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IRS Expands Guidance on Residential Energy Tax Credit
(Parker Tax Publishing: November 06, 2013)

Taxpayers that place certain nonbusiness energy property in service before 2014 or before 2017 may be eligible for tax credits under Code Sec. 25C and Code Sec. 25D, respectively. Each credit has different requirements and covers different types of property. The credits, which are aimed at homeowners installing energy efficient improvements such as insulation, new windows (including skylights), certain roofs, furnaces, and hot water boilers, range from $50 to $1,500, depending on the type of property placed in service. In Notice 2013-70, the IRS provides additional guidance on the types of property that qualify for the credits.

For example, while improvements made to a second home are not eligible for the credit under Code Sec. 25C nor under Code Sec. 25D with respect to fuel cell property, Notice 2013-70 provides that a taxpayer may claim a Code Sec. 25D credit for other qualifying property described in Code Sec. 25D, such as solar electric property, solar water heating property, small wind energy property, and geothermal heat pump property, installed in a dwelling unit used as a second home or a vacation home by the taxpayer. Notice 2013-70 also provides that, because the sales tax on a qualifying property is part of the amount paid or incurred, a taxpayer may include the amount of sales tax when calculating both the Code Sec. 25C credit and the Code Sec. 25D credit. In addition, Notice 2013-70 provides that window sash replacement kits may be eligible for the Code Sec. 25C credit even though they are not whole windows.

Practice Tip: To the extent the notice provides new insight into the types of property that qualify, practitioners may be able to use this guidance to take credits on a client's 2013 tax return or file amended returns for prior years in which their clients placed such property in service.

OBSERVATION: While the credit under Code Sec. 25C is scheduled to expire for property placed in service after 2013, there are ongoing efforts in Congress to extend tax provisions scheduled to expire at the end of 2013. The Obama administration, however, is not backing the annual tax extenders package and instead wants to make a few of the provisions permanent while pushing forward with tax reform.

Background

Code Sec. 25C allows a credit in an amount equal to the sum of (1) 10 percent of the amount paid or incurred by the taxpayer for qualified energy efficiency improvements installed during the year, and (2) the amount of the residential energy property expenditures paid or incurred by the taxpayer during the year. The credit is allowed for qualifying property placed in service through December 31, 2013. For property placed in service in tax years beginning in 2009 and 2010, Code Sec. 25C allowed taxpayers to claim a maximum aggregate credit of $1,500. However, for years other than tax years beginning in 2009 and 2010, Code Sec. 25C limits the credit allowable to any taxpayer to the excess of $500 over the aggregate credits allowed to that taxpayer under Code Sec. 25C for all prior tax years ending after December 31, 2005 (including credits claimed in 2009 and 2010).

In Notice 2009-53, the IRS defines the term qualified energy efficiency improvements and the term residential energy property expenditures to include building envelope components that satisfy specified efficiency standards and energy property that satisfy specified energy standards and (1) are installed in or on a dwelling unit located in the United States and owned and used by the taxpayer as the taxpayer's principal residence, (2) the original use of the item begins with the taxpayer, and (3) in the case of a building envelope component, can reasonably be expected to remain in use for at least five years.

The credit under Code Sec. 25C may be limited depending on the type of property placed in service. For example, the maximum amount of credit allowed for any tax year is $50 for any advanced main air circulating fan; $150 for any qualified natural gas, propane, or oil furnace or hot water boiler; and $300 for any item of energy-efficient building property. In addition, in the case of amounts paid or incurred for exterior windows, including skylights, Code Sec. 25C limits the credit to the excess of $200 over the aggregate maximum amount of the credits allowed to that taxpayer for exterior windows under Code Sec. 25C for all prior tax years ending after December 31, 2005.

Code Sec. 25D allows a credit for qualified expenditures made by a taxpayer for residential energy efficient property. Taxpayers may claim the Code Sec. 25D credit for qualified property placed in service before January 1, 2017. In Notice 2009-41, the IRS defines qualified expenditures for residential energy efficient property to include (1) qualified solar electric property expenditures for use in a qualifying dwelling unit; (2) qualified solar water heating property expenditures for property which heats water for use in a qualifying dwelling unit if at least half of the energy used by the property for such purpose is derived from the sun; (3) certain qualified fuel cell property expenditures; (4) qualified small wind energy property expenditures for property which uses a wind turbine to generate electricity for use in connection with a qualifying dwelling unit; and (5) certain qualified geothermal heat pump property used to heat a dwelling unit or as a thermal energy sink to cool the dwelling unit that meets the requirements of the Energy Star program.

