Inflation Reduction Act: Tax Credits for Homeowners

August 19th update: It has come to my attention that the original Example 3 was not clearly supported by the statute. This has been fixed and I apologize for the error.

On Friday, the House passed the Inflation Reduction Act; it now goes to President Biden for his signature. There are three new tax credits in this law every homeowner should know about: the Energy Efficient Home Improvement Credit, the Residential Clean Energy Credit, and the Alternative Fuel Vehicle Refueling Property Credit (for electric vehicle chargers).

Note: These credits are nonrefundable—in other words, you need to have at least $500 of tax liability to claim a $500 credit.

The Energy Efficient Home Improvement Credit (IRC § 25C)

Section 13301 of the Inflation Reduction Act rebrands the Nonbusiness Energy Property credit as the “Energy Efficient Home Improvement Credit.” The bill extends the credit to December 31, 2032, and significantly expands the credit to be more generous. These new rules apply to property placed in service after December 31, 2022.

What qualifies for the tax credit?

In general, the credit is equal to 30% of what you spent on qualified energy efficiency improvements, residential energy property, and home energy audits during the year (though there are annual limits, which I describe later).

Qualified energy efficiency improvements

Qualified energy efficiency improvements are building envelope improvements. This includes insulation, energy-efficient windows, and energy-efficient exterior doors.

To qualify for the credit, these improvements to the building envelope need to meet certain criteria:

In addition to these component-specific rules, there are some general rules the improvements must follow, too. The improvement must be installed in the United States, you must be the original user of the improvement, you must reasonably expect to use the improvement for at least 5 years, and the improvement must be to your principal residence (as that term is defined by Section 121 of the Internal Revenue Code).

Residential energy property

Side view of outdoor energy unit hanging on brick wall of house on a sunny day. Air to air heat pump for cooling or heating the home. Outdoor unit powered by renewable energy. Air conditioner and air heat pump.Residential energy property is, in a nutshell, energy-efficient versions of appliances that heat or cool the air inside of your home, or heat water in your home. The term includes:

  • Heat pumps, central air conditioners, water heaters, furnaces, and boilers as long as the appliance meets the highest efficiency tier (not including advanced tiers) established by the Consortium for Energy Efficiency;
  • Biomass stoves and boilers with a thermal efficiency rating of at least 75 percent;
  • Certain energy-efficient oil furnaces and hot water boilers; and
  • Cost to upgrade a panel to at least 200 amps if the panel upgrade was installed in conjunction with, and enabled the installation and use of, any qualified energy efficiency improvements or other residential energy property (e.g., your home needed a panel upgrade to install an electric heat pump).

You can include labor costs in the total cost of residential energy property when calculating your credit.

As is the case for building envelope improvements, there are some additional rules you’ll need to follow to get a credit for purchasing one of these energy efficient appliances. The property must be installed in the United States, you must be the original user of the property, and the property must be installed on or in connection with a dwelling unit you use as a residence (not necessarily your principal residence).

Home energy audits

A home energy audit is exactly what you’d expect: a home energy auditor comes to your home and identifies the most significant and cost-effective energy improvements you could make. Predictably, the audit must be for a home in the United States and it must be for your principal residence. The Treasury will explain certification requirements for home energy auditors in future regulations.

How will I know if the improvement I purchased qualifies for the credit?

Starting in 2025, the Treasury will have a new system of product identification numbers to verify if property is eligible for the credit. Before then, you’ll have to rely on the definitions in the statute (explained in the previous section).

How to calculate the credit

As mentioned above, the general formula is that the credit is equal to 30% of what you spent on “qualified energy efficiency improvements,” “residential energy property,” and “home energy audits” during the year. But there are limits to the credit.

Annual limits

In my opinion, these caps are too complicated. But we’re stuck with the complexity, so here we go:

Component-specific limits

Windows. Limited to $600 per taxpayer per year. So, you could spend up to $2,000 on new energy-efficient windows in a given year and still get the full credit, since 30% × $2,000 = $600.

Exterior doors. Limited to $250 per door, and $500 for all doors, per taxpayer per year. So, you could spend up to $833 on an energy-efficient door—and $1,667 on multiple energy-efficient doors—in a given year and still get the full credit, since 30% × $833 = $250 and 30% × $1,667 = $500.

Residential energy property. Limited to $600 per taxpayer per year, just like windows.

Home energy audits. Limited to $150 per taxpayer per year.

Total annual limit

The total annual cap to the credit is $1,200 per year. This $1,200 cap applies to almost every type of improvement that qualifies for the credit: e.g., windows, doors, insulation, air conditioners, furnaces, panel upgrades, home energy audits.

Example 1: In 2023, a homeowner spends $2,500 on Energy Star most-efficient windows, $700 on one Energy Star door, $900 on another Energy Star door,  and $5,000 to upgrade their home’s insulation. They calculate their tax credit as follows:

Windows    
  Total window cost $ 2,500
  Multiply total cost by 30% 750
  Tentative credit for windows: Lesser of 30% of cost or $600 $ 600
 
Doors
  Total cost of first door 700
  Multiply total cost by 30% 210
  Tentative credit for first door: Lesser of 30% of cost or $250 210
 
  Total cost of second door 900
  Multiply total cost by 30% 270
  Tentative credit for second door: Lesser of 30% of cost or $250 250
 
  Tentative credit for all doors before limit 460
  Tentative credit for all doors: Lesser of sum of credit for all doors or $500   460
 
Insulation
  Total cost of insulation 5,000
  Tentative credit for insulation: Multiply total cost by 30%   1,500
 
Total credit
  Sum of credit for windows, doors, and insulation before limit 2,560
  Total credit: Lesser of credit before limit or $1,200 $ 1,200

Because it’s an annual limit, you can sometimes get a larger credit if you break a project up over multiple years.

