Energy Incentives for Individuals in the American Recovery and Reinvestment Act

With 2010 almost over, the IRS reminds taxpayers to take advantage of the numerous tax breaks made available earlier this year in the American Recovery and Reinvestment Act (ARRA).

The recovery law provides tax incentives for first-time home buyers, people purchasing new cars, those interested in making their home more energy efficient and parents and students paying for college. But all of these incentives have expiration dates so taxpayers should take advantage of them while they can.

The American Recovery and Reinvestment Act provides tax incentives for individuals to invest in energy-efficient products.

Treatment of Alternative Motor Vehicle Credit as a Personal Credit Allowed Against AMT: Starting in 2009, the new law allows the Alternative Motor Vehicle Credit, including the tax credit for purchasing hybrid vehicles, to be applied against the Alternative Minimum Tax. Prior to the new law, the Alternative Motor Vehicle Credit could not be used to offset the AMT. This means the credit could not be taken if a taxpayer owed AMT or was reduced for some taxpayers who did not owe AMT.

Conversion Kits: The new law also provided a tax credit for plug-in electric drive conversion kits. The credit is equal to 10 percent of the cost of converting a vehicle to a qualified plug-in electric drive motor vehicle and placed in service after February 17, 2009. The maximum amount of the credit is $4,000. The credit does not apply to conversions made after December 31, 2011. A taxpayer may claim this credit even if the taxpayer claimed a hybrid vehicle credit for the same vehicle in an earlier year.

Plug-In Electric Vehicle Credit: The new law also creates a special tax credit for two types of plug-in vehicles certain low-speed electric vehicles and two-or three wheeled vehicles. The amount of credit is 10% of the cost of the vehicle, up to a maximum credit of $2,500 for purchases made after February 17, 2009, and before January 1, 2012. To qualify, a vehicle must be either a low speed vehicle propelled by an electric motor that draws electricity from a battery with a capacity of 4 kilowatt hours or more or be a two-or three-wheeled vehicle propelled by an electric motor that draws electricity from a battery with the capacity of 2.5 kilowatt hours. A taxpayer may not claim this credit if the plug-in electric drive vehicle credit allowable.

Plug-In Electric Drive Vehicle Credit: The new law modifies the credit for qualified plug-electric drive vehicles purchased after December 31, 2009. To qualify, vehicles must be newly purchased after December 31, 2009. To qualify, vehicles must be newly purchased, have four or more wheels, have a gross vehicle weight rating of less than 14,000 pounds, and draw propulsion using a battery with at least four kilowatt hours that can be recharged from an external source of electricity. The minimum amount of credit for kilowatt hours that can be recharged from an external source of electricity. The minimum amount of the credit for qualified plug-in electric drive vehicles is $2,500 and the credit tops out at $7,500, depending on the battery capacity. The full amount of the credit will be reduced with respect to a manufacturer’s vehicles after the manufacturer has sold at least 200,000 vehicles.

Residential Energy Efficient Property Credit: This nonrefundable energy tax credit will help individual taxpayers pay for qualified residential alternative energy equipment, such as solar hot water heaters, geothermal heat pumps and wind turbines. The new law removes some of the previously imposed maximum amount and allows for a credit equal to 30% of the cost of qualified property.

Residential Energy Property Credit: The new law increases the energy tax credit for homeowners who make energy efficient improvements to their existing homes. The new law increases the credit rate to 30% of the cost of all qualifying improvements and raises the maximum credit limit to $1,500 for improvements placed in service in 2009 and 2010.

The credit applies to improvements such as adding insulation, energy efficient exterior windows and energy-efficient heating and air conditioning systems.

A similar credit was available for 2007, but was not available in 2008. Homeowners should be aware that the standards in the new law are higher than the standards for the credit that was available in 2007 for products that qualify as “energy efficient” for purposes of this tax credit.

For property purchased before June 1, 2009, homeowners generally can rely on the manufacturers’ certifications and Energy Star labels that were available at the time for those products. Manufacturers have been advised that they should not continue to provide certifications for property that fails to meet the new standards. The IRS has issued a notice that will allow manufacturers to certify that their products meet the new standards. Please note, not all ENERGY STAR qualified products qualify for a tax credit. For detailed information about qualifying improvements, visit the U.S. Department of Energy’s Energy Star Web site.

