New and enhanced energy tax credits for individuals

The Inflation Reduction Act of 2022, P.L. 117-169, is widely considered the most important U.S. legislation to date to combat climate change. The act includes two dozen tax provisions designed to accelerate the deployment of clean energy. While most of these provisions are aimed at corporations, many provisions are designed to encourage individual households to invest in energy-efficient improvements. This includes both the extension of some existing energy-related credits and the creation of some new credits that support individuals’ transition to energy efficiency in their homes and vehicles. While many of these credits became available in 2023, the need for expertise in individual energy credits is just beginning.

Consumer energy-efficient purchases are likely to become even more common in the coming years. In addition to the tax credits, the Inflation Reduction Act authorized $8.8 billion for the Department of Energy’s Home Energy Rebate programs, which are administered through the states. The rebates can be worth up to $14,000 or more per household, depending on the state’s design. These rebates are not distributed through the tax system, but they will act as a catalyst for increased energy-efficient purchases by effectively serving as discounts for homeowners who are looking to make updates to their property or vehicles.

On April 18, 2024, the U.S. Department of Energy approved the first state application for New York, which was awarded an initial $158 million to distribute in energy rebates. Since then, California, Indiana, Michigan, New Mexico, Rhode Island, Washington, and some other states have had their applications approved, and many more are close behind. These rebates should drive increased demand for individual energy tax credits as, in some cases, a household will be able to receive a home energy rebate and also claim a tax credit on the remaining costs of the same upgrade.

It will be important for tax professionals to be knowledgeable of the energy credit landscape to best serve their clients as they navigate the transition to clean energy. This article provides an overview of the energy-related tax incentives created by the Inflation Reduction Act that are available to individuals.

Currently, two categories of energy-related tax credits exist for individuals: those related to clean energy use and energy-efficiency improvements with respect to homes and those related to the purchase of clean-energy vehicles.

RESIDENTIAL ENERGY CREDITS

Sec. 25C energy-efficient home improvement credit

While most energy-related credits apply to businesses, individual taxpayers can claim a tax credit based on energy-efficient home improvements through the Sec. 25C credit. Individuals are eligible under 25C(a) for a credit of up to 30% of the amount paid or incurred for the following:

• New qualified energy-efficient improvements installed during the year with respect to their principal residence (as defined in Sec. 121);
• Residential energy property expenditures with respect to their residence (whether or not it is their principal residence as defined in Sec. 121); and
• Home energy audits with respect to their principal residence (as defined in Sec. 121).

Qualified energy-efficient improvements are any energy-efficient building envelope component with an expected lifespan of at least five years. These include exterior windows and skylights, exterior doors, and certain insulation and air sealing materials or systems. Each improvement type has its own credit allowance. For example, the maximum annual credit available for windows is $600, while doors are eligible for up to $250 per exterior door, with an aggregate limit of $500 for all exterior doors (Secs. 25C(b)(3) and (4)).

Residential energy property expenditures include energy-efficient heating and cooling equipment. In this category, the expenditures are eligible for a maximum annual credit of $600 (Sec. 25C(b)(2)). Lastly, home energy audits are eligible for up to a $150 credit (Sec. 25C(b)(6)). In total, the maximum annual credit for the energy-efficient home improvement credit is generally $1,200 (Sec. 25C(b)(1)). For certain heat pumps, heat pump water heaters, and biomass stoves or boilers, a separate maximum credit of $2,000 applies (Secs. 25C(b)(5) and (d)(2)).

Individual taxpayers should be cautioned that this credit is neither refundable nor able to be carried forward (see Notice 2013-70). Thus, they should make sure that their tax liability is adequate to take full advantage of the credit or spread out their eligible expenditures over multiple tax years to ensure that they receive the full credit.

Still, this is more favorable than the previous Sec. 25C credit, which imposed lifetime limitations, before amendment by the Inflation Reduction Act. While the current credit is set to expire for property placed in service after Dec. 31, 2032 (and began in 2023), taxpayers still have multiple years to strategically plan for it. Also, this credit is permitted only for existing homes located in the United States that individual taxpayers improve or add onto, and not new homes.

The energy-efficient home improvement credit is claimed by filing Form 5695, Residential Energy Credits. For more information on the energy-efficient home improvement credit, see the IRS website.