Example 2: Assume the same facts as before, except the homeowner installs the windows and doors in 2023 and the insulation in 2024. In this case, the total credit for the project is $2,260, while in Example 1 it was only $1,200:

Tax Year 2023
  Windows
  Total window cost $ 2,500
  Multiply total cost by 30% 750
  Tentative credit for windows: Lesser of 30% of cost or $600 $ 600
 
  Doors
  Total cost of first door 700
  Multiply total cost by 30% 210
  Tentative credit for first door: Lesser of 30% of cost or $250 210
 
  Total cost of second door 900
  Multiply total cost by 30% 270
  Tentative credit for second door: Lesser of 30% of cost or $250 250
 
  Credit for doors before limit: Sum of credit for all doors 460
  Tentative credit for all doors: Lesser of sum of credit for all doors or $500   460
 
  Total credit
  Sum of credit for windows and doors before limit 1,060
    Total 2023 credit: Lesser of credit before limit or $1,200 $ 1,060

 

Tax Year 2024
  Insulation
  Total cost of insulation $ 5,000
  Tentative credit for insulation: Multiply total cost by 30%   1,500
 
    Total 2024 credit: Lesser of credit before limit or $1,200 $ 1,200
The heat pump exception

The $1,200 annual limit and the $600 residential energy property limit don’t apply to heat pumps; instead, heat pumps get their own annual credit cap of $2,000. So, you could spend up to $6,667 on a new heat pump in a given year and still get the full credit, since 30% × $6,667 = $2,000. (This exception applies to biomass stoves and boilers, too.)

Example 3: In 2023, a homeowner spends $6,000 to install a new heat pump. They calculate their tax credit as follows:

Heat pump    
  Total cost of heat pump   6,000
  Multiply total cost by 30%   1,800
  Credit for heat pump: Lesser of 30% of cost or $2,000   1,800

One final comment about these credit limits: I suspect the IRS will issue an updated version of Form 5695 within the next several months. (That’s the form you’ll use to claim these credits.) Once that’s available, you can use the form and its instructions as you plan your home improvements to confirm you understand the credit formulas correctly.

How utility rebates interact with the credit

I mentioned this in our blog post on the Inflation Reduction Act for real estate investors, but it’s worth repeating here: there’s a bit of tax law, Section 136, that exempts some utility rebates from taxable income.

More specifically, Section 136 says a taxpayer’s gross income doesn’t include “any subsidy provided (directly or indirectly) by a public utility to a customer for the purchase or installation of any energy conservation measure.” This section also says, “no deduction or credit shall be allowed for, or by reason of, any expenditure to the extent of the amount excluded under subsection (a) for any subsidy which was provided with respect to such expenditure.”

That’s potentially relevant for all tax credits I’ll mention in this article, but it’s particularly relevant to the Energy Efficient Home Improvement Credit. It means that when you calculate your tax credit for something like new windows or a new heat pump, you’ll need to first subtract any utility rebates from the cost of the improvement, and then multiply the cost by 30%.

The Residential Clean Energy Credit (IRC § 25D)

Solar panels on the gable roof of the beautiful houseSection 13302 of the Inflation Reduction Act rebrands the residential energy efficient property credit as the “Residential Clean Energy Credit”—a fitting name, since this credit is most commonly used for residential solar panels.

The bill extends the credit to December 31, 2034, alters the phase-out schedule, and slightly modifies which property qualifies for the credit. For the most part, the new rules apply to property placed in service after December 31, 2021. Starting in 2023, biomass stoves no longer qualify for a credit under Section 25D, but battery storage technology does.

The new phase-out schedule is:

For improvements installed in: The credit percentage is:
2021 26%
2022 through 2032 30%
2033 26%
2034 22%
2035 onward 0%

Example 4: You install a $20,000 solar panel system on your home in 2022. Your credit is 30% of the cost of the system—so, $6,000.

Example 5: You install a $20,000 solar panel system on your home in 2033. Your credit is 26% of the cost of the system—so, $5,200.

A final comment about the Residential Clean Energy Credit: while this credit isn’t refundable, you can carry it forward to reduce your tax liability in future years.

Applying the credits to condominiums and cooperative housing associations

If a cooperative housing association installs property or improvements that qualify for a credit under Sections 25C or 25D, the tenant-stockholders of the corporation claim the credit in much the same way they claim an itemized deduction for property taxes. In other words, the expenditure is allocated to the tenant-stockholder on their “proportionate share” of the expenditure. The tax law uses similar, albeit less detailed, language to explain how to allocate expenditures of a condominium management association.

For example, in my housing cooperative I own 55 shares, which is 2.8947% of the total outstanding stock in the corporation (1,900 shares). If my building spends, say, $60,000 in 2025 to replace some of our windows with Energy Star most efficient windows, I can report on my 2025 personal tax return that I spent $1,737 on those windows (because, well, through the co-op dues I did) and claim a $521 credit for that year.

One final comment about energy credits and housing cooperatives: in 2010, the Office of Chief Counsel noted in IRS Information Letter 2010-0244 that when a tenant-stockholder arranges for and purchases the improvement themselves, they are entitled to a credit based on the entire expenditure (as one would expect).

The EV Charger Credit (IRC § 30C)

I discussed the new EV charger credit in a previous blog post for real estate investors, so I won’t go into too much detail here. But know that a smaller version of the EV charger credit is available for homeowners located in a low-income community or rural area. That credit is 30% of the cost of the charger up to a $1,000 limit. And if you’re a homeowner, you don’t need to worry about the prevailing wage and apprenticeship rules that apply to businesses and real estate investors.