New Law Includes Unpleasant Surprise In Nonbusiness Energy Property Credit

While the recently passed Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (2010 Tax Relief Act) contained a host of taxpayer-friendly provisions—including 100% bonus depreciation, reduced Social Security tax, increased alternative minimum tax exemptions, and the extension of many business and individual tax credits—for taxpayers hoping to take advantage of the nonbusiness energy property credit, it was less than generous. True, the credit was extended one year, but it was not the same credit that taxpayers previously knew.

Background. Individuals are allowed a nonrefundable personal income tax credit, known as the nonbusiness energy property credit, for certain energy efficient property installed in a dwelling located in the U.S. and owned and used by the taxpayer in the taxpayer's principal residence. Under pre-2010 Tax Relief Act law, the credit was equal to 30% of the sum of:

1. the amount paid or incurred by the taxpayer during the tax year for qualified energy efficiency improvements (building envelope components meeting certain requirements) installed during the tax year, and

2. the amount of residential energy property expenditures paid or incurred by the taxpayer during the tax year for the purchase of: (a) advanced main air circulating fans; (b) qualified natural gas, propane, or oil furnace or hot water boilers; and (c) energy-efficient building property. The credit wasn't available for property placed in service after Dec. 31, 2010.

The aggregate amount of the credit allowed for a taxpayer for tax years beginning in 2009 and 2010 was $1,500.

Observation: The above rules were enacted by the 2009 Recovery Act (Sec. 1121(a), PL 111-5, 2/17/2009), effective for tax years beginning after Dec. 31, 2008. The credit wasn't available for property placed in service in 2008, but a credit equal to 10% of qualified energy efficiency improvements plus specified dollar amounts for residential energy property expenditures, subject to a $500 lifetime limit ($200 for windows), applied for 2006 and 2007.

Nonbusiness energy property credit. Under the 2010 Tax Relief Act, subject to a lifetime $500 maximum, the nonbusiness energy property credit is equal to the sum of:

1. 10% of the amount paid or incurred by the taxpayer for qualified energy efficiency improvements installed during the tax year, and

2. the amount of the residential energy property expenditures paid or incurred by the taxpayer during the tax year. (Code Sec. 25C(a))

Thus, the nonbusiness energy property credit consists is now a 10% credit, instead of a 30% credit. In addition, a taxpayer's lifetime maximum nonbusiness energy property credit is no longer $1,500. Instead, it is now $500, of which no more than $200 may be for expenditures on windows. Specifically, the nonbusiness energy property credit allowed to a taxpayer for a tax year can't exceed the excess (if any) of $500 over the aggregate nonbusiness energy property credits allowed to that taxpayer for all earlier tax years ending after Dec. 31, 2005. (Code Sec. 25C(b)(1)) Further, the credit allowed for residential energy property expenditures can't exceed:

... $50 for each advanced main air circulating fan;

... $150 for each qualified natural gas, propane, or oil furnace or hot water boiler; and

... $300 for each item of energy-efficient building property. (Code Sec. 25C(b)(3))

Observation: The above credit rates, dollar limits, and lifetime limits were those that were in effect for 2006 and 2007 before the 2009 Recovery Act provided an enhanced nonbusiness energy property credit for 2009 and 2010. Thus, the 2010 Tax Relief Act returns the credit to its earlier, less generous form for 2011.

Observation: To apply the $500 lifetime limit, the taxpayer must look back to all tax years for which the nonbusiness energy property credit was in effect. Those years include 2006 and 2007, when the credit was subject to a $500 lifetime limit, and 2009 and 2010, when there was a $1,500 aggregate limit. If the total of nonbusiness energy property credits for all earlier years is $500 or more, the taxpayer can't claim a credit for 2011. If the total is less than $500, the taxpayer can claim up to $500 minus the total credits claimed in earlier years.

In addition, the 2010 Tax Relief Act restores to their earlier levels certain efficiency standards that were previously more lenient. (Code Sec. 25C(d)) The tightening of standards will make it harder to qualify for a nonbusiness energy property credit for the affected items. The 2010 Tax Relief Act also reinstates the rule that denies the credit for expenditures made from subsidized energy financing. (Code Sec. 25C(e)(3)) Thus, it excludes financing provided under a federal, state, or local program that has a principal purpose to provide subsidized financing for projects designed to conserve or produce energy.

However, on a positive note, under the 2010 Tax Relief Act, exterior windows, skylights, and exterior doors can qualify for the credit by meeting the Energy Star program requirements. (Code Sec. 25C(c)(1)) This change will make it easier to claim the credit for exterior windows, skylights, and exterior doors, because taxpayers can rely on the Energy Star label for those items.

References: For the Code Sec. 25C credit for nonbusiness energy property, see Federal Tax Coordinator 2d ¶A-4751 et seq.; United States Tax Reporter ¶25C4; TaxDesk ¶569,551; TG ¶1488.