6 energy tax credits saved from 'the cliff'

Richard Barrington | Improvement Center Columnist | March 1, 2013

Tax credits for energy-efficient home improvements weren't just teetering on the fiscal cliff -- they had actually already gone over it. These tax credits had expired at the end of 2011, but the budget deal to avoid the fiscal cliff restored them for both 2012 and 2013.

This could provide a surprise bonus for home owners who already made these improvements last year, and also creates an incentive for home owners to look into such improvements this year.

A dramatic rescue

The fate of these tax credits was more than a cliff hanger -- they were dead and gone before the budget deal brought them back to life. That could be great news for home owners.

Here's what happened: The Energy Policy Act of 2005 created section 25C of the Internal Revenue Code. Among other things, this section provided tax credits for the installation of certain energy-efficient heating and cooling units. Those tax credits were temporary, and had expired at the end of 2011. However, as part of the recent budget deal to extend certain tax breaks, these credits were reinstated -- retroactively for 2012, and going forward until the end of 2013.

This means that if you installed the right kind of equipment last year, you might have a tax break coming on your 2012 return. If you haven't yet made this type of improvement, you have the remainder of this year to have Uncle Sam help foot the bill for making your home more energy-efficient.

Here's the key to this deal: This is a tax credit, not a tax deduction. A tax credit is much more valuable than a tax deduction. A deduction simply reduces the income you have to declare, so what you actually save is the taxable portion of that deduction. A tax credit is like an amount of tax you have already paid, so your tax bill is reduced by the entire amount of the tax credit.

What home improvements are covered?

The tax credit in question applies to the purchase and installation of certain types of equipment that make heating or cooling your home more energy efficient. That makes these improvements an investment that can pay you back twice -- first with the up-front tax credit, and then on a continuing basis with reduced energy bills.

Here are the home improvements that may be eligible for tax credits, along with the corresponding amount of the tax credit:

  1. Central air conditioning -- $300
  2. Air-source heat pumps -- $300
  3. Gas, oil, or propane furnace or hot water boilers -- $150
  4. Main air circulating fans -- $50
  5. Gas, oil, or propane water heaters -- $300
  6. Electric heat pump water heaters -- $300

One important limitation: A lifetime total limit of $500 applies to this energy-efficiency tax credit.

All equipment must meet specific standards of high energy efficiency. How can you tell if a piece of equipment meets those standards? The manufacturer should be able to certify that the equipment is eligible for a Section 25C tax credit. Also, the Air Conditioning, Heating, and Refrigeration Institute (AHRI) website not only has a table describing which types of equipment are eligible, but they also have a handy search tool that allows you to specify eligibility for the federal tax credit when screening for brands and models.

How can you benefit?

To benefit from this tax credit, you should do the following:

  1. Identify equipment which meets the energy efficiency standards for the tax credit.
  2. Once you've purchased the equipment, obtain a certification from the manufacturer that the equipment is eligible. These certifications are often available online at the manufacturer's web site.
  3. Save that certification and your dated purchase receipt with your tax records. You don't need to file them with your return, but you should keep them on hand in case you are audited.
  4. Complete IRS Form 5695 as part of the appropriate year's tax return.

If you made the purchase last year, you should still be able to obtain a certification and file for the tax credit as part of your 2012 return.

If you made any kind of heating and air conditioning improvements last year, do not fill out your 2012 tax return until you have checked to see if they qualify for a section 25C tax credit. If you have not upgraded your heating and air conditioning equipment yet, 2013 is the time to do it. The tax credit will help offset the upfront cost, and your energy savings over the years can continue to pay you back for your investment.

About the Author

Richard Barrington has earned the CFA designation and is a 20-year veteran of the financial industry, including having previously served for over a dozen years as a member of the Executive Committee of Manning & Napier Advisors, Inc. Richard has written extensively on investment and personal finance topics.