Year-end Tax Planning

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Year-end tax planning—Claim the nonbusiness energy property credit while you can

Practice Alert
Of the many energy-saving provisions in the Code, few are more accessible to ordinary taxpayers than the $500 credit for nonbusiness energy property. The Code Sec. 25C credit can apply to relatively inexpensive, easy-to-do (perhaps even do-it-yourself) items—the installation of insulation (e.g., exterior caulking and weather-stripping), doors, and windows—as well as slightly more expensive but standard items such as central air conditioning and heat pumps. However, currently this credit only applies through 2011, and the prospects for an extension are uncertain. As a result, homeowners should consider accelerating energy-saving home improvements into this year if doing so will generate a credit.

Summary of the credit. The nonbusiness energy property credit, as most recently extended, applies only through Dec. 31, 2011. A taxpayer can claim a credit on Form 5695 equal to 10% of the cost of: (1) qualified energy efficiency improvements, and (2) residential energy property expenditures. (Code Sec. 25C(a)) There is a lifetime credit limit of $500 (with no more than $200 due to windows and skylights) over the total credits allowed to the taxpayer for all earlier tax years ending after 2005. (Code Sec. 25C(b)) The expenses must be for property originally placed in service by the taxpayer and made on or in connection with a dwelling unit located in the U.S., and owned and used by taxpayer as his principal residence (under the Code Sec. 121 home sale exclusion rules) at the time of installation. (Code Sec. 25C(c), Code Sec. 25C(d))

Qualified energy efficiency improvements are energy efficient building envelope components, such as (a) insulation materials or systems specifically and primarily designed to reduce heat loss/gain that meet criteria set by the International Energy Conservation Code (IECC); or (b) exterior windows, skylights or doors, or any metal roof with pigmented coating or asphalt roof with cooling granules specifically designed to reduce heat gain, installed on a dwelling unit that meet Energy Star program requirements. The component must be expected to last for at least five years. (Code Sec. 25C(c)) This requirement is met if the manufacturer offers a two-year warranty to repair or replace at no extra charge.

Residential energy property expenses are expenses for qualified energy property (including labor costs for onsite preparation, assembly, or original installation) that meets specific standards set out in Code Sec. 25C(d). The credit allowed for energy property expenditures can’t exceed:

• $300 for any energy-efficient building property (electric heat pump water heater, electric heat pump; central air conditioner; natural gas, propane or oil water heater; or a stove burning biomass fuel to heat or provide hot water to a taxpayer’s residence in the U.S.) that meets specific energy efficiency standards;
• $150 for a qualified natural gas, propane, or oil furnace; or qualified natural gas, propane, or oil hot water boiler; or
• $50 for an advanced main air circulating fan. (Code Sec. 25C(d))

There’s no credit for expenditures made from subsidized energy financing. (Code Sec. 25C(e))

Extension history. The nonbusiness energy property credit, as added by the Energy Tax Incentives Act of 2005 (Energy Act, P.L. 109-58, 8/8/2005), originally applied for property placed in service after 2005 and before 2008. Thus, it only applied for 2006 and 2007. Like many credits, it was extended (with certain modifications), but only after 2008 had come and gone. The credit, as extended by the Emergency Economic Stabilization Act of 2008 (EESA, P.L. 110-343, 10/3/2008), skipped 2008 and was available for property placed in service after 2008 and before 2010. The credit was once more extended (through 2010), as well as increased, broadened, and liberalized by the American Recovery and Reinvestment Act of 2009 (ARRA, P.L. 111-5, 2/17/2009). The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (2010 Tax Relief Act, P.L. 111-312, 12/17/2010) provided the most recent extension of this credit—a one-year extension until the end of 2011.

Arguably, such a long history of extensions might indicate the likelihood of further extensions. But while still a valuable credit for homeowners, the final extension through 2011 demonstrated a more parsimonious attitude by Congress towards the credit. Thus, the nonbusiness energy property credit available in 2011 consists of a 10% credit, instead of what had previously been a 30% credit. In addition, a taxpayer’s lifetime maximum nonbusiness energy property credit is no longer the previous $1,500. Instead, it is now $500 (of which no more than $200 may be for expenditures on windows). Further, the credit is no longer available for expenditures from subsidized energy financing.

RIA observation: The 2011 credit rates, dollar limits, and lifetime limits are those that were in effect for 2006 and 2007 before ARRA provided an enhanced nonbusiness energy property credit for 2010. Thus, the 2010 Tax Relief Act returned the credit to its earlier, less generous form for 2011.

Aggregate credit limit. Perhaps most suggestive that there may not be a future for the nonbusiness energy property credit is the aggregate credit limit imposed by the 2010 Tax Relief Act in the latest extension—it not only imposes a relatively modest cap for 2011, but in doing so takes into consideration all such credits taken in all previous (sometimes more generous) years. The nonbusiness energy property credit allowed to a taxpayer for 2011 can’t exceed the excess (if any) of $500 over the aggregate nonbusiness energy property credits allowed to that taxpayer for all earlier tax years ending after 2005.

RIA observation: Thus, to apply the $500 lifetime limit, the taxpayer must look back to all tax years for which the nonbusiness energy property credit was in effect. Those years include 2006, 2007, and 2009 when the credit was subject to a $500 lifetime limit, and 2010, when there was a $1,500 aggregate limit. If the total of nonbusiness energy property credits for all earlier years is $500 or more, the taxpayer can’t claim a credit for 2011. If the total is less than $500, the taxpayer can claim up to $500 minus the total credits claimed in earlier years.

Source: Federal Tax Updates on Checkpoint News tab 9/26/2011