Real Estate Group Newsletter – Spring 2023
Kathy Z. Jeziorski, Anita S. Wescott
Incentives for Energy-Efficient Homes and Buildings: Are You Getting the Credit You Deserve?
Kathy Jeziorski, CPA
Incentives for Home Developers/Builders
Last year’s Inflation Reduction Act (IRA) revived the federal tax credit for new energy-efficient homes, which had expired at the end of 2021, and extended it through 2032. Previously, eligible developers and builders of both single and multifamily homes were entitled to a credit up to $2,000 ($1,000 for most manufactured homes) for each new unit that meets specified energy-efficiency standards.
Starting this year, increased credits are available, although homes must meet more stringent standards to qualify for them. The credit is increased to $2,500 for single-family and manufactured homes that meet ENERGY STAR® guidelines and doubled to $5,000 for homes that meet Zero Energy Ready Home (ZERH) requirements.
Multifamily homes that meet ENERGY STAR® guidelines are eligible for a credit of $500 per unit, increased to $1,000 for units that meet ZERH requirements. These credits are increased fivefold to $2,500 and $5,000, respectively, for development projects that meet prevailing wage and apprenticeship requirements.
Related Read: The Inflation Reduction Act Includes Wide-Ranging Tax Provisions
Incentives for Homeowners
Energy-Efficient Home Improvement Credit
This incentive allows homeowners to claim a federal tax credit based on the cost of certain energy-efficient home upgrades. Before this year, the credit was 10% of costs up to a $500 lifetime cap, but the IRA increased it to 30% of costs up to $3,200 per year.
Qualifying expenditures include:
- Improvements to the building envelope such as exterior doors, windows and insulation;
- Installation of energy-efficient air conditioners, water heaters or boilers;
- Electrical panel upgrades;
- Home energy audits; and
- Heat pumps and biomass stoves and boilers.
Separate annual limits apply to various types of expenditures listed above. For example, the credit for exterior doors is 30% of the cost up to $250 per door, up to $500 total. The credit for air conditioners, water heaters and boilers is 30% of costs, including labor, up to $600 each item.
Overall, the maximum annual credit is $1,200 plus an additional $2,000 limit for heat pumps, biomass stoves and biomass boilers.
Residential Clean Energy Credit
The IRA extended this incentive, formerly known as the Residential Energy Efficient Property Credit, through 2034. It provides a federal tax credit equal to 30% (previously 26%) of the cost of qualifying clean energy equipment, including solar panels and water heaters, fuel cells (additional limits apply), wind turbines, geothermal heat pumps, and battery storage technology. The credit percentage rate drops to 26% in 2033 and 22% in 2034.
Incentives for Commercial Building Owners
The IRA expanded the federal tax deduction for energy-efficient commercial buildings. Previously, owners could deduct up to $1.88 per square foot for eligible improvements to a building’s interior lighting system, HVAC/hot water systems and building envelope designed to reduce annual energy costs by at least 50% relative to certain benchmarks (partial deductions were available for improvements to one of these systems).
The IRA reduced the energy savings target from 50% to 25%. Now the deduction is based on a sliding scale from 50 cents per square foot to $1 per square foot for projects that generate energy savings ranging from 25% to 50%. The deductions are increased fivefold to $2.50 and $5 per square foot, respectively, for projects that meet prevailing wage and apprenticeship requirements.
Owners may claim this deduction as frequently as once every three years. Previously, the $1.88 per square foot limit was a lifetime cap.
State and Local Incentives
Be sure to investigate additional energy-efficiency incentives available in your state or locality, such as tax credits, low-interest loans and utility rebates. Illinois, for example, is one of a handful of states with a Solar Renewable Energy Credit (SREC) program. Homeowners who install solar energy systems receive one SREC for each 1,000 kilowatt-hours produced by their solar panels. They can then sell these credits to their local power companies to help those companies meet state standards that require them to generate a portion of their electricity from renewable sources. Homeowners are paid up front, based on the amount of renewable energy their systems are expected to generate over the first 15 years of operation.
