The Inflation Reduction Act of 2022 (IRA) made several consequential changes to federal tax rules, offering incentives to taxpayers to make more energy-efficient choices related to their homes and automobiles. In this article, we provide an overview of five key provisions that will provide tax relief to individual taxpayers who make qualifying expenditures for:
- The Energy Efficient Home Improvement Credit (EEHI)
- The Residential Clean Energy Property Credit (RCE)
- Clean Vehicle Energy Credits
- Previously Owned Clean Vehicle Credits
- Qualified Alternative Fuel Refueling Property Credit
These credits, some newly created by the IRA and others enhanced by it, provide taxpayers with significant new incentives to consider energy-efficient options when upgrading or replacing cars and home utility systems.
The Energy Efficient Home Improvement Credit (EEHI)
The amount of the EEHI credit available to homeowners who make certain energy-efficient upgrades took a sizable jump through an expansion of Section 25C. Through Dec. 31, 2022, this program permitted taxpayers to claim a total of $500 of credit against their federal income taxes for qualifying purchases over the course of the taxpayers’ lifetimes (beginning after 2005). The enhanced rules more than double the general limitation to $1,200 and allow the credit to be claimed on an annual basis beginning Jan. 1, 2023, and running until the expiration date of the credit currently set for Dec. 31, 2032. An additional $2,000 in annual credit is available for purchases of very specific types of heat pumps, water heaters, and other equipment, making for a total possible annual credit of $3,200 available to taxpayers who spend enough on qualified purchases.
The amount of credit is equal to 30% of the cost of qualifying improvements and expenditures. Such amounts are then subject to specific category-based limitations, in addition to the overall annual limitation described above. Credits claimed for purchases of building envelope components designated as qualified energy improvements under the law are limited to:
- Up to $250 per door for exterior doors, with an annual limit of $500 (2 doors). (Note: The law caps the credit per door at $250, so that amount represents 30% of the door price, which would be $833.33.)
- $600 in the aggregate for exterior windows.
- Amounts spent on insulation materials and air sealing materials/systems are not subject to any separate annual limitation outside of the total 30% up to $1,200 amount.
The rules also limit credits claimed annually for certain residential energy property expenditures to $600 each for:
- Central air conditioners
- Furnaces (gas, propane, or oil)
- Water heaters (gas, propane, or oil)
- Panelboard (breaker box) improvements
On the other hand, the rules allow a more generous separate $2,000 annual credit for 30% of expenditures on the below items with a thermal efficiency rating of at least 75%:
- Electric or natural gas heat pumps
- Electric or natural gas heat pump water heaters
- Biomass stoves and biomass boilers
Therefore, a taxpayer could qualify for $1,200 of credits with qualifying expenditures on energy improvements and residential energy property and an additional $2,000 of credits for purchases of qualifying heat pump and biomass equipment.
In addition to credit amounts available for money spent on equipment, the law also allows a credit for 30% of the cost of a home energy audit up to $150 of credit per year (30% of the cost of a $500 energy audit.) That amount would count toward the $1,200 annual cap.
The annual cap on the credit brings up another important consideration: Under the current rules, the EEHI credits are nonrefundable (meaning that they can reduce your federal tax liability for the year to zero, but the IRS won’t pay you a refund on your federal taxes to the extent these credits reduce them below zero), and excess credits don’t carry forward. If a taxpayer doesn’t owe enough federal tax in the year the credit is claimed, they will likely lose the benefit of some or all of the credit. Therefore, tax planning surrounding when a taxpayer completes certain energy-efficient upgrades may ensure that usage of the EEHI credit is maximized.
The IRA legislation also created an unusual distinction in terms of the type of residence that can qualify for different aspects of the EEHI credit. For an energy-efficient improvement to a building envelope component (e.g., exterior window, exterior door) to qualify, it must be made to the taxpayer's primary residence and the taxpayer must own the residence. “Qualified energy property” (e.g., electric or natural gas heat pump, central air conditioner), however, will qualify for the credit even if installed in a dwelling unit that’s merely a residence of the taxpayer. For qualified energy property, the residence where the property is installed doesn’t have to be the taxpayer’s primary residence, nor does the taxpayer have to own it.
The IRS website includes several useful resources as it pertains to the Section 25C credit including the EEHI IRS Homepage and the EEHI IRS FAQs.
