Energy-efficient home improvement credit

The Inflation Reduction Act of 2022, P.L. 117-169, expanded and renamed the nonbusiness energy property credit as the energy-efficient home improvement credit. The following discussion applies to qualifying expenditures that relate to property placed in service after Dec. 31, 2022, and prior to Jan. 1, 2033 (Sec. 25C(i)(2), as amended by the Inflation Reduction Act).

Amount of the credit

Individuals can claim a nonrefundable credit for a tax year in an amount equal to 30% of the sum of (1) the amount paid or incurred by the taxpayer for qualified energy-efficiency improvements installed during the year (known as energy-efficient building envelope components); plus (2) the amount of residential energy property expenditures (known as qualified energy property) paid or incurred by the taxpayer during the year; plus (3) the amount paid or incurred by the taxpayer during the year for home energy audits (Sec. 25C(a), as amended by the act).

For energy-efficient building envelope components, the credit is allowed only for amounts paid to purchase the components. It is not available for amounts paid for on-site preparation, assembly, or original installation of the components. In contrast, the credit for qualified energy property is allowed not only for amounts paid to purchase the property but also for costs of on-site preparation, assembly, or original installation of the property (Sec. 25C(d)(1), as amended by the act).

As a practical matter, practitioners should be aware of the types of expenditures that qualify for the credit. However, for purposes of the credit prior to the Inflation Reduction Act, the taxpayer could rely on the manufacturer’s certification that an item was eligible for the credit, according to Notice 2009-53, which also contained manufacturer certification requirements for building envelope components and residential energy property expenditures. Practitioners should be alert for similar guidance from the IRS for the applicability of the energy-efficient home improvement credit under the Inflation Reduction Act.

Credit limitations

Under the Inflation Reduction Act, the lifetime maximum credit limitation that was in place under the nonbusiness energy property credit has been repealed. The energy-efficient home improvement credit is subject to the following limitations (Sec. 25C(b), as amended by the act):

• Annual overall limitation: The credit allowed for any tax year cannot exceed $1,200.
• Annual limitation for qualified energy property: The credit allowed for any tax year with respect to any item of qualified energy property cannot exceed $600.
• Annual limitation for exterior windows and skylights: The credit allowed for any tax year with respect to all exterior windows and skylights in the aggregate cannot exceed $600.
• Annual limitation for exterior doors: The credit allowed for any tax year cannot exceed $250 with respect to any exterior door and $500 in the aggregate for all exterior doors.
• Special limitation for certain qualified energy property: Notwithstanding the limitations of the first two items above, the credit for any tax year cannot exceed $2,000 with respect to amounts paid or incurred for specified heat pumps, heat pump water heaters, and biomass stoves and boilers.
• Annual limitation for home energy audits: The amount of the credit allowed for any tax year with respect to a home energy audit cannot exceed $150.

Tax liability limitation

The energy-efficient home improvement credit is allowed to offset regular income tax (reduced by the foreign tax credit) plus alternative minimum tax (Sec. 26(a)).

Energy-efficient building envelope components

Eligible building envelope components must be installed in or on a dwelling that is the taxpayer’s principal residence and that is in the United States (vacation homes do not qualify). The component’s original use must begin with the taxpayer, and the component must be reasonably expected to remain in use for at least five years (Sec. 25C(c)(1), as amended by the act).

The component must meet or exceed the criteria established by the most recent International Energy Conservation Code standard in effect as of the beginning of the calendar year that is two years prior to the calendar year the component is placed in service (or in the case of exterior windows or skylights meets the Energy Star most-efficient certification requirements, and in the case of an exterior door meets the applicable Energy Star requirements) (Sec. 25C(c)(2), as amended by the act).

The manufacturer should certify to the purchaser whether an item meets the necessary criteria.

