credits for various qualifying energy efficient improvements to a taxpayer’s primary residence, such as: energy efficient doors, windows, insulation, air conditioners, water heaters, boilers, heat pumps, and more. The credits apply to improvements made on or after January 1, 2023.

Because the law was just recently passed, there are not an overwhelming number of resources available about it. If you would like more information, you may consider reviewing the law itself (Internal Revenue Code Section 25C) and the available IRS guidance.

The Inflation Reduction Act included a number of other interesting provisions, that we may explore in future posts, including:

• Residential Clean Energy Property Credit – this credit incentivizes the implementation of various renewal energy products/systems.

• More closely related to the Energy Efficient Home Improvement Credit, are the potential for rebates for purchasing energy efficient products. These rebates are supposed to be especially meaningful for low and moderate income earners. As best I can tell, these programs are not yet set up, but are supposed to be later in the year. There will likely be overlap between the rebate programs and the Energy Efficient Home Improvement Credit.

How to determine if your energy efficiency improvements qualify

Because of the different aspects of the credit, I think it is best to determine whether or not improvements qualify by asking the following questions:

• Does the expense/product meet qualifying standards?

• Do specific expense/product limits apply?

• Do the total/aggregate limits apply?

Does the expense/product meet qualifying standards?

Not all expenses/products qualify for the energy efficient home improvement credit – only items that meet certain efficiency standards. This is the goal of the law – to incentivize the use and adoption of more energy efficient systems.

The law and related guidance use several different organizations and metrics to set the efficiency standards:

• Energy Star – government program to promote energy efficiency.

• Consortium for Energy Efficiency (CEE) – non-profit whose goal is to promote energy efficiency.

• International Energy Conservation Code (IECC).

• Different standard metrics that are used to measure the efficiency of different machines, such as: SEER2, EER2, HSPF2, AFUE.

Here are brief descriptions of the qualifying standards, some of which reference resources from the organizations mentioned above. The standards get a little complicated, so we will not go into all of the details here:

• Exterior doors – Must meet applicable Energy Star requirements.

• Exterior windows and skylights – must have Energy Star's most efficient certification.

• Insulation, air sealing – must meet International Energy Conservation Code (IECC) standards from two years prior.

• Home energy audits – must meet certain requirements.

• Residential energy property and heat pumps – must meet or exceed the highest efficiency tier (not including an advanced tier) established by the Consortium for Energy Efficiency (CEE). This property includes:

  • Central air conditioners.

  • Natural gas, propane, or oil water heaters.

  • Natural gas, propane, or oil furnace or hot water boilers.

  • Electric or natural gas heat pump water heaters.

  • Electric or natural gas heat pumps.

• Biomass stoves and boilers – thermal efficiency rating of at least 75%

• Electrical work related to energy efficiency improvements – consistent with National Electric Code, load of at least 200 amps.

Some websites of HVAC suppliers/manufacturers already identify which specific pieces of equipment meet the standards. I assume there will be increasing clarity about which expenses/products qualify as the law becomes better understood.

Do specific expense/product limits apply?

The tax credits for different expenses have specific limits. Here are the limits, divided into the following categories: building envelope, home energy audits, residential energy property, heat pumps and biomass stoves/boilers:

• Building envelope:

  • Exterior doors – Credits are equal to 30% of costs. Limited to $250 per door. Annual total is limited to $500.

  • Exterior windows and skylights – Credits are equal to 30% of costs. Annual credit limit of $600.

  • Insulation, air sealing – Credits are equal to 30% of costs.

• Home energy audits – Credits are equal to 30% of costs. Limited to $150.

• Residential energy property – Credits are equal to 30% of costs (including labor). There is a limit of $600 per item:

  • Natural gas, propane, or oil water heaters.

  • Natural gas, propane, or oil furnace or hot water boilers.

  • Central air conditioners.

  • Electrical work related to improvements.

• Heat pumps, biomass stoves and boilers – Credits are equal to 30% of costs (including labor):

  • Electric or natural gas heat pumps.

  • Electric or natural gas heat pump water heaters.

  • Biomass stoves and boilers.

Do the total/aggregate limits apply?

There are two separate total/aggregate limits that apply to the different categories:

• The sum of the building envelope, home energy audit, and residential energy property credits is limited to $1,200/year.

• Separately, the maximum credit for heat pumps, biomass stoves and boilers is $2,000/year.

If a taxpayer were to take full advantage of the credits, they would total $3,200/year (1,200 + 2,000).

Examples

Jill buys an exterior door for $1,000. She spends $1,500 on a home energy audit. She also buys a new air conditioner for $4,000. All items qualify for the Energy Efficient Home Improvement Credit.

The credit for the exterior door is limited to $250. The credit for the home energy audit is limited to $150. The credit for the new air conditioner is limited to $600. The total credit is $1,000 (this is under the $1,200 aggregate limit):

Jack buys two exterior doors for $2,500 a piece. He spends $500 on a home energy audit. He also buys a $7,000 air conditioner and a $9,000 heat pump. All items qualify for the Energy Efficient Home Improvement Credit.

The credit for the doors is limited to $500. The credit for the home energy audit is equal to the limit of $150. The credit for the new air conditioner is limited to $600. The total/aggregate limit for the building envelope, home energy audit, residential energy property is limited to $1,200. The credit for the heat pump is limited to $2,000. The total credit is $3,200:

If you have any comments, questions, or ideas for future posts, please let me know

I hope you found this post helpful and educational. If you have any comments, questions, or ideas for future posts, please let me know. You can reach me directly via email at crawford@ulmerfinancial.com.