Both Notice 2009-41 and Notice 2009-53 provide guidance to taxpayers seeking to claim credits under Code Sec. 25C and Code Sec. 25D in reliance on a manufacturer's certification. The notices provide that for either credit, a taxpayer may rely on a manufacturer's certification that property is eligible for the credit so long as the IRS has not withdrawn the manufacturer's right to make the certification. The notices further clarify that the IRS may determine that a manufacturer's certification is erroneous; in such cases, the IRS will withdraw a manufacturer's right to provide a certification on which future purchasers of the component or property may rely, and taxpayers purchasing the component or property after the date on which the IRS publishes an announcement of the withdrawal may not rely on the manufacturer's certification.

Practice Tip: A taxpayer may qualify for the credits under Code Sec. 25C and Code Sec. 25D without a manufacturer's certification statement if the taxpayer can show that the property meets the required efficiency standards. A taxpayer should retain documentation sufficient to establish the entitlement to, and amount of, any credit.

Years the Credits May Be Claimed

A taxpayer may not claim the credits under Code Sec. 25C and Code Sec. 25D until the year the property is installed. The installation must be completed before the end of 2013 for the Code Sec. 25C credit and before the end of 2016 for the Code Sec. 25D credit.

In the case of an expenditure incurred in connection with the construction or reconstruction of a structure, a taxpayer cannot claim the credits until the year in which the taxpayer's original use of the constructed or reconstructed structure begins, and the taxpayer's original use of the constructed or reconstructed structure must begin before the end of 2013 for the Code Sec. 25C credit and before the end of 2016 for the Code Sec. 25D credit.

Credits May Be Available for a Second Home in Some Circumstances

Improvements made to a second home are not eligible for the credit under Code Sec. 25C because that provision requires that qualified energy efficiency improvements and residential energy property must be installed in or on a dwelling unit owned and used by the taxpayer as the taxpayer's principal residence (within the meaning of Code Sec. 121).

With respect to the credit under Code Sec. 25D, fuel cell property credits are not available for second homes because fuel cell property must be installed on or in connection with a dwelling unit that is used as the taxpayer's principal residence.

However, a taxpayer may claim a Code Sec. 25D credit for other qualifying properties that are not fuel cell properties. Thus the credit may be available for solar electric property, solar water heating property, small wind energy property, and geothermal heat pump property installed in or on a dwelling unit used as a second home or a vacation home by the taxpayer.

OBSERVATION: A taxpayer may not claim the Code Sec. 25D credit for expenditures for improvements made to an investment property, such as rental property, that is not also used as a residence by the taxpayer.

Credits May Be Available for Certain Business Property

For both credits under Code Sec. 25C and Code Sec. 25D, if a taxpayer uses property solely for business purposes, the property does not qualify for the credit. For a taxpayer who otherwise qualifies for the credits, but whose use of the qualified property for business purposes exceeds 20 percent, both Code Sec. 25C(e)(1) and Code Sec. 25D(e)(7) provide that the taxpayer, when calculating the amount of credit, may take into account only that portion of the expenditures for the property that are properly allocable to use for nonbusiness purposes. A taxpayer who qualifies for the credits and whose use of the qualified property for business purposes is not more than 20 percent may claim the full credit.

Labor Costs May Be Included in Calculating Certain Credits

When calculating the Code Sec. 25C credit, a taxpayer may include the labor costs for the onsite preparation, assembly, or original installation of residential energy property such as qualifying electric heat pumps, qualifying air conditioners, and qualifying biomass stoves. In contrast, a taxpayer may not include the labor costs for qualified energy efficient building envelope components including a qualifying insulation material or system, exterior window, skylight, exterior door, or roof. Thus, for an energy efficient building envelope component for which a taxpayer pays a fixed price, the taxpayer must make a reasonable allocation between the qualifying cost of the property and the nonqualifying labor cost of the installation. When calculating the Code Sec. 25D credit, a taxpayer may include the expenditures for labor costs properly allocable to the onsite preparation, assembly, or original installation of the qualified property and for piping or wiring to interconnect the qualifying property to the home.

Sales Tax May Generally Be Included in Calculating Expenses Eligible for the Credits

Because the sales tax on a qualifying property is part of the amount paid or incurred, a taxpayer may include the amount of sales tax when calculating both the Code Sec. 25C credit and the Code Sec. 25D credit. However, because labor costs for qualified energy efficient building envelope components in Code Sec. 25C are ineligible for the credit, to the extent sales tax is allocable to these labor costs, the sales tax is similarly ineligible for the credit.

