IRS issues guidance on tax treatment of energy efficiency rebates

The Inflation Reduction Act (IRA) established and expanded numerous incentives to encourage taxpayers to increase their use of renewable energy and adoption of a range of energy efficient improvements. In particular, the law includes funding for nearly $9 billion in home energy rebates.

While the rebates aren’t yet available, many states are expected to launch their programs in 2024. And the IRS recently released some critical guidance (Announcement 2024–19) on how it’ll treat the rebates for tax purposes.

The rebate programs

The home energy rebates are available for two types of improvements. Home Efficiency Rebates apply to whole-house projects that are predicted to reduce energy usage by at least 20%. These rebates are applicable to consumers who reduce their household energy use through efficiency projects. Examples include the installation of energy efficient air conditioners, windows and doors.

The maximum rebate amount is $8,000 for eligible taxpayers with projects with at least 35% predicted energy savings. All households are eligible for these rebates, with the largest rebates directed to those with lower incomes. States can choose to provide a way for homeowners or occupants to receive the rebates as an upfront discount, but they aren’t required to do so.

Home Electrification and Appliance Rebates are available for low- or moderate-income households that upgrade to energy efficient equipment and appliances. They’re also available to individuals or entities that own multifamily buildings where low- or moderate-income households represent at least 50% of the residents. These rebates cover up to 100% of costs for lower-income families (those making less than 80% of the area median income) and up to 50% of costs for moderate-income families (those making 80% to 150% of the area median income). According to the Census Bureau, the national median income in 2022 was about $74,500 — meaning some taxpayers who assume they won’t qualify may indeed be eligible.

Depending on your state of residence, you could save up to:

• $8,000 on an ENERGY STAR-certified electric heat pump for space heating and cooling,
• $4,000 on an electrical panel,
• $2,500 on electrical wiring,
• $1,750 on an ENERGY STAR-certified electric heat pump water heater, and
• $840 on an ENERGY STAR-certified electric heat pump clothes dryer and/or an electric stove, cooktop, range or oven.

The maximum Home Electrification and Appliance Rebate is $14,000. The rebate amount will be deducted upfront from the total cost of your payment at the “point of sale” in participating stores if you’re purchasing directly or through your project contractors.

The tax treatment

In the wake of the IRA’s enactment, questions arose about whether home energy rebates would be considered taxable income by the IRS. The agency has now put the uncertainty to rest, with guidance stating that rebate amounts won’t be treated as income for tax purposes. However, rebate recipients must reduce the basis of the applicable property by the rebate amount.

If a rebate is provided at the time of sale of eligible upgrades and projects, the amount is excluded from a purchaser’s cost basis. For example, if an energy-efficient equipment seller applies a $500 rebate against a $600 sales price, your cost basis in the property will be $100, rather than $600.

If the rebate is provided at a later time, after purchase, the buyer must adjust the cost basis similarly. For example, if you spent $600 to purchase eligible equipment and later receive a $500 rebate, your cost basis in the equipment drops from $600 to $100 upon receipt of the rebate.

Interplay with the Energy Efficient Home Improvement Credit

The IRS guidance also addresses how the home energy rebates affect the Energy Efficient Home Improvement Credit. As of 2023, taxpayers can receive a federal tax credit of up to 30% of certain qualified expenses, including:

• Qualified energy efficiency improvements installed during the year,
• Residential energy property expenses, and
• Home energy audits.

The maximum credit each year is:

• $1,200 for energy property costs and certain energy-efficient home improvements, with limits on doors ($250 per door and $500 total), windows ($600) and home energy audits ($150), and
• $2,000 per year for qualified heat pumps, biomass stoves or biomass boilers.

Taxpayers who receive home energy rebates and are also eligible for the Energy Efficient Home Improvement Credit must reduce the amount of qualified expenses used to calculate their credit by the amount of the rebate. For example, if you purchase an eligible product for $400 and receive a $100 rebate, you can claim the 30% credit on only the remaining $300 of the cost.

Act now?

While the IRA provides that the rebates are available for projects begun on or after August 16, 2022, projects must fulfill all federal and state program requirements. The federal government, however, has indicated that it’ll be difficult for states to offer rebates for projects completed before their programs are up and running. In the meantime, though, projects might qualify for other federal tax breaks. Contact us to determine the most tax-efficient approach to energy efficiency.

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