Credits Benefiting the Environment

April 13, 2006

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Currently, the largest group of tax credits are those designed to encourage energy conservation or other activities that benefit the environment. However, most of these credits are narrowly targeted, so the number of people eligible for them is actually quite small. The seven credits in this group are the residential energy property credit, the credit for electric vehicles, the energy credit, the reforestation credit, the alternative fuels credit, the alcohol fuels credit, the enhanced oil recovery credit, and the renewable resources electricity production credit.

Residential energy property credit. A new tax credit of up to $500 is available to individuals for nonbusiness energy property, such as residential exterior doors and windows, insulation, heat pumps, furnaces, central air conditioners and water heaters placed in service in 2006 and 2007. The nonbusiness energy property must be installed in or on a dwelling unit in the United States that is owned and used by the taxpayer as the taxpayer's principal residence and originally placed in service by the taxpayer. There must be a reasonable expectation that the qualified energy efficiency improvements (exterior doors and windows, insulation, and certain metal roofs) will remain in use for at least 5 years.

The residential energy property credit is limited to a maximum of $500 for all tax years and no more than $200 of the credit can be based on expenditures for windows. The credit is equal to: (1) the residential energy property expenditures plus (2) 10 percent of the cost of qualified energy efficiency improvements. Eligible improvements include: insulation materials; exterior windows, including skylights; exterior doors; metal roofs with special pigmented coatings; electric heat pump water heaters; electric and geothermal heat pumps; central air conditioners; natural gas, propane, or oil water heaters or furnaces; hot water boilers; and advanced main air circulating fans.

There is also a nonrefundable tax credit available to help individual taxpayers pay for residential alternative energy equipment. The residential alternative energy credit is 30 percent of a qualified solar electric property expenditure, qualified solar water heating property expenditure, or qualified fuel cell property expenditure made by the taxpayer during the year. The maximum credit for any tax year is $2,000 for each category of solar equipment, and $500 for each half kilowatt of capacity of fuel cell property installed during the year. Eligible equipment must be placed in service during 2006 through 2008.

Credit for qualified electric vehicles. If you purchase a new electric vehicle and place it in service before 2007, you can receive a tax credit for 10 percent of the purchase price (up to $4,000). In 2006, the maximum credit is reduced by 75 percent. The credit is eliminated entirely in 2007. Any part of the cost that you elect to expense under Section 179 is not eligible for the credit, and the credit amount reduces the tax basis of the vehicle. The credit is claimed on Form 8834, Qualified Electric Vehicle Credit.

Energy credit. An energy credit is allowed for 10 percent of the cost of the following types of property placed in service during the year: (1) equipment that uses solar energy to generate electricity, heat or cool a structure, provide hot water, or provide solar process heat; or (2) equipment used to produce, distribute, or use geothermal energy stored in rocks, water, or steam. The property must be depreciable (i.e., used in your business). The energy credit is part of the investment tax credit, and can be recaptured (paid back to the IRS) if the qualifying property is sold or disposed of before the end of its recovery period. It is claimed on Form 3468, Investment Tax Credit.

Reforestation credit. For those in timber production, the 10 percent reforestation credit applies to up to $10,000 of the expenses you incur each year to forest or reforest your property. Eligible expenses include the costs of site preparation, seeds or seedlings, labor, and tools, including depreciation on machinery and equipment. The property must be held for growing trees for sale or use in the commercial production of timber products. The reforestation credit is part of the investment tax credit and is claimed on Form 3468, Investment Tax Credit.

Alcohol fuels credit. Producers of alcohol fuels or mixtures such as gasohol or ethanol can receive a tax credit for any sale or use of such fuels. The credit is scheduled to terminate with respect to sales or uses that occur: for any period after December 31, 2010, or for any period before January 1, 2011, during which the rates of tax are 4.3 cents per gallon. No carryforward of the credit is permitted for any tax year beginning after 1994. The alcohol fuels credit is part of the general business credit. It's claimed on Form 6478, Credit for Alcohol Used as Fuel.

Enhanced oil recovery credit. If you begin or significantly expand a domestic oil recovery project that uses certain tertiary recovery methods - such as the injection of liquids, gasses, or other matter - to increase crude oil production, you can take a credit for 15 percent of your qualified enhanced oil recovery costs for the tax year. The enhanced oil recovery credit is part of the general business credit. It's claimed on Form 8830, Enhanced Oil Recovery Credit.

The renewable resources electricity production credit. This credit is based on electricity that is produced from wind or closed-loop biomass (organic material grown exclusively for electricity production) and sold to third parties, from facilities placed in service after 1992 and before January 1, 2008, or wind energy facilities placed in service after 1993 and before January 1, 2009.

The credit also applies to electricity produced by poultry waste facilities placed in service in 2000 through the end of 2008. In addition, the credit applies to the following types of facilities placed in service after October 22, 2004, and before January 1, 2009: geothermal, solar energy, small irrigation power, landfill gas, and trash combustion. Refined coal production facilities also qualify if placed in service before January 1, 2009.

The credit for calendar year 2006 is 1.9 cents per kilowatt hour of such electricity sold (adjusted annually for inflation). The credit is part of the general business credit. It's claimed on Form 8835, Renewable Electricity Production Credit.