764 / What is the credit for nonbusiness energy property that may be taken against the tax?

Editor’s Note: The credit for nonbusiness energy property initially expired on December 31, 2007, but has been revived by Congress several times. As of the date of this publication, this provision has been renamed, expanded and extended through 2032 by the Inflation Reduction Act of 2022. See heading below for details.¹

An individual taxpayer may claim as a credit an amount equal to the sum of: (1) 10 percent of the amount paid or incurred by the taxpayer for “qualified energy efficiency improvements” (see below) installed during the taxable year; and (2) the amount of the “residential energy property expenditures” (see below) paid or incurred by the taxpayer during the taxable year.²

Qualified energy efficiency improvements means any energy efficient “building envelope component” (see below) that meets certain energy conservation criteria, if: (1) the component is installed in or on a dwelling located in the United States that is owned and used by the taxpayer as his principal residence; (2) original use of the component commences with the taxpayer; and (3) the component reasonably can be expected to remain in use for at least five years.³ The term “building envelope component” means: (1) any insulation material or system specifically and primarily designed to reduce the heat loss or gain of a dwelling when installed in or on the dwelling; (2) exterior windows, including skylights; (3) exterior doors; and (4) metal roofs if the roof has appropriate coatings specifically and primarily designed to reduce the heat gain of the dwelling.⁴

In guidance, the Service clarified that a component will be treated as reasonably expected to remain in use for at least five years if the manufacturer offers, at no extra charge, at least a two-year warranty providing for repair or replacement of the component in the event of a defect in materials or workmanship. However, if the manufacturer does not offer such a warranty, all relevant facts and circumstances are taken into account in determining whether the component reasonably can be expected to remain in use for at least five years. The Service also confirmed that a taxpayer may rely on a manufacturer’s certification that a building envelope component is an “eligible building envelope component.” A taxpayer is not required to attach the certification to the tax return on which the credit is claimed, but should retain the certification statement as part of his records. In addition, the Service stated that a credit is allowed only for amounts paid or incurred to purchase the components, not for the onsite preparation, assembly, or original installation of the components.⁵

Residential energy property expenditures means expenditures made by the taxpayer for “qualified energy property” that is: (1) installed on or in connection with a dwelling unit located in the United States and owned and used by the taxpayer as the taxpayer’s principal residence; and (2) originally placed in service by the taxpayer.⁶ The term “qualified energy property” means: (1) “energy-efficient building property” (see below); (2) a qualified natural gas, propane, oil furnace or hot water boiler; or (3) an advanced main air circulating fan. All of the types of property listed in the preceding sentence must meet certain performance and quality standards.⁷ “Energy efficient building property” means: (1) electric heat pump water heaters; (2) electric heat pumps; (3) geothermal heat pumps; (4) central air conditioners; and (5) natural gas, propane, or oil water heaters.⁸

The Service has confirmed that a taxpayer may rely on a manufacturer’s certification that a product is “qualified energy property.” A taxpayer is not required to attach the certification to the tax return on which the credit is claimed, but should retain the certification statement as part of his records. In addition, the Service stated that a credit is allowed for amounts paid or incurred to purchase qualified energy property and for expenditures for labor costs allocable to the onsite preparation, assembly, or original installation of the property.⁹ The Service has issued additional guidance regarding the credit.¹⁰

Prior to 2023, the lifetime limitation with respect to any taxpayer for any taxable year was $500.¹¹ An additional limit of $200 applied to windows.¹² Other limits were as follows: advanced main air circulating fans – $50; qualified natural gas, propane, oil furnace or hot water boilers – $150; and energy-efficient building property – $300.¹³

The credit is available for property placed in service after December 31, 2005, and before January 1, 2008, and in 2009 through 2021. (See Editor’s Note above and the discussion of the Inflation Reduction Act below for details on the credit’s expansion beginning in 2023.)¹⁴

Inflation Reduction Act of 2022

The Inflation Reduction Act renamed the pre-existing IRC Section 25C nonbusiness energy property tax credit the “Energy Efficient Home Improvement Credit.” While the nonbusiness energy property tax credit technically expired at the end of 2021, the bill retroactively extended the existing credit through 2022. Beginning in 2023, the new and expanded Energy Efficient Home Improvement Credit is available through the 2032 tax year.

However, beginning with the 2023 tax year, the credit will be expanded to equal to 30% of the costs of eligible home improvements made during the year. Home improvements such as insulation, roofing, windows and other energy-efficient home improvements will continue to be covered under the new rules if they satisfy certain energy rating standards. The credit will also be expanded to cover the cost of additional energy-efficient property, including electric panels and related equipment, biomass stoves and home-energy auditing. Roofing and air-circulating fans will be removed from the list of qualifying improvements.

The existing lifetime limits will be replaced with a more generous $1,200 annual limit and the $200 limitation for windows will be eliminated entirely.

The annual limits for specific types of qualifying home improvements will also be modified beginning in 2023. The new limits will be:

(1)  $2,000 for electric or natural gas heat pump water heaters, electric or natural gas heat pumps, biomass stoves and boilers,

(2)  $600 for central air conditioners, exterior windows and skylights, electric panels and related equipment, natural gas, propane or oil water heaters, natural gas, propane or oil furnaces or hot water boilers,

(3)  $250 for exterior doors (with a cap of $500 for all exterior doors installed) and

(4)  $150 for home energy audits.

The tax credit applies in the year the project is installed—and installations must meet certain energy-related standards and criteria, which can vary from project to project (it is expected that future regulations will provide more specific details). The credit isn’t refundable—meaning that it cannot generate a tax refund—but the credit can be carried forward to subsequent tax years to offset future tax liability.¹⁵