Energy Bill Provides New Tax Breaks

With energy prices up and supplies of many energy sources becoming scarcer, Congress has agreed on a new law that, among other provisions, creates and expands tax incentives for certain energy efficient expenditures. President Bush signed the Energy Policy Act of 2005 into law on August 8, 2005. The law provides tax benefits to both individual and business taxpayers.

Home Improvements

The new law allows a lifetime federal income-tax credit of up to $500 for implementing qualified energy saving improvements to an existing U.S. principal residence. (A tax credit is a direct offset against tax; a deduction only reduces the amount of income subject to tax.) Only $200 of this credit amount may be for qualifying windows expenditures.

The tax credit for qualifying energy saving improvements equals the sum of the credits for:

(1) Qualified energy efficient improvements. These items include: insulation material or an insulation system specifically and primarily designed to reduce heat loss or gain in the dwelling unit in which it is installed; exterior windows (including skylights); exterior doors; and certain specially coated metal roofs. A credit may be claimed for 10% of the cost of these improvements.

(2) Residential energy property expenses. These expenses and related credits include: an up to $300 credit for the cost of energy efficient building property meeting specified standards (electric heat pump water heater, electric heat pump, geothermal heat pump, central air conditioner, and natural gas, propane or oil water heater); an up to $150 credit for a natural gas, propane or oil furnace or hot water boiler; and an up to $50 credit for an advanced main air circulating fan.

These tax credits will be available for improvements placed in service in 2006 or 2007.

Example: In 2006, you spend $3,500 on new energy efficient exterior windows installed in your home. In 2007, you pay $2,000 for a new energy efficient gas furnace and spend $1,500 on new roof insulation. For 2006, you may claim a tax credit of $200 for the cost of the windows (the credit is limited to $200). In 2007, you may take a credit of $150 for the new furnace and $150 for 10% of the cost of the insulation. You have reached the lifetime credit limit of $500.

Solar and Fuel Cell Equipment

The new law also provides tax credits for solar and fuel cell equipment placed in service in a residence. The credits may be claimed each year you place qualifying equipment in service (there is no lifetime limit). The credits include:

(1) 30% of the cost of equipment that uses solar energy to generate electricity (so-called photovoltaic property), up to a $2,000 maximum annual credit.

(2) 30% of the cost of solar water heating equipment, up to a $2,000 maximum annual credit.

(3) 30% of the cost of a fuel cell power plant (as defined in the law), up to a $500 maximum credit for each half-kilowatt of capacity.

The equipment in (1) and (2) above may be installed in either a primary or secondary residence. Thus, installing the equipment in a vacation home qualifies. The equipment in (3) must be installed in a principal residence. Credits won’t be given for equipment used to heat a swimming pool or hot tub. The credits are available for equipment placed in service in 2006 and 2007.

Alternative Power Vehicles

The Energy Policy Act provides an alternative motor vehicle credit that replaces the current deduction for clean fuel vehicles, starting next year.

The new credit consists of the sum of four items: (1) the qualified fuel cell motor vehicle credit; (2) the advance lean burn technology motor vehicle credit; (3) the qualified hybrid motor vehicle credit; and (4) the qualified alternative fuel motor vehicle credit. Each credit is subject to complex formulas and requirements set forth in the new law. The vehicle owner or lessor (if the vehicle is subject to a lease) may claim the credits for the year a vehicle is placed in service. Limits apply to the number of sales of vehicles that may qualify for the credits available under (2) and (3) above.

Credit for Building Energy Efficient Homes

Under the Energy Policy Act, eligible contractors – builders or home manufacturers – will receive a tax credit for building new energy efficient homes. To qualify, a structure must: be located in the U.S.; be substantially completed after August 8, 2005; meet specific energy saving requirements; be built by the eligible contractor; and be acquired for residential use during the tax year.

The amount of the credit will be $2,000 or $1,000 per home depending on the type of home and which energy-saving criteria the home meets. The credit is available for homes completed after August 8, 2005, and purchased in 2006 and 2007.

Tax Breaks for Commercial Realty

A widely applicable provision of the new law gives building owners an incentive to upgrade buildings to make them more energy efficient and to construct new energy-efficient buildings. The law provides a new tax deduction for certain expenses incurred for energy-efficient commercial buildings. The new deduction goes into effect for qualifying property placed in service during 2006 and 2007.

The maximum energy efficient commercial building (EECB) deduction is equal to (1) $1.80 per building square foot ($.60 per foot for certain separate building systems) less (2) the aggregate amount of EECB deductions previously allowed for the building. There is no overall per-building deduction limit.

To qualify, the energy efficient property must meet several conditions, including a certification that the installed property is part of a plan designed to reduce the total energy and power costs with respect to interior lighting, heating, cooling, ventilation, and hot water systems by 50% or more in comparison with specified minimum standards. A partial deduction is allowable if the 50% requirement is not met for the total property. The IRS is expected to issue guidance spelling out how the new deduction works.

Other Provisions

Several other tax benefits are found in the new law, including a research and experimentation tax credit for energy-related research, a new production tax credit for qualifying advanced nuclear power facilities, and a new credit for clean coal facilities producing electricity.

Summary

The Energy Policy Act of 2005 contains a number of tax “goodies” for both individual and business taxpayers. For more information on how the new tax provisions can benefit you, talk to us.

The information provided in the newsletter has been obtained from sources believed to be reliable but its accuracy is not guaranteed.