The Inflation Reduction Act (IRA) signed into law in August sets aside $369 billion for clean energy investments. And with more than $20 billion set aside specifically for home efficiency and electrification incentives, the exciting work is just beginning—starting with a major upgrade to 25C, the residential energy efficiency tax credit.
Money for home energy improvements is about to spike thanks to 25C.
On January 1, 2023, tax credits for heat pumps jump from $300 to $2,000; for weatherization, the increase is from $500 to $1,200. Perhaps the best news is that the $500 lifetime cap is replaced with an annual one that resets each January.
All told, the estimated worth of the tax credits is $12.4 billion, but unlike other IRA incentive programs, tax credits have no budget cap, meaning they could be worth much more if there is high market adoption.
Here are three ways to make that happen.
Tax credits have no budget cap, which means they could be worth much more if there is high market adoption.
25C’s annual cap should be $3,200
To start, the rules and language establishing the total annual value of 25C need to be sorted out.
As written, the tax credit language is ambiguous on whether or not the annual tax credit cap for installing a heat pump is $2,000 or is in fact $3,200 when installing a heat pump and other home efficiency upgrades at the same time.
The IRS’s recently issued request for comment interprets the annual cap as only $2,000, but we believe that’s incorrect.
In the IRA text, Congress included “notwithstanding” language that signals their intention to allow the IRS to set a separate and higher annual cap of $2,000 for heat pump technologies that is stackable with other efficiency improvements up to a total value of $3,200.
A $1,200 difference may not appear substantial, but a $3,200 annual tax credit cap would enable homeowners to make more meaningful strides toward efficient whole-home electrification each year.
For instance: A $3,200 annual tax credit encourages homeowners to install a heat pump and weatherize at the same time—and at a more affordable price. Or if a homeowner needs to replace their water heater, they can receive a $2,600 tax credit to overcome the high cost of installing a heat pump water heater ($2,000) and upgrade their home’s electrical panel ($600).
Put simply, a $3,200 annual tax credit will generate greater energy reductions, lower greenhouse gas emissions, create more jobs, and make for more comfortable, healthy homes.
To unlock this win-win-win scenario for American households, Congress should work with the White House, Internal Revenue Service (IRS), and Department of Energy (DOE) to clarify the correct amount is $3,200.
Looking for more information on energy-efficiency tax credits for homeowners? Check out our Complete Guide to the Inflation Reduction Act for Homeowners, read The 8 best energy-efficient home improvements you could make to increase value, or check out our Energy rebates directory.
ENERGY STAR heat pumps are high-efficiency heat pumps
Regardless of the final annual tax credit cap, no amount of tax credit can drive the installation of heat pumps that are unavailable in the market.
In the IRA text, Congress ties eligibility for heat pump tax credits to the highest efficiency tier established by the Consortium of Energy Efficiency (CEE). The CEE is an industry group of energy-efficiency program administrators from the electric and gas utilities who collaborate to maximize the impact of energy-efficiency programs on a national level.
One way the CEE advances the impact of these programs is by adopting and updating its tier system that ranks the efficiency of various appliances—including heat pumps.
But tier-setting is an art, not a science. Set the tier too high, and heat pumps will be too expensive and unavailable for most homeowners. Set the tier too low, and the CEE isn’t accomplishing its organizational mission of maximizing program impact.
Now that the heat pump tax credit is tied to the highest tier, it’s more important than ever that the CEE strikes the right balance.
Fortunately, the CEE has proposed to closely align its 2023 heat pump tier with ENERGY STAR’s heat pump efficiency levels.
Sealed supports this proposal for four reasons:
- First, consumers know and recognize the ENERGY STAR brand.
- Second, ENERGY STAR heat pumps are always more efficient than minimum-efficiency products.
- Third, aligning tax credit eligibility with ENERGY STAR simplifies future eligibility with the High-Efficiency Electric Home Rebate program.
- Fourth, it gives the HVAC industry time to adapt to new regulations. Right now the industry is retooling nearly three-fourths of its product lines to meet new federal minimum-efficiency requirements starting in 2023. After that, the industry only has two years to retool those same product lines to meet EPA refrigerant regulations.
By aligning with ENERGY STAR and holding steady for two years, the CEE can help make heat pumps more accessible and affordable, accelerating their adoption into American homes.
Let’s weatherize all American homes, including the existing ones
Finally, when it comes to weatherization, the IRS should focus on enabling weatherization in all existing buildings, especially older homes.
The IRA ties the tax credit for weatherization (i.e., insulation and air sealing) to the standards outlined in the International Energy Conservation Code 2021 (IECC), the voluntary energy building code standard for new construction in the U.S.
But the law doesn’t clarify how those standards must be met, which raises various questions and challenges.
The fundamental challenge raised by using the IECC for eligibility is applying a new construction standard to an existing building.
Because 81 million American homes were built before 2000, it’s difficult or physically impossible to meet the new construction requirements established by the IECC.
81 million American homes were built before 2000, so it’s difficult or physically impossible to meet the same requirements for new construction homes.
Fortunately, the IECC’s Existing Building Chapter clarifies that “new envelope assemblies” being installed outside of a new addition are exempt from the new construction levels of insulation.
The IRS should make this exemption clear and allow homes constructed before 2000 to claim the weatherization tax credit through a specific climate-zone definition of weatherization for existing buildings.
With an existing-building weatherization pathway created, next the IRS needs to overcome a decades-long industry challenge and define weatherization for existing homes.
States have historically struggled to find a common definition of weatherization when designing programs to air seal and insulate homes comprehensively.
The IRA defines weatherization at new construction levels of insulation, but as noted above, that’s a blunt definition that may inadvertently eliminate millions of homes from qualifying for the weatherization tax credit.
To overcome this challenge, we recommend the IRS work with the DOE to establish a weatherization definition for existing buildings that includes climate-zone-appropriate insulation levels.
For example, at Sealed, we have seen significant energy savings and comfort benefits in colder climates by insulating homes to R30 at the roof deck or R49 at the attic floor and R10 in crawl spaces, while also air sealing major sources of air leakage.
But those levels may not be appropriate for other climate zones. And so now it’s up to the IRS and DOE to leverage their extensive research and resources, such as recent ResStock findings, to define appropriate insulation levels for different areas of the country.
Finally, to enable the benefits of weatherization nationally, the IRS needs to focus on weatherizing the top and bottom of homes and not the whole home.
We recommend the IRS work with the DOE to establish a weatherization definition for existing buildings that includes climate-zone-appropriate insulation levels.
Insulation and air sealing in those two areas alone can reduce annual energy usage by anywhere between 10% and 45%, according to a recent study by the consulting firm ICF.
By incentivizing homes to move forward with the most impactful weatherization investments, the IRS will enable a functioning market and drive energy reductions across America.
Better yet, these homes will be more resilient to extreme weather and better positioned to participate in virtual power plants, like the ones that saved California’s grid in September.
If the IRS implements all three recommendations, the weatherization tax credit should make thousands of homeowners happy by making it more affordable to have a healthier, more comfortable home.
Conclusion
Politicians, advocacy groups, and the energy-efficiency industry should be thrilled about the new and improved tax credits coming in 2023.
The higher values will generate billions of dollars of investment into stopping home energy waste, electrifying heating, and creating jobs from Anchorage, Alaska, to Key West, Florida.
But higher values also mean higher expectations, making the IRS’s implementation and 2023 launch of the 25C tax credit a high-stakes maneuver.
Come January 1, let’s stick the landing—ensuring that the tax credits are accessible and the upgrades are affordable—and deliver the benefits of energy efficiency and electrification to the American people.