Items that are energy-efficient building envelope components (provided they meet the energy-efficiency criteria) are:

• Insulation systems, including air sealing material or systems, that reduce heat loss/gain;
• Exterior windows (including skylights); and
• Exterior doors (Sec. 25C(c)(3), as amended by the act).

Qualified energy property

Qualified energy property must be installed on or in connection with a residence of the taxpayer (it does not have to be the principal residence); also, the property must be in the United States and placed in service originally by the taxpayer (it cannot be used property) (Sec. 25C(d)(1), as amended by the act). Items that can be qualified energy property (provided they meet the energy-efficient criteria for that specific component) are:

• Electric or natural gas heat pump water heaters;
• Electric or natural gas heat pumps;
• Central air conditioners;
• Natural gas, propane, or oil water heaters;
• Natural gas, propane, or oil furnaces (including their advanced main air-circulating fan with a specified maximum annual energy usage) or hot water boilers;
• Biomass stoves or boilers (which must meet a specific minimum thermal efficiency rating);
• Any oil furnace or hot water boiler that meets Energy Star efficiency criteria and is rated by the manufacturer for use with certain specified fuel blends (if placed in service after Dec. 31, 2022, and before Jan. 1, 2027) or achieves a minimum fuel utilization efficiency rate of not less than 90 and is rated by the manufacturer for use with certain specified fuel blends (if placed in service after Dec. 31, 2006); and
• Any improvement to, or replacement of, a panelboard, sub-panelboard, branch circuit, or feeder that is (1) installed consistent with the National Electric Code; (2) has a load capacity of not less than 200 amps; (3) is installed in conjunction with any energy-efficient building envelope component or in conjunction with any qualified energy property for which an energy-efficient home improvement credit is allowed; and (4) enables the installation and use of any such property (Secs. 25C(d)(2) and (d)(3), as amended by the act).

Home energy audits

A home energy audit is an inspection and written report with respect to a dwelling unit located in the United States and owned or used by the taxpayer as the taxpayer’s principal residence (within the meaning of Sec. 121) that (1) identifies the most significant and cost-effective energy-efficiency improvements with respect to the dwelling unit, including an estimate of the energy and cost savings with respect to each such improvement, and (2) is conducted and prepared by a home energy auditor that meets the certification or other requirements specified by the IRS in regulations or other guidance (Sec. 25C(e), as amended by the act).

Special rules

Rules similar to the joint occupancy and allocation of expenditure rules for the residential clean energy credit apply for purposes of the energy-efficient home improvement credit.

Joint occupancy rules

In the case of any dwelling unit that is jointly occupied and used during any calendar year as a residence by two or more individuals, the following rules apply with respect to qualified fuel cell property (Sec. 25D(e)(4)):

1. The maximum amount of expenditures that may be taken into account by all such individuals with respect to the dwelling unit during the calendar year is $1,667 in the case of each half-kilowatt of capacity of the fuel cell property (as defined in Sec. 48(c)(1)).
2. The expenditures allocated to any individual for the tax year in which the calendar year ends is an amount equal to the lesser of —
   1. The amount of expenditures made by such individual with respect to such dwelling during such calendar year, or
   2. The maximum amount of such expenditures set forth in item 1 above multiplied by a fraction (i) the numerator of which is the amount of such expenditures with respect to the dwelling made by the individual during the calendar year, and (ii) the denominator of which is the total expenditures made by all such individuals with respect to the dwelling during the calendar year.
3. Items 1 and 2 are applied separately with respect to each qualified fuel cell property expenditure.

Allocation of expenditures

If less than 80% of the use of an item is for nonbusiness purposes, only that portion of the expenditures for the item that is properly allocable to use for nonbusiness purposes is taken into account (Sec. 25D(e)(7)).

Basis adjustments

The basis of the property must be reduced by the amount of the credit allowed (Sec. 25C(g), as amended by the act).

Contributor

Patrick L. Young, CPA, is an executive editor with Thomson Reuters Checkpoint. For more information about this column, contact thetaxadviser@aicpa.org.