Need to Know Now How the Inflation Reduction Act Impacts Residential Real Estate?

The Inflation Reduction Act of 2022 was signed into law on August 16th 2022.  Although there are differing opinions on the law’s ability to lower inflation, there are specific provisions within the law that will impact homeowners that could save you money when it comes to home energy costs and related tax credits.  Continue reading to find out what this means to you and residential housing.

What is Inflation?

Although inflation is a worrisome buzzword for many people that strikes fear and emotion, it has been around for a long time.  An article from The International Monetary Fund (IMF) defines inflation as “the rate of increase in prices over a given period of time.”  For example, it could be the increase in the cost of living, items like food or gas, or even services like going to the hair salon or receiving healthcare.  Historians have identified recorded inflationary periods as far back as China in the 1300’s and the Roman Empire.   

How Does Inflation Impact Real Estate?

In addition to the cost of living and consumer spending on goods and services, inflation also impacts the real estate market and ultimately the home you live in.  This article is a great resource to explain the ways inflation can impact homeowners, prospective homeowners, and those who may be renting a home.  Homebuyers may be impacted by rising interest rates when searching for lenders to secure financing to purchase a new home, while homeowners may not be able to easily upgrade to a larger house due to rising home prices.  Renters may have less income due to the rising cost of living expenses, but may be faced with rising rents when the lease is renewed.

The Inflation Reduction Act and Energy Efficient Home Improvements

Within the Inflation Reduction Act under Subtitle D – Energy Security, the Internal Revenue Code of 1986 is amended by two sections of the Act.  These two sections are within Part 3 of the Act called Clean Energy and Efficiency Incentives for Individuals.  This first section deals with the formerly titled “Nonbusiness Energy Property” credit which is now called the “Energy Efficient Home Improvement Credit”.  Most of the changes made by the Inflation Reduction Act will apply to improvements and expenditures for energy efficient solutions placed in service after December 31, 2022.

Below are the specific changes to the tax credit amounts that are currently allowable under Nonbusiness Energy Property tax credit.

Currently, you can get tax credits for 10% of the amount paid or incurred for qualified energy efficiency improvements installed during the taxable year plus the amount of residential energy property expenditures paid or incurred during the taxable year with certain limitations.  Qualified efficiency improvements are “building envelope components” such as fenestration (doors and windows), roofs (prior to the act, see changes mentioned later), walls, and insulations.  Residential energy property expenditures consist of the following:

• Certain electric heat pump water heaters; electric heat pumps; central air conditioners; natural gas, propane, or oil water heaters; and stoves that use biomass fuel.
• Qualified natural gas, propane, or oil furnaces and qualified natural gas, propane, or oil hot water boilers.
• Certain advanced main air circulating fans used in natural gas, propane, or oil furnaces.

Here are the changes to the tax credit amounts:

1. The credit is extended through 2032 instead of ending in 2021.
2. The credit is now 30% of the sum of the amount paid or incurred for qualified energy improvements installed during the taxable year, the amount of residential energy property expenditures paid or incurred, and what you may have paid for home energy audits.  This means that instead of applying 10% only to energy efficiency improvements, 30% is now applied to the overall total of anything you paid or incurred (i.e., received a bill/invoice).  Plus, home energy audit costs are newly added to the total sum.  We’ll discuss home energy audits later.
3. The lifetime maximum credit has increased from $500 to $1200.
4. The maximum credit for any item of qualified energy property is now increased from $300 to $600 (such as energy efficient electric heat pump water heaters, electric heat pumps, central air conditioners, and natural gas, propane or oil water heaters.
5. The taxable year limit for windows (in aggregate and including skylights) has been raised from $200 to $600.
6. Taxable year limits have been added for doors which are $250 credit for any exterior door, and $500 in aggregate for all exterior doors.
7. A new maximum credit taxable year limit of $2,000 has been added for costs paid or incurred in aggregate for heat pumps, heat pump water heaters, and biomass stoves and boilers.

Changes have been made to how Qualified Energy Efficiency Improvements are determined.

As a reminder, “qualified energy efficiency improvements” are defined as  “building envelope components” such as fenestration (doors and windows), roofs (roofing was allowed prior to the new Act, see changes mentioned below), walls, and insulations.  Basically, any insulation material or system which is designed to reduce the heat loss or gain within a home would qualify if it meets certain requirements and standards.