Tax Treatment of Subsidies and Incentives

Special rules apply if a government or a public utility provides a subsidy (for example, an incentive, grant, or rebate) to a taxpayer to purchase or install a qualifying property under Code Sec. 25C or Code Sec. 25D. Under Code Sec. 136, if a public utility provides (directly or indirectly) a subsidy to a customer for the purchase or installation of any energy conservation measure, the customer does not include in his or her gross income the value of the subsidy. As a result, the taxpayer may not claim a credit for the amount of the subsidy that is excluded from the taxpayer's gross income. This rule applies whether a third-party contractor receives a subsidy on behalf of the taxpayer or the taxpayer receives the subsidy directly. Not all payments from a public utility fall within the provisions of Code Sec. 136.

Rebates generally represent a reduction in the purchase price or cost of property, and the taxpayer must exclude the amount of the rebate from the amount of the qualified expenditure on which the taxpayer calculates the tax credit. In general, for a receipt of funds to be considered a nontaxable rebate, the rebate must be based on or related to the cost of the property; the rebate must be received from someone having a reasonable nexus to the sale of the property, for example, the manufacturer, distributor, or seller/installer; and the rebate must not represent payment or compensation for services.

Some states provide energy-efficiency incentives to encourage taxpayers to purchase qualifying property under Code Sec. 25C or Code Sec. 25D. These incentives are not addressed by Code Sec. 136.

In this situation, Notice 2013-70 provides that a taxpayer is not required to reduce the purchase price or cost of property acquired with a governmental energy-efficiency incentive that is not a rebate. Many states label their energy-efficiency incentives as rebates, but these incentives may not in fact constitute rebates or purchase-price adjustments for federal income tax purposes.

However, for qualifying property under Code Sec. 25C placed in service after 2010 that is financed in whole or in part by subsidized energy financing, the amount of expenditures eligible for the Code Sec. 25C credit does not include any expenditures that are made from subsidized energy financing. Subsidized energy financing means financing provided under a federal, state, or local program a principal purpose of which is to provide subsidized financing for projects designed to conserve or produce energy. A taxpayer does not reduce the amount of the qualified expenditure by the amount of the state tax credit claimed in calculating the credits under Code Sec. 25C or Code Sec. 25D.

Caulk and Weather Stripping May Be Eligible for the Code Sec. 25C Credit

Code Sec. 25C(c) defines a building envelope component eligible for the credit under Code Sec. 25C as any insulation material or system that is specifically and primarily designed to reduce the heat loss or gain of a dwelling unit when installed in or on such dwelling unit and meets certain criteria.

Thus, if a taxpayer uses an air barrier material, suitable film, or solid material such as caulk or weatherstripping to seal the areas of a principal residence listed below, the taxpayer may claim the Code Sec. 25C credit with respect to amounts paid for such sealant, as long as the taxpayer satisfies the other requirements of Code 25C:

1. All joints, seams, and penetrations.

2. Site-built windows, doors and skylights.

3. Openings between window and door assemblies and their respective jambs and framing.

4. Utility penetrations.

5. Dropped ceilings or chases adjacent to the thermal envelope.

6. Knee walls.

7. Walls and ceilings separating a garage from conditioned spaces.

8. Behind tubs and showers on exterior walls.

9. Common walls between dwelling units.

10. Attic access openings.

11. Rim joist junction.

12. Other sources of infiltration.

Window Sash Replacement Kits Are Eligible for Code Sec. 25C Credit

Although window sash replacement kits are generally comprised of only the sashes, glazing, and adjacent parts and are not whole windows, Notice 2013-70 provides that the kit is an exterior window for purposes of the credit. However, to be eligible for the credit, the window sash replacement kit must meet the requirements of the Energy Star program.

Determining the Code Sec. 25D Credit for the Cost of Property Installed in a Newly Constructed Home

A taxpayer may claim a Code 25D credit if qualifying property is installed in or on an existing home or a newly constructed home. In the case of a newly constructed home, the taxpayer may request that the homebuilder make a reasonable allocation or the taxpayer may use any other reasonable method to determine the cost of the property that is eligible for the Code Sec. 25D credit. For example, where a homebuilder constructed a house in which qualifying Code Sec. 25D property was installed in Year 1, but the house was not sold and used as a residence until Year 2, the taxpayer that buys the home for use as a residence in Year 2 may still claim the Code Sec. 25D credit as long as the taxpayer begins to use the house as a residence before 2017. Code Sec. 25D(e)(8) treats an expenditure in connection with the construction or reconstruction of a structure as made when the taxpayer begins to originally use the constructed or reconstructed structure as a residence.

If the house was a model home, and the qualifying property was used during the time it was marketed for sale, the taxpayer can still claim the Code Sec. 25D credit in Year 2 because the expenditure is treated as made when the use of the structure as a residence begins.

