Falling used car prices warrant a second look at Sec. 25E incentives

With substantial price declines in the used car market over the past year, practitioners should be aware of tax incentives implemented by Sec. 25E for previously owned clean vehicles, known as the used clean vehicle credit. As of this writing, wholesale used-vehicle prices see smaller decline in July, according to Cox Automotive and Manheim. Used car prices have declined 11.6% since July 2022, reaching levels not seen since April 2021. As used cars again become more affordable, practitioners and taxpayers should take a fresh look at tax incentives associated with clean vehicles.

Following enactment of the Inflation Reduction Act of 2022, P.L. 117-169, the tax credits available under Sec. 30D were well-publicized (see “Guidance on Clean Vehicle Tax Credit,” JofA, Aug. 17, 2022). The Sec. 30D credit, applicable to new plug-in electric vehicles and fuel cell vehicles, allows a nonrefundable credit for up to $7,500 of the purchase price. Additional restrictions on the credit for vehicles purchased after April 18, 2023, which pertain to the location of extraction or processing of the critical minerals used in the battery and place of manufacture of other battery components, limit the Sec. 30D credit to a short list of qualified vehicles, all of which have a manufacturer’s suggested retail price well above the median for new vehicles. Consequently, the purchase of a new clean vehicle is unaffordable for many taxpayers.

With continued moderation of used car prices, though, taxpayers might find more value in the Sec. 25E tax credit introduced by the Inflation Reduction Act. The used clean vehicle credit applies to purchases of qualified vehicles made on or after Jan. 1, 2023. Vehicles that qualify include electric vehicles, plug-in hybrid electric vehicles, and fuel cell vehicles, all weighing less than 14,000 pounds (Sec. 25E(c)(1)(D)). The vehicle’s model year must be at least two years earlier than the calendar year of purchase, meaning that taxpayers must consider vehicles with a model year of 2021 or earlier in calendar year 2023 (Sec. 25E(c)(1)(A)). Importantly, there is no requirement as to the extraction, processing, or manufacturing location of critical minerals or battery components; thus, more than twice as many vehicles qualify under Sec. 25E as qualify under Sec. 30D. Also, many more vehicle makes qualify for the Sec. 25E credit. The full list of qualified used clean vehicles is available at Federal tax credits for pre-owned plug-in electric and fuel cell vehicles.

The Sec. 25E credit is equal to 30% of a vehicle’s purchase price, with a maximum credit of $4,000 (Sec. 25E(a)). The purchase needs to be made through a licensed dealer (as defined in Sec. 30D(g) (8)) engaged in the sale of vehicles, with a purchase price not exceeding $25,000. The purchase may only be the vehicle’s first transfer (other than to the original owner) since the date of Sec. 25E’s enactment (Aug. 16, 2022) (Sec. 25E(c)(2)). For example, a 2017 Toyota Prius Prime sells at an average dealer retail price of around $20,615, according to Edmunds.com, and it would be eligible for the full $4,000 tax credit, bringing the after-credit cost to the buyer down nearly 20% to $16,615. The continued decline in used car prices will bring more used clean vehicles into the credit’s price range, making these vehicles more attractive options for consumers aware of the Sec. 25E credit.

Of course, the Sec. 25E credit is not without further restrictions. The credit is nonrefundable and applies only to individuals who are not the original owner and those who are not purchasing the vehicle for resale (Secs. 25E(c)(3)(A) and (B)). In addition, the taxpayer claiming the credit cannot be claimed as a dependent on another return and cannot have claimed the used clean vehicle credit in the three years preceding the vehicle purchase (Secs. 25E(c)(3)(C) and (D)). Taxpayers can claim the credit only if their modified adjusted gross income is below the threshold amount for the tax year of purchase or the preceding tax year, whichever is the lesser (Sec. 25E(b)(1)). The threshold amounts for claiming the credit are $150,000 for married taxpayers filing jointly or surviving spouses; $112,500 for heads of household; and $75,000 for other taxpayers, including single taxpayers and married taxpayers filing separately (Sec. 25E(b)(2)).

Compliance requirements include that the selling dealer must report required information to the taxpayer and IRS at the time of sale and that the taxpayer must file Form 8936, Qualified Plug-In Electric Drive Motor Vehicle Credit. The taxpayer must include the vehicle identification number on Form 8936 (Sec. 25E(d)). For vehicles acquired after Dec. 31, 2023, the Sec. 25E credit can be transferred in the same manner as the Sec. 30D credit under Sec. 30D(g). In addition, special rules similar to those under Sec. 30D(f) apply (Sec. 25E(e)), including that the vehicle’s basis must be reduced by the amount of the credit (Sec. 30D(f)(1)) and no additional “double benefit” of any other federal income tax credit is allowed for the same vehicle (Sec. 30D(f)(2)).

As more used clean car prices fall under the Sec. 25E credit’s $25,000 threshold, more taxpayers will find value in this benefit. The tax credit is available for purchases made through Dec. 31, 2032.

■ Sec. 25E, enacted by Section 13402 of the Inflation Reduction Act, P.L. 117-169

— Thomas Godwin, CPA, CGMA, Ph.D., and John McKinley, CPA, CGMA, J.D., LL.M., are both professors of the practice in accounting and taxation in the SC Johnson College of Business at Cornell University. To comment on this column, contact Paul Bonner, the JofA’s tax editor.