2 Tax Credits to Claim for Energy-Efficient Home Renovations

Two federal income tax credits reward energy-efficient home improvements very differently. Which credit you use depends on the improvements you make. Under federal tax law, new energy-efficient windows and doors don’t count for much, but a system that uses renewable energy to power a home gets you a juicy tax break. The credits differ in other ways, with one imposing a cap and the other, for the most part, placing no such limit. Whether home improvements to a vacation home can qualify is another differentiator.

Neither of these tax credits is refundable; they can only be used to reduce the amount of income tax owed. If the credit exceeds your tax liability, the IRS won’t refund you the difference. Eligible homeowners claim the credits on IRS Form 5695. Although the clock is ticking for the use of both home improvement credits, it may be less of a problem than you think.

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The Residential Energy Efficiency Property Credit

A person installs solar panels on a house.

If you installed an alternative energy system in your home that relies on a renewable source, this credit is for you. Renewable energy sources include solar, wind, geothermal or fuel cell technology to generate power. Solar panels, solar electric equipment, solar-powered water heaters and wind turbines are all eligible for the credit, whether they are installed in a primary residence or vacation home. A residential fuel cell, however, must be installed in your primary home to qualify.

The size of the tax credit varies and equals 26% of the cost of equipment and installation for renewable energy systems that were put in between 2020 and 2022. The credit falls to 23% in 2023 before expiring in 2024. Pre-2020 installations qualified for a 30% tax credit. There is no maximum dollar limit for solar, wind or geothermal equipment, but the tax credit for fuel cells is capped at $500 for each half-kilowatt of power capacity. Any unused portion of the credit can be carried over to future tax years.

Keep in mind you can only qualify for the credit once the alternative energy system has been installed. If you buy solar panels at the end of 2021 but don’t install them until early 2022, you cannot claim the 26% tax credit on your 2021 return. Instead, you must wait and claim it when you file your 2022 taxes.

Homeowners who install a renewable energy system sometimes qualify for a rebate from their utility company, which will affect the tax credit amount. Although these rebates are nontaxable, the cost of the system is reduced by the rebate amount when you calculate your tax credit. For example, if you install a $20,000 solar system this year and the utility gives you a one-time installation rebate of $1,000, your tax credit is $4,940 (26% x [$20,000 – $1,000]).

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The Nonbusiness Energy Property Credit

A seating area under a skylight in a home.

Although less valuable, this credit works for homeowners who make smaller energy-saving purchases for a primary residence in 2021. The credit applies to 10% of the cost of certain types of insulation, external windows and doors, and skylights. The credit also includes 100% of the cost of electric heat pumps and water heaters, some central air-conditioning systems, stoves that use biomass fuels, or similar energy-saving investments.

This may sound like a generous tax break, but it’s not. The total credit is worth at most $500, and amounts taken in prior years count against it. For instance, if you claimed a $300 credit on your 2014 return for a natural gas furnace, you are only entitled to $200 more until the credit expires in 2022. The credit is also capped for many items. No more than $150 can be claimed for water heaters and furnaces, $200 for windows and $50 for a furnace-circulating fan.

Don’t worry about the expiration dates for these tax credits. Congress has extended both credits many times, including retroactively. Some lawmakers want to make both credits permanent and even expand them. One Senate bill calls for raising the residential energy efficiency property credit to 30% and the maximum nonbusiness energy property credit to $1,500 per year. Whether these proposals will be enacted is unclear, but Democrats are pushing for them.



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