The Residential Clean Energy Property Credit (RCE)
Another existing credit that was significantly enhanced by the IRA is the Section 25D Residential Clean Energy Credit (RCE). In general, the IRA extended the availability of the RCE through 2034, modified the credit rates to step down as the provision gets closer to expiration, and expanded the list of eligible purchases to include certain battery storage technology.
There is generally no overall limit on the amount of credit that can be claimed under the RCE, with the exception of the new fuel cell property limits discussed below. The taxpayer can take a credit against federal income taxes for 30% of the cost of qualified expenditures made for property placed in service anytime beginning in 2022 and extending through 2032. Under the current law, the credit rate drops to 26% in 2033, 22% in 2034, and the credit will fully phase out for property placed in service after 2034.
Qualifying residential clean energy expenditures include:
- Solar panels, including certain solar roof tiles and shingles (and possibly roofing costs related to the installation; the cost of a full roof replacement wouldn’t be eligible.)
- Solar water heaters
- Wind turbines used to generate electricity
- Geothermal heat pump expenditures
- Battery storage technology expenditures (capacity of at least 3 kilowatt hours; installed after Dec. 31, 2022)
- Fuel cell property expenditures (up to $500 for each half kilowatt of capacity)
The RCE can be claimed on any dwelling unit located in the United States and used by the taxpayer as a residence, except in the case of fuel cell property, in which case the dwelling unit must be the primary residence of the taxpayer for the related costs to qualify for the credit.
Unlike the EEHI, the RCE can be carried forward to future tax years if it’s not usable in the year that the qualifying property is installed. However, to the extent that fuel cell credits are constrained by the kilowatt capacity limitation, that particular excess can’t be carried forward.
The IRS website also includes several useful resources for the Section 25D credit, including the Residential Clean Energy Credit IRS Homepage and the Residential Clean Energy Credit IRS FAQs.
Timing and substantiation of the home-based energy credits
Taxpayers are unable to claim the EEHI or the RCE credits until the year that the applicable qualifying property is installed in the residence. It’s possible to qualify for both credits based on installations related to the same residence in the same year. The key to supporting a claim for either of these credits is thorough recordkeeping. Taxpayers looking to rely on such purchases to reduce their tax liabilities should carefully maintain all related receipts. Furthermore, if planning to make a claim based on fuel cell property expenditures, additional attention should be paid to documentation of the fuel cell capacity.
Clean Vehicle Energy Credits
The IRA legislation expanded tax benefits available to those who purchase new plug-in electric vehicles (EVs) or fuel cell vehicles (FCVs). Under the New Clean Vehicle Tax Credit, Section 30D permits qualified taxpayers, both individuals and businesses, to claim a nonrefundable credit of up to $7,500 against their federal income tax for the purchase of a new qualifying vehicle anytime through 2032. The credit amount is subject to a two-tier computation, as well as an overall income-based phase out.
- Credit elements — The credit amount will ultimately be composed of two elements, each equal to either $0 or $3,750. However, these computational rules require further guidance from the IRS, so they have not been fully implemented.
When applicable, the first element is a requirement that a stated percentage of the critical minerals used in the battery must be either: (a) recycled in North America, or (b) extracted or processed in the United States or a country with which the United States has a free trade agreement. The required percentage starts at 40% in 2023 and increases by 10% per year, up to 80% in 2027 and after.
The second element is a requirement that a stated percentage of the value of the components contained in the battery must be either manufactured or assembled in North America. The required percentage starts at 50% in 2023, increases to 60% for 2024 and 2025, and continues to increase by 10% per year, up to 100% in 2029 and after.
- Phase out — The credit is also subject to a full phase out if the modified adjusted gross income (MAGI) of the taxpayer exceeds an applicable threshold. When determining this, a taxpayer can apply the lower of: (1) the MAGI for the tax year when the vehicle is placed in service, or (2) the MAGI for the prior tax year. However, in any event, the income-based limitation operates as a cliff, resulting in full disqualification. The applicable MAGI thresholds are as follows:
- $300,000 for joint filers
- $225,000 for heads of households
- $150,000 for all other filers
Taxpayers qualify if:
- The original use of the vehicle commences with the taxpayer (e.g., new vehicle).
- The vehicle is for personal or business use, not for resale.
