Explaining the (Stingier) Energy Tax Credit

By Jonnelle Marte

Homeowners who make energy-efficient improvements to their houses can still get a break from Uncle Sam next year, but the payback will be smaller and there are several catches that could shut out some taxpayers altogether.

The tax law passed in December extends a federal tax credit through 2011 for people who make their homes more energy efficient.  The catch: The government reduced the credit to pre-2009 levels. This means that taxpayers will be able to get a maximum $500 lifetime credit for up to 10% of costs of making their home more efficient. That’s down drastically from the maximum $1,500 credit that covered up to 30% of expenses which taxpayers could claim in tax years 2009 and 2010. (Now and then, you’d have to spend at least $5,000 to get the maximum credit.)

The new rules also limit how much of the federal tax credit can be awarded for various types of equipment. Windows get the most stringent rules. If you spend up to $2,000 this year to install new windows you can get a maximum $200 credit—but after getting that credit, you can’t claim any tax credits for windows in future years, not even if you get even more efficient windows later or move to a new home and install such windows there.

The caps on other types of equipments reset annually. So you can get a $150 credit for a furnace or hot water boiler in 2011, and again in 2012 if you upgrade. The credit is capped at $50 a year for smaller equipment like an advanced main circulating fan (they make furnaces more efficient), but can be as high as $300 for most other types of qualified property.

The new limits will affect people who make energy improvements to their homes this year and claim the energy credit on their 2011 tax forms. So if you made improvements in 2010, you still qualify for the larger $1,500 credit, the maximum allowed total for improvements made in 2009 and 2010.

Given the newly-reduced $500 lifetime limit, you won’t be able to claim a credit this year or in future years if you’ve already claimed an energy credit of $500 or more in previous years. Many taxpayers got a second chance to get the credit and make additional energy efficient improvements to their homes in 2009 and 2010 when the credit was temporarily increased.

The credit applies to people who make qualifying upgrades to their insulation, windows, doors, roofs, heating, ventilation and air-conditioning systems, among other equipment.  A separate 30% federal credit exists for alternative-energy equipment installations, such as fuel cells and solar-water heaters, which applies to improvements made through 2016. The only maximum here is for fuel cells, capped at a $500 credit.

Don’t forget that the improvements must be made on your principal residence, and that equipment must meet certain energy requirements to qualify. “If my brother-in-law had some old windows in his basement and he gives them to me and I install them, I don’t get any credit,” says Jackie Perlman, an analyst with the Tax Institute at H&R Block. And you’ll have to fill out detailed paperwork to prove that you used approved equipment. The IRS website offers  more details on how to qualify.

One bright side: Even if you max out on federal credits, you may still be able to take advantage of other incentives offered by your state or local governments, and in some places, even your utility company.

Readers, did you take advantage of the energy credit last year? Do the current limits still encourage you to make energy efficient improvements this year?