Related Read: Greening Your Projects Can Bring In More Green
Don’t Leave Money on the Table
These are just a few examples of the many financial incentives available to real estate developers and owners who invest in energy efficiency. To reap the benefits of these incentives, you need to ask for them. To avoid leaving money on the table, ask your ORBA advisor to help you determine which incentives are appropriate for your business and show you how to claim them.
For more information about financial and tax incentives for energy efficiency, please contact Kathy Jeziorski. Visit ORBA.com to learn more about our Real Estate Group.
Do You Qualify for the ‘Real Estate Professionals’ Exception to the Passive Activity Limit for Rental Activities?
Anita Wescott, CPA
The passive-activity loss rules can significantly limit the tax benefits of owning rental properties, but the IRS provides a potentially valuable exception for so-called “real estate professionals.” You may be familiar with some of the better-known tests for determining whether you qualify, but you could qualify under one of the lesser known tests. If you think you are eligible, regardless of under which test, you also need to understand how the IRS will make the determination.
The Tax Breaks for Real Estate Professionals
Under the Internal Revenue Code (IRC), taxpayers generally are prohibited from deducting passive-activity losses against non-passive sources of income, such as wages. Passive-activity losses can be used only to offset passive-activity income, with any excess losses in a tax year carried forward to be applied against future passive-activity income.
The IRC defines “passive activity” as any trade or business in which the taxpayer does not participate on a regular, continuous and substantial basis — what is known as “material participation.” A passive activity loss is the excess of the taxpayer’s deductions from all passive activities for the tax year over the gross income from those activities.
The IRS typically considers rental real estate activities to be passive, regardless of whether the taxpayer materially participates. But it allows real estate professionals to deduct their passive-activity losses against non-passive income.
Real estate professional status also can reduce your liability for the 3.8% net investment income tax (NIIT) on passive income. You must, however, engage in a trade or business related to the rental real estate activities; the rental activities cannot be merely incidental to a non-rental trade or business.
Specifically, net rental income may be excluded from the calculation of NIIT if:
- You are a real estate professional;
- The rental activity rises to the level of a trade or business; and/or
- You materially participate in the trade or business.
In these circumstances, rental income is considered to come from conducting business, not an investment.
The Material Participation Requirements
You qualify as a real estate professional if you satisfy two requirements:
- More than 50% of the personal services you perform in trades or businesses are performed in real property trades or businesses in which you materially participate; and
- You perform more than 750 hours of services in real property trades or businesses in which you materially participate.
If you file a joint tax return with your spouse, you can meet the requirements if only one of you separately meets the requirements.
The Material Participation Tests
Federal tax regulations identify several tests for determining whether a taxpayer has materially participated in an activity for a taxable year (the determination is made on a year-by-basis). Many rental property owners know they can qualify by:
- Working in the activity for more than 500 hours during the year (spousal hours are included but not those of children);
- Doing “substantially all” of work; or
- Working for more than 100 hours during the year, and no other individual works more hours (including non-owners and employees).
You may not know, though, that you could still qualify as a real estate professional even if you fail to satisfy these tests. For example, you might qualify if you materially participated in the activity in any five of the previous ten years (consecutive or not).
Finally, even if you do not meet any of the tests above, you can establish your material participation in the rental real estate activities based on all of the facts and circumstances. Note that this test applies only if you work at least 100 hours in the activity, and no one spends more hours managing the activity or is compensated for managing the activity. In other words, you cannot rely on this test if you have paid management for your property.
Related Read: Hiring a Property Manager? Consider Lodging as a Fringe Benefit
Making Your Case
Federal tax regulations provide that taxpayers can establish the extent of their participation in rental real estate activities “by any reasonable means.” That can include the identification of services performed over a time period and the approximate number of hours spent on those services during the period.
You can base these figures on documents such as appointment books, calendars or narrative summaries. While contemporaneous daily time reports, logs or the like are not required, they are highly advisable. Some type of detailed documentation of your rental activity hours is essential. Tax courts have not looked favorably on estimates based on records assembled some time after the activities occurred.
For more information, please contact Anita Wescott. Visit ORBA.com to learn more about our Real Estate Group.
Health Care GroupLaw Firm GroupManufacturing and Distribution GroupNot-For-Profit GroupReal Estate Group