LeAnn Luna
LeAnn Luna
Going Green May Result in Significant Tax Savings

Summer is a good time to remind clients that generous federal tax credits are available to offset costs of improving their home’s energy efficiency.

June 10, 2010
by LeAnn Luna

Individuals who are considering home improvements that increase their home’s energy efficiency or contemplating major investments in alternative energy products should be reminded that generous tax credits are available for eligible taxpayers to offset qualifying energy efficient purchases. The tax credits cover purchases of both traditional items such as HVAC systems, water heaters and insulation as well as nonstandard products utilizing fuel cells, wind, solar or geothermal energy.

Credit for Conventional Home Improvement Items (Sec. 25C)

Most homeowners will be interested in the incentives outlined in IRC Sec. 25C, which provides for a 30-percent credit on purchases through December 31, 2010 of items such as heating, ventilating and air conditioning (HVAC) systems, insulation, roofs, water heaters and windows and doors. The combined maximum credit for purchases in both 2009 and 2010 is $1,500. For example, if a taxpayer makes eligible purchases of $4,000 in 2009 and $2,000 in 2010, he or she can claim a credit of $1,200 ($4,000 x 0.30) in 2009. While 30 percent of $2,000 is $600, the taxpayer can claim only an additional $300 credit in 2010 ($1,500 maximum for both years minus the $1,200 claimed in 2009). The credit only applies for purchases related to the taxpayer’s primary residence, so upgrades for second homes and vacation homes are ineligible. Qualifying products must meet stringent energy efficiency standards, but taxpayers can rely on manufacturers to verify eligibility, which they do by issuing Manufacturers Certification Statements for qualifying products. These certifications are available either at the time of purchase or on the manufacturer’s website. Taxpayers must retain a copy of the statement for their records, but they do not need to attach a copy to their tax return.

The credit is based on the total purchase price of qualified equipment, including sales taxes, but the credit eligibility of installation costs depends on the item. Installation costs of HVAC systems, water heaters and biomass stoves are eligible for the tax credit. However, installation costs of roofing, windows and doors and insulation do not qualify for the credit. Taxpayers should require contractors installing such items to break out labor costs separately so that qualifying costs are clearly identified. If necessary, the invoice should apply sales taxes separately to qualifying and non-qualifying costs.

If the taxpayer’s utility provider offers rebates, which are generally nontaxable, the rebate will reduce the amount eligible for the federal tax credit. In the case of state/local tax credits or rebates, the impact depends on whether the credit is taxable on the taxpayer’s federal return. Taxable credits (reported on Form 1099) do not reduce the basis of the item for credit purposes. However, if the credit is not taxable for federal purposes, taxpayers must reduce the qualifying cost by the amount of the state tax credit and calculate the federal credit based on the reduced basis. The premise behind these rules is to deny a double benefit.
There are no income limits on taxpayers eligible to claim the credits, but two important restrictions apply:

  1. The Sec. 25C credit is nonrefundable and credits that cannot be used in the year generated cannot be carried forward or carried back and therefore expire.
  2. Congress specifically provided that credits on 2009 purchases qualify for alternative minimum tax (AMT) purposes.

However, unless Congress changes the law, that provision is not applicable to 2010 purchases. Therefore, taxpayers in an AMT situation in 2009 who expect to pay AMT in 2010 will receive no benefit for 2010 purchases. Furthermore, practitioners should prepare pro-forma AMT schedules even for those clients who have not paid AMT in the past to determine the expected credit availability.
Credits for Solar, Wind, Geothermal

Sec. 25D describes a second class of energy credits that may apply to homeowners purchasing fuel cells, geothermal heat pumps, small wind turbines and solar energy systems including solar water heaters for household use ( i.e. not swimming pools or hot tubs) and solar electricity generators for general use in a dwelling. Expenditures for qualified fuel cells are eligible for a maximum credit of $500 per each 0.5 kilowatt of capacity. The residential energy efficient property (REEP) credit for geothermal, wind and solar systems applies to any purchase before December 31, 2016 and is equal to 30 percent of the eligible purchase price. The cost to install any item listed in Sec. 25D does qualify for the REEP credit.

The REEP credit is available for a wide range of properties. Individuals can claim the credit for expenditures for both the primary residence and a second home (but fuel cells must be installed in the primary residence). Furthermore, if a qualified asset is purchased by a condominium management association, condominium owners may claim the credit on their proportionate share of any cost. Similar rules apply to tenant-stockholders of a cooperative housing corporation.

The REEP credit is unlimited (except the fuel cell limitation noted above) and it does qualify for AMT purposes. The credit is nonrefundable, but taxpayers can carry over any unused credits to future years. There is no expiration date on the credits.

Current Developments

Congress has expanded energy efficiency related credits several times in recent years and the House passed another expansion on May 6, 2010. The bill (H.R. 5019) would replace Sections 25C and 25D and further expand the credit available to up to $8,000 for comprehensive energy efficiency improvements. The credit would apply to purchases in 2010 and 2011 but would be paid to contractors rather than to taxpayers.

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LeAnn Luna is an associate professor of accounting and holds a dual appointment with the Department of Accounting and Information Management and the Center for Business and Economic Research, both at The University of Tennessee.