1. For exterior windows or skylights, you have to meet the most efficient Energy Star Requirements (read this article to learn more about Energy Star). 
2. For exterior doors, you must meet the applicable Energy Star requirements and not specifically version 6.0 of the Energy Star Program which was mentioned in the tax code before this new Act.
3. For all other components, you have to stay up to date with the most recent International Energy Conservation Code standard.
4. Also, roofs are no longer being treated as building envelope components.  However, air sealing insulation has been added.

Changes have been made to how Residential Energy Property Expenditures are determined.

Residential energy property expenditures are what a taxpayer pays for a qualified energy property which is not the dwelling property (the home) itself, but rather something that is installed on or in connection with the home.  Examples include an energy efficient electric heat pump or central air conditioner.

1. Residential energy property expenditures are no longer bound to the taxpayer’s principal residence, but can now be applied to a dwelling unit used as a residence by a taxpayer.
2. “Qualified energy property is now identified in greater detail along with the applicable ways to measure efficiency and the standards that should be used.  For example, all qualified energy property must meet or exceed the highest efficiency tier established by the Consortium for Energy Efficiency.
3. As another example of increased requirements, any oil furnace or hot water boiler placed in service after Dec. 2022, must meet or exceed 2021 Energy Star efficiency criteria.
4. Also added as qualified energy property is any improvement to, or replacement of, a panelboard, sub-panelboard, branch circuits, or feeders under certain circumstances.

Home Energy Audits have been added.

A home energy audit is a professional assessment that is conducted to determine where your home may be experiencing energy loss such as in attics and foundations, and opportunities to increase efficiency with equipment like smart thermostats and energy efficient appliances. To learn more about home energy audits, check out this article that also discusses how audits are now reimbursable/funded by the Infrastructure Investment and Jobs Act that was passed in 2021.  Read this eBook to learn all about it and the impact to Real Estate.

1. As stated earlier, home energy credits are now included in the total costs that the 30% rate is applied to in order to determine the credit that is allowable for the taxable year.
2. Home energy audits have their own limits to the credits that can be applied during a taxable year.
3. The credit is limited to $150 and may require certain documentation.
4. The Inflation Reduction Act amends the tax code to define the home energy audit as “an inspection and written report with respect to a dwelling unit located in the United States and owned or used by the taxpayer as the taxpayer’s principal residence.”  The audit “identifies the most significant and cost-effective energy efficiency improvements with respect to such dwelling unit, including an estimate of the energy and cost savings with respect to each such improvement, and is conducted and prepared by a home energy auditor that meets the certification or other requirements specified by the Secretary in regulations or other guidance.”  
5. So, make sure you locate and hire the right professional to perform the audit!

One last note.  Starting in 2024, if you install residential energy property items, be prepared to supply product identification numbers with your tax return.

The Inflation Reduction Act and Clean Energy

Section 25D of the tax code allows a credit for qualified expenditures made by a taxpayer for residential energy efficient property.  It mainly supports credits for installing solar energy, but also includes wind, geothermal heat pumps and fuel cells.  Below are highlights of the changes made to this existing energy related credit.

1. The residential clean energy credit has been extended to 2034.
2. “Qualified biomass fuel property expenditures” has been replaced by “qualified battery storage technology expenditures” which helps a solar powered home operate at night and during power grid outages.  Biomass stoves and boilers are now included in the energy efficient home improvement credit.  Biomass is renewable energy from plants and animals.  Sources include firewood, soybeans and human and animal manure for biogas as a renewable natural gas.
3. Qualified battery storage technology expenditures are allowed as credits as long as they meet certain capacity requirements (3 kilowatt hours).  However, the change does not take effect until after December 31, 2022. 
4. “Residential energy efficient property” is now named “residential clean energy credit”.

In Conclusion

Although the Inflation Reduction Act is meant to address inflation by its name, it also has many changes to encourage energy conservation and cleaner energy usage.  Homeowners who make energy conscious decisions can take advantage of new and increased tax credits when they file yearly taxes which will save them money and may indirectly offset increases of overall prices of goods and services in the economy which happens during times of inflation.

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