Home ownership avails tax deductions such mortgage interest and ad valorem taxes for those individuals that itemize on their personal income tax return. Deductions are good since they reduce your taxable income; however, tax credits are much better since they reduce the tax itself dollar-for-dollar. One of my mantras when helping our clients with tax planning is “deduction is good, but credits are great!”
Recent legislation passed by Congress and signed into law by President Biden is the Inflation Reduction Act. There has been significant debate as to the title of the law as being misleading. Let us leave the politics to the politicians and we will focus on the important matter of the impact this law has on your 2023 federal income tax return.
Claiming credits against your federal income tax takes a little work to understand and navigate the maze of qualifications to claim the credit. In claiming the Energy Efficient Home Improvement Credit, a taxpayer must provide certain manufacturer certifications and an inspector’s report as to the sufficiency of the improvement to meet the criteria in the law. Further, if you built your home after December 31, 2022, and before January 1, 2033, you may claim a credit against your federal income tax of 30% of the costs paid for such improvements as exterior windows and skylights, exterior doors, and other qualifying energy property.
Overall, the annual limit for such tax credits is $3,200 with no lifetime limit. In that regard, you may make improvements that qualify for the credit on an annual basis as you convert your residence to a more energy efficient dwelling.
Other limitations apply when claiming tax credits. Some credits are refundable and others are nonrefundable. The difference in the credits’ refund status is critical. Refundable credits allow for the refund to be paid the taxpayer even if it exceeds your total tax liability. For example, let us assume your total federal income tax on your 2023 return is $2,500 and you could claim a refundable credit of $4,000. The IRS would send you a check for $1,500. Sounds good, right?
Assume the same tax liability of $2,500 and you claimed a $4,000 nonrefundable credit. The IRS would allow you use $2,500 of the credit to offset your tax and carryover to tax year 2024 the remaining $1,500 to considered in the following year’s calculation of tax.
An additional residential credit provided for in the Inflation Reduction Act is the Residential Clean Energy Credit. Like the previously mentioned credit, the qualified energy property improvements must be installed on a taxpayer’s residence before January 1, 2035. The credit is equal to 30% of the cost of eligible property placed in service in 2022 through 2032; 26% for tax year 2033; and 22% for 2034. Limitations are placed on the credit by kilowatt capacity of the installed property. For example, the credit is $500 for each 0.5 kilowatt of capacity of qualified fuel cell property expenditures for each tax year.
To qualify for the Residential Clean Energy Credit, you may install solar water heating systems, solar electric systems, fuel cell property, small wind energy property, geothermal heat pump property and, for years beginning in 2022, battery storage technology. Each of the eligible property improvements requires certain criteria be met through certifications provided by manufacturers of the products.
Tax laws are complicated. To properly take advantage of opportunities to lower your family’s income tax burden, seek a complimentary consultation from a CERTIFIED FINANCIAL PLANNER™ professional. Judge Learned Hand said it best, “Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.”