Sec. 25D residential clean-energy credit

The Inflation Reduction Act also enhanced the Sec. 25D residential clean-energy credit, under which qualifying individual taxpayers may claim up to a 30% credit for expenditures of installing certain alternative energy property. This credit is permitted for both existing and newly constructed homes. Eligible expenses here include the installation of certain solar panels, solar water heaters, fuel cells, wind turbines, geothermal heat pumps, and battery storage technologies. To qualify, the alternative energy property must be installed in or on the taxpayer’s residence. And, unlike the energy-efficient home improvement credit, the residential clean-energy credit can be carried forward (Sec. 25D(c)). This credit will begin to phase out beginning in 2033, with the percentage dropping to 26% for property placed in service during 2033 and 22% for 2034 before terminating entirely for property placed in service after Dec. 31, 2034. Like the energy-efficient home improvement credit, the residential clean-energy credit is claimed by filing Form 5695, Residential Energy Credits. For more information on the residential clean-energy credit, see the IRS website.

VEHICLE CREDITS

New clean vehicle credit

The Inflation Reduction Act also amended Sec. 30D, under which an individual taxpayer may claim up to $7,500 for purchasing and placing in service a new clean vehicle. The purchase is eligible for a credit of up to $3,750 if the vehicle’s battery has a certain percentage of the value of its critical minerals extracted or processed in the United States or a country that the United States has a free trade agreement with or is recycled in North America. The purchase is also eligible for up to another $3,750 if a certain percentage of the battery components was manufactured or assembled in North America.

To qualify for the credit, the vehicle must be a motor vehicle (i.e., any vehicle with at least four wheels that is manufactured primarily for use on public streets, roads, and highways) that meets the following criteria (see Sec. 30D(d)):

• Be new (its original use commences with the taxpayer) and for the taxpayer’s own use or lease (not for resale);
• Not be used predominantly outside the United States (Sec. 30D(f)(4));
• Be propelled to a significant extent by an electric motor that draws electricity from a rechargeable battery with a capacity of at least 7 kilowatt hours;
• Have a gross vehicle weight rating of under 14,000 pounds;
• Be made by a qualified manufacturer (one that meets certain regulatory requirements of Title II of the Clean Air Act (42 U.S.C. §7521 et seq.) and agrees to provide certain periodic written reports to the IRS providing specified vehicle information — see Rev. Proc. 2023-38);
• Be treated as a motor vehicle for purposes of Title II of the Clean Air Act; and
• Undergo final assembly in North America.

Additionally, the sale of the vehicle will qualify only if the seller reports the required information to the taxpayer at the time of the sale and to the IRS (see Sec. 30D(d)(1)(H)). The manufacturer suggested retail price of the vehicle must be less than $80,000 for vans, SUVs, and pickup trucks or $55,000 for other vehicles (Sec. 30D(f)(11)).

In addition, to qualify for the credit, the taxpayer’s modified adjusted gross income (MAGI) in either the year of purchase or the preceding year must be less than or equal to $300,000 for a married taxpayer filing jointly or a surviving spouse; $225,000 for a taxpayer filing as a head of household; or $150,000 for all other taxpayers. For purposes of the credit, MAGI is adjusted gross income increased by any amount excluded from gross income under Sec. 911, 931, or 933. [Note: An earlier version of this article misstated the above requirement.]

This credit is set to expire for any vehicle placed in service after 2032. For more information on the credit, see the IRS website.

Previously owned clean vehicle credit

The purchase and placing in service of previously owned clean vehicles is also eligible for a similar, though lesser, credit under Sec. 25E, also added by the Inflation Reduction Act. Individual taxpayers who are qualified buyers for purposes of the credit are eligible for the lesser of $4,000 or 30% of the sales price for previously owned clean vehicles placed in service between 2023 and 2032, when the credit expires.

To qualify for the credit, a taxpayer must be a qualified buyer who purchases and places in service a previously owned clean vehicle.

A qualified buyer is a taxpayer who:

• Is an individual who cannot be claimed as a dependent by another taxpayer, who buys a previously owned clean vehicle for use and not for resale; and
• Has not been allowed a previously owned clean vehicle credit during the three-year period ending on the date of the sale.

