Energy Tax Credits: How To Reduce Income Taxes
Tax credits, including energy tax credits, are a mechanism to incentivize the adoption of a good like a commodity. Historically, the US has seen a variety of energy tax credits approved that resulted in the expansion of industries. For example, over the past 20 years solar and wind projects benefited tremendously from energy tax credits. Most recently, the electrical vehicle and battery energy storage industries received meaningful incentives to increase the adoption of each technology. In this blog post, we’ll cover the ins and outs of energy tax credits including how they work, examples of the types of energy tax credits currently available, and nuances to look out for before implementing renewable energy technologies or energy efficiency upgrades.
What Are Energy Tax Credits?
To encourage the adoption and reduce the cost of using renewable energy, the US government has turned to the use of energy tax credits. One of the primary goals of energy tax credits is to reduce the cost of using renewable energy for individuals and businesses. Those who qualify for energy tax credits can take the cost of their energy-saving improvements as a one-for-one deduction on their total tax bill.
Examples of energy tax credits currently available include the Energy Efficient Home Improvement Credit and the Residential Clean Energy Credit. These credits may change over time. However, the structure of these credits can be used as a building block to understanding how energy tax credits work at a fundamental level.
How Do Energy Tax Credits Work?
Energy tax credits work by reducing the amount of income tax you owe the federal government. For example, if you buy a qualifying residential solar system for $20,000 you receive a 30% investment tax credit. In other words, you deduct $6,000 from your tax bill come tax time ($20,000 * 30% = $6,000).
The Energy Efficient Home Improvement Credit and the Residential Clean Energy Credit are the two primary energy tax credits available to homeowners. Developers, like Solis Renewables, tap energy tax credits like the Investment Tax Credit and Production Tax Credit, depending on what works best economically for their projects.
The Energy Efficient Home Improvement and Residential Clean Energy Credits offer a 30% tax credit for qualifying energy improvements. If the tax credit amount changes over time, simply multiply the new tax credit percentage by the amount you paid for the improvement to determine your deduction. Note that current legislation prevents you from utilizing both of these tax credits in the same tax year.
Types of Energy Tax Credits
This article is focused on the principles surrounding energy tax credits for homeowners. But keep in mind energy tax credits are also available to renewable energy project developers. With that said the two primary energy tax credits homeowners can look into to understand how energy tax credits works are the Energy Efficient Home Improvement Credit and the Residential Clean Energy Credit.
Both of these credits work by providing homeowners with a 30% tax credit for qualifying equipment purchases and improvements. Energy Efficient Home Improvements generally fall into three buckets - energy efficiency improvements, energy property expenses, and home energy audits. The Residential Clean Energy credits cover the cost of new clean energy property for your home.
Energy Efficient Home Improvement Credit
Qualifying energy-efficient improvements made to your home after January 1, 2023, through the end of 2032 may qualify for the Energy Efficient Home Improvement Credit. The credit equals 30% of qualifying expenses that include residential energy efficiency improvements, residential energy property expenses, and home energy audits.
The maximum credit you can claim annually is $1,200 for energy efficiency improvements, residential energy property expenses, and home energy audits. You can claim an additional $2,000 annually for qualifying heat pumps, biomass stoves, and biomass boilers.
More specifically, below is a breakdown of qualifying expenses and the maximum amount you can spend that qualifies for the tax credit.
Energy Efficient Improvements
Exterior doors up to $250 per door or $500 total
Exterior windows and skylights up to $600 total
Insulation and air-sealing materials up to $1,200 total, excluding labor costs, depending on the amount spent on other energy efficiency improvements, energy property expenses, and home energy audits
Residential Energy Property Expenses
Central air conditioners; natural gas, propane, or oil water heaters; natural gas, propane, or oil furnaces and hot water boilers up to $600 and no more than $1,200 inclusive of any other Energy Efficient Improvements. Labor and electrical component costs related to these expenses also qualify.
Electric or natural gas heat pumps; electric or natural gas heat pump water heaters; biomass stoves and boilers qualify for an additional credit of $2,000 annually.