However, Code Sec. 25D(e)(8) generally treats an expenditure as made when the original installation of the qualifying property is completed. In the case of an expenditure incurred in connection with the construction or reconstruction of a structure, the expenditure is treated as made when the original use of the constructed or reconstructed structure as a residence by the taxpayer begins. Thus, only the taxpayer who begins the original use of the constructed or reconstructed structure as a residence or the taxpayer using the home as a residence when the property was originally installed is eligible for the tax credit.

Solar Property

Solar Panels. For purposes of the credit under Code Sec. 25D, Code Sec. 25D(d)(2) defines a qualified solar electric property expenditure, in part, as an expenditure for property that uses solar energy to generate electricity for use in a dwelling unit that is used as a residence by the taxpayer. Therefore, if solar panels that are not directly located on the taxpayer's home use solar energy to generate electricity directly for the taxpayer's home, the taxpayer may claim the Code Sec. 25D credit.

Off-Site Solar Panels. In certain situations, a taxpayer may purchase solar panels that are placed on an off-site solar array and connected to a local public utility's electrical grid that supplies electricity to the taxpayer's residence. The taxpayer enters into a direct contractual arrangement with the local public utility that supplies electricity to the taxpayer's residence to allow the taxpayer to provide electricity to the grid using a net metering system that measures the amount of electricity produced by the taxpayer's solar panels and transmitted to the grid and the amount of electricity used by the taxpayer's residence and drawn from the grid. The contract states that the taxpayer owns the energy transmitted by the solar panels to the utility grid until drawn from the grid at his residence. Absent unusual circumstances, the panels will not generate electricity for a specified period in excess of the amount expected to be consumed at the taxpayer's residence during that specified period. The taxpayer's expenditure for off-site solar panels under this type of contractual arrangement with a local public utility that supplies electricity to the taxpayer's residence meets the definition of qualified solar electric property expenditure.

Credit Limited Where Taxpayer Sells Excess Electricity. Alternatively, a taxpayer may purchase and install solar electric property to generate electricity for the taxpayer's own home and to allow the taxpayer to sell excess electricity to a utility. In this case, the taxpayer generates more than a minimal amount of excess electricity and may not claim the Code Sec. 25D credit for the full amount of the solar electric property expenditure because the property not only generates electricity for use in the taxpayer's home, but it also generates electricity for sale by the taxpayer. The taxpayer may only claim the Code Sec. 25D credit for the portion of the solar electric property expenditure that relates to the electricity generated for use in the taxpayer's home. In addition, the taxpayer may be able to claim the Code Sec. 48 credit for a portion of the solar electric property expenditure if the requirements of Code Sec. 48 are satisfied.

Solar Air Heaters. An expenditure for a solar air heater is not eligible for the Code Sec. 25D credit because Code Sec. 25D(d)(2) defines a qualified solar electric property expenditure, in part, as an expenditure for property that uses solar energy to generate electricity for use in a dwelling unit and Code Sec. 25D(d)(1) defines a qualified solar water heating property expenditure, in part, as an expenditure for property to heat water for use in a dwelling unit if at least half of the energy used by such property for such purpose is derived from the sun. A solar air heater that warms air and does not generate electricity or heat water is thus not eligible for the Code Sec. 25D credit.

Solar Powered Exhaust Fans. Only the component part of a property that actually generates electricity for the dwelling unit is eligible for the Code Sec. 25D credit. Thus, if a solar panel on a fan generates electricity to power the fan for use in the dwelling unit, the cost of the panel component may be eligible for the Code Sec. 25D credit if all the requirements of Code Sec. 25D are met; however, the entire cost of the fan is not eligible.

Small Wind Energy Property

A taxpayer may claim the Code Sec. 25D credit for the purchase of small wind energy property made from remanufactured wind turbines.

Geothermal Heat Pump Property

Where a taxpayer contacts a seller o ask about installing a geothermal heat pump to heat his home and the seller/installer tells the taxpayer that additional items must be installed in addition to the geothermal heat pump, not all of those items are eligible for the Code Sec. 25D credit. For example, if the seller/installer says that the additional equipment that needs to be installed include heat exchange equipment in the ground outside of the house, a distribution system for the home, and a back-up emergency heating or cooling system, only the cost of the heat exchange equipment in the ground outside the house is eligible for the Code Sec. 25D credit. The costs for the distribution system for the home and a back-up emergency heating or cooling system are not eligible for the credit because they are not incurred for qualified geothermal heat pump property.

Additionally, a manufacturer of geothermal heat pump property is not required to become an Energy Star partner to provide a certification pursuant to Notice 2009-41. However, the geothermal heat pump property must meet the requirements of the Energy Star program in effect at the time the taxpayer purchases the property. (Parker Tax Publishing Staff Writers)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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