A previously owned clean vehicle is, with respect to the taxpayer, a motor vehicle (i.e., a vehicle with at least four wheels manufactured primarily for use on public streets, roads, and highways):

• That is a model year at least two years earlier than the calendar year in which the taxpayer acquires it;
• The original use of which commences with another taxpayer (i.e., the taxpayer is not the vehicle’s original owner); and
• That is acquired by the taxpayer in a qualified sale of a vehicle that:
  • Is made by a qualified manufacturer, treated as a motor vehicle for purposes of Title II of the Clean Air Act, has a gross vehicle weight of less than 14,000 pounds, is propelled to a significant extent by an electric motor that draws electricity from a rechargeable battery with a capacity of at least 7 kilowatt hours, and for which the seller furnishes a report containing certain required information to the taxpayer at the time of the sale and to the IRS; or
  • Is a qualified fuel cell motor vehicle as described in Secs. 30B(b)(3)(A) and 30B(b)(3)(B) that has a gross vehicle weight of less than 14,000 pounds.

A qualified sale is a sale of a motor vehicle:

• By a dealer;
• For a sale price that does not exceed $25,000;
• That is the first transfer after Aug. 16, 2022 (the Inflation Reduction Act’s date of enactment) to a qualified buyer other than the vehicle’s original owner.

Additionally, no Sec. 25E credit will be allowed for a tax year if the taxpayer’s MAGI is greater than $150,000 if the taxpayer is married filing jointly or a surviving spouse, $112,500 if filing as a head of household, and $75,000 if filing single or married filing separately in either the year of vehicle delivery or the preceding year. As with the clean vehicle credit, MAGI for purposes of the previously used clean vehicle credit is adjusted gross income increased by any amount excluded from gross income under Sec. 911, 931, or 933. For more information on the credit, see the IRS website.

Transfer of credit

New for tax years 2024 and following, taxpayers also have the option of transferring their new and used clean vehicle credits to a registered dealer to effectively take their credit at the time of purchase rather than waiting until they file their tax return (Rev. Proc. 2023-33). If the taxpayer chooses to wait and claim the credit at the end of their tax year, they need simply to file Form 8936, Clean Vehicle Credit, with their tax return.

One note of caution, though — the credits are both nonrefundable and cannot be carried forward. Thus, where credit amounts will not be able to be claimed against remaining taxable income in the year of purchase, the taxpayer is better off transferring the credit and taking it at the time of the sale.

IMPACT OF STATE TAX INCENTIVES

A state may provide incentives to encourage taxpayers to purchase property that also qualifies for a Sec. 25C energy-efficient home improvement credit or a Sec. 25D residential clean energy property credit. Generally, state energy-efficiency incentives will not reduce the qualified costs of home improvements for federal tax credit purposes unless they qualify as a rebate or purchase-price adjustment under federal income tax law (see Notice 2013-70).While many states call their energy-efficiency incentives “rebates,” these incentives may not qualify as rebates or purchase-price adjustments under federal income tax law and could be included in the taxpayer’s gross income for federal income tax purposes (see Q&A No. 4, IRS Fact Sheet FS-2024-15 (updated April 2024)). For information about coordinating the rebates and credits, see the Treasury website.

OPTIMAL SAVINGS FOR TAX CLIENTS

The Inflation Reduction Act added significant value to individual energy tax credits. With proper understanding of the provisions, individual households can save thousands of dollars on clean-energy purchases. However, it will take careful planning to maximize the resulting savings. The energy credit landscape is complicated, and individuals will have to turn to tax professionals with expertise in the area to maximize their benefit. Individuals might begin by considering having a home energy audit conducted by a licensed professional to determine how to best make energy-efficient upgrades. Once energy needs are determined, tax professionals should be prepared to help clients navigate the complex credit regimes to maximize the savings on their energy-efficient purchases.

About the authors

Shannon Veyon Jemiolo, CPA, Ph.D., is an associate professor of accounting at the Wehle Business School of Canisius University in Buffalo, N.Y. Curtis Farnsel, CPA, CMA, Ph.D., M.Acc., is an assistant professor of accounting at the University of Dayton in Dayton, Ohio.

AICPA & CIMA MEMBER RESOURCES

Article

“Falling Used Car Prices Warrant a Second Look at Sec. 25E Incentives,” JofA, Nov. 1, 2023

Tax Section resource (members only)

 Inflation Reduction Act Energy Credits Chart

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