Home Energy Audits
Home energy audits up to $150
Residential Clean Energy Credit
In addition to the Energy Efficient Home Improvement Credit, homeowners may also benefit from the Residential Clean Energy Credit. Homeowners investing in battery storage, fuel cells, geothermal, solar, and wind may qualify annually for the Residential Clean Energy Credit. This credit equals 30% of the cost of qualifying new clean energy technology installed for your home between 2023-2032. The credit amount you receive can’t exceed the amount of taxes you owe. You can carry forward any unused credit you earned into future tax years. Loan origination fees and interest do not qualify for the credit.
Qualifying clean energy expenses include battery storage, fuel cells, geothermal heat pumps, solar panels, solar water heaters, and wind turbines. Labor expenses directly tied to the onsite preparation, installation of the equipment, and connection of the equipment to the home qualify. All other labor costs don’t qualify. Note that battery storage, geothermal heat pumps, and solar water heaters have standards you need to meet. For example, battery storage must be at least 3 kilowatt hours.
Who Qualifies for Energy Tax Credits?
Homeowners may qualify for the Energy Efficient Home Improvement Credit for improvements to their existing home, not a new home. Your home is where you live most of the year. The home must be located in the US for the expenses to qualify for the credit. Landlords and property owners can’t claim the Energy Efficient Home Improvement Credit for homes or residences they do not live in. Business owners may qualify for a portion of this credit provided they meet the IRS requirements.
Homeowners may also qualify for the Residential Clean Energy Credit whether you rent or own your home. Your main home is the one where you live most of the year. The credit applies to new and existing homes in the US. Landlords and property owners can’t qualify for the Residential Clean Energy Credit if they’re not living in a residence with clean energy upgrades. Business properties don’t qualify for the credit. However, business owners using their home partly for business may qualify for a portion of this credit.
Are Energy Tax Credits Refundable?
Energy tax credits are nonrefundable. This means that you can’t get back more money from the IRS than you owe in taxes. The Energy Efficient Home Improvement Credit doesn’t allow you to apply an excess credit earned in future tax years. However, the Residential Clean Energy Credit allows you to roll forward any unused tax credit earned to use in future tax years. Note that loan origination fees and interest aren’t a qualifying expense. Energy tax credits are typically nonrefundable, meaning they can only reduce your tax liability to zero but cannot result in a refund if they exceed the amount you owe in taxes. However, any unused portion of the Residential Clean Energy Credit can often be carried forward to future tax years.
Other Energy Tax Credits
Renewable energy developers primarily utilize two forms of energy tax credits - the Investment Tax Credit (ITC) and the Production Tax Credit (PTC). Developers can’t claim both of these credits on the same project. One focuses on reducing the federal income tax liability for the total installed cost of a solar project. The other is a per kilowatt-hour credit for electricity produced during the first 10 years of a project’s operational life.
The Investment Tax Credit reduces the federal income liability for a project investor’s investment for a percentage of the installed cost of a solar project during the year the solar project was installed. The ITC percentage has changed over time but currently sits at 30%.
The Production Tax Credit is a per kilowatt-hour credit for electricity generated during the first 10 years of a solar and other qualifying technology project’s life. This credit reduces the investor’s federal income tax liability and is adjusted annually for inflation. Similar to the ITC, the PTC’s value has changed over time but currently sits at 2.75 cents per kilowatt-hour.
In Conclusion
Energy tax credits can be a valuable mechanism to incentivize homeowners and developers to install certain types of energy efficiency improvements and clean energy projects. These tax credits work by reducing the amount of income tax that you owe, however, energy tax credits are non-refundable. The Energy Efficient Home Improvement and Residential Clean Energy are currently the two primary credits available to homeowners, though this may change over time. Similarly, the Investment and Production Tax Credit are financial incentives renewable energy project developers utilize. One of the many interesting aspects of energy tax credits is how they drive behavior in the market, whether your’re a homeowner or pojrect developer.