- The vehicle is primarily used in the United States.
A vehicle qualifies for the credit if:
- Its gross vehicle weight is less than 14,000 pounds.
- It’s propelled by an electric motor drawing on a battery with a capacity of at least 7 kilowatt hours that’s capable of being recharged from an external source, or it’s powered by 1 or more fuel cells.
- It’s made by a qualified manufacturer (except for FCVs).
- It undergoes final assembly in the United States.
- Its MSRP doesn’t exceed:
- $80,000 for vans, sport utility vehicles, and pickup trucks.
- $55,000 for other vehicles
Taxpayers have options as to how to claim the credit. First, qualifying taxpayers may claim the credit by including Form 8936 with their federal income tax return. Alternatively, qualifying credits may be transferred immediately upon sale to the dealership for a cash reduction or a partial down payment on the vehicle. This process is further outlined through helpful IRS resources such as the Clean Vehicle Tax Credit Homepage and the Transferring New Clean Vehicle Credit IRS FAQs.
To see if a vehicle is eligible for the Section 30D New Clean Vehicle Tax Credit, the DOE has provided a helpful eligibility tool. Furthermore, the IRS hosts a Clean New Vehicle Tax Credit homepage and published a helpful Checklist through Publication 5866.
Previously Owned Clean Vehicle Credits
For the first time, the IRA extended potential tax credits to the purchase of qualifying used EVs or FCVs, as well. Under the Previously Owned Clean Vehicles Credit via Section 25E, taxpayers who buy a qualified used vehicle from a licensed dealer for $25,000 or less may be eligible for a previously owned clean vehicle tax credit pursuant to Section 25E. The amount of the credit is equal to 30% of the sale price up to a maximum credit of $4,000.
To qualify, taxpayers must be individuals who can’t be claimed as a dependent on another person’s tax return. The eligible taxpayer’s MAGI must also not exceed an applicable threshold. Similar to the Section 30D credit, the income threshold operates as a cliff, but taxpayers can apply the lower of: (1) the MAGI for the tax year when the vehicle is placed in service, or (2) the MAGI for the prior tax year. The applicable MAGI thresholds are as follows:
- $150,000 for joint filers
- $112,500 for heads of households
- $75,000 for all other filers
A previously owned clean vehicle qualifies if:
- The sale price is $25,000 or less.
- The purchase occurs from a dealer.
- The model year is at least two years earlier than the calendar year in which the used car is purchased.
- It has not already been transferred to a qualified buyer after Aug. 16, 2022.
- The gross vehicle weight is less than 14,000 pounds.
- It’s a qualified EV with a battery capacity of at least 7 kilowatt hours or is an FCV.
Similar to the new car credit, taxpayers have options when it comes to claiming the credit. First, the applicable credit may be claimed on the eligible taxpayer’s applicable federal income tax return for the year in which the taxpayer took possession of the vehicle. Alternatively, an eligible taxpayer is able to claim the credit through the dealership by transferring it for a cash discount or a partial down payment on the vehicle.
The previously owned vehicle credit also can’t be carried forward, so there will be similar considerations to the clean vehicle credit regarding how this interacts with a taxpayer’s ability to transfer the credit for cash or a down payment at the time the vehicle is purchased.
To see if a vehicle is eligible for the Section 25E Previously Owned Clean Vehicle Tax Credit, the DOE has provided a helpful eligibility tool. Furthermore, the IRS hosts a Previously Owned Clean Vehicle Tax Credit homepage.
Qualified Alternative Refueling Property
The IRA also expanded the credit under Section 30C for the installation of alternative fuel refueling property, including EV charging equipment. For individuals, the credit is equal to 30% of the cost of such property, up to a maximum of $1,000. However, the property must be installed in specific locations within the United States. Namely, the property must be installed in either: (1) a census tract defined as a low-income community for purposes of the New Markets Tax Credit (poverty rate of at least 20% or not exceeding 80% of median family income comparison test), or (2) a census tract that wasn’t designated as an urban area based on the most recent census.
For more information, visit the IRS’s Alternative Fuel Vehicle Refueling Property Credit Homepage.
Give yourself some credit
These new and expanded tax breaks for making certain clean energy upgrades to homes and cars can make the ultimate cost more affordable, but the credits aren’t without their quirks and complexities.