Real Estate and the AMT Rental or Investment Property

The Alternative Minimum Tax is a very important consideration for taxpayers who own real estate because just about every tax rule applying to real estate is different for the AMT than it is for the Regular Tax. This article on Real Estate and the AMT will address those situations where the individual holds the real estate as an investment, typically as rental property. The differences in tax treatment between the Regular Tax and the AMT can be significant.

Interest expense

Interest paid on the mortgage taken out to acquire the property is fully deductible, both for the Regular Tax and the Alternative Minimum Tax. Unlike itemized deductions that allow a tax benefit for what amounts to personal expenses, the tax law generally allows all deductions a taxpayer has to make in the pursuit of business income. Thus, the limitations discussed in the previous article on home mortgage interest do not apply.

If, however, the equity in the rental property is used as security for an additional loan – a second mortgage, for example – then the taxpayer must look to how the proceeds of that loan are used to determine interest deductibility. If the proceeds are used for a car loan or to finance a child’s education, for example, then the interest is nondeductible personal interest. If the proceeds are used to improve the rental property, the interest is deductible.

Suggestion – it is best that taxpayers keep personal borrowings separate from business borrowings. Mixing the two creates recordkeeping challenges and can result in disputes with the IRS.

Property taxes

Property taxes paid on rental or investment property are allowed in full both for Regular Tax purposes as well as for the Alternative Minimum Tax.

Planning idea – if you have an opportunity to pay your property tax bill either this year or next, pay it in a year when you have enough income from the property so as not to generate a rental loss. This strategy can help avoid triggering the passive activity loss limitations described below.

Example – in Florida property tax bills are mailed in October, and are payable under the following discount schedule: November – 4%, December – 3%, January – 2%, February – 1%. If you have a loss from the property in 2010 but expect to generate income in 2011, do not pay your bill in November or December – forgoing that small discount could help you avoid the loss-limitation rules.

Depreciation

Depreciation is allowed for property held for investment. The portion of the cost allocable to land is not depreciable, but for the building itself and the furniture, appliances, carpeting, etc. a depreciation deduction may be taken.

Real property (this is the legal definition of the house or other building) held for rental/investment may only be depreciated for Regular Tax purposes under the “straight-line” method, over a useful life of 27.5 years. Thus, a property with $275,000 allocated to the building would be depreciated at the rate of $10,000 per year.

Personal property (this is the legal definition of things such as furniture, appliances, carpeting and the like) may be depreciated for Regular Tax purposes under an “accelerated” method over a useful life of five years. An accelerated method allows a larger depreciation deduction in the early years, in recognition of an obsolescence or decline-in-value factor that you see in new property (cars are a good example).

For purposes of the AMT, however, personal property may be depreciated only by using a straight-line method. Thus, an AMT item will be generated in the early years if the accelerated method is used.

Planning idea – for personal property consider electing the straight-line method for Regular Tax purposes. While giving up a little tax benefit from the greater depreciation in the early years, it could mean avoiding paying the AMT.

Active/passive investment rules and the “at-risk” rules

A taxpayer who is not “active” in managing investment property may not use losses from rental property to offset other income such as salaries and wages, dividends, interest, capital gains, etc. Instead, these losses are deferred until the taxpayer either sells the property or generates passive income from this or other passive investment sources.

The at-risk rules similarly deny using these types of losses to the extent the taxpayer has acquired the investment with borrowed money and does not have personal liability on the debt.

Planning idea

If these loss limitations apply, consider the planning ideas mentioned above to minimize the losses being generated each year. They are not doing you any good anyway.

Sale of the property

Several different AMT issues can arise on the sale of rental/investment property. One is that your gain or loss may be different for the AMT than it is for Regular Tax purposes. This would be caused if different depreciation methods were used. For example, if the personal property was depreciated using an accelerated method for Regular Tax purposes, then the basis in that property when calculating gain or loss on sale would be different because the straight-line method had to be used for Alternative Minimum Tax purposes.

Gain on the sale of investment property generally is capital gain, although a portion may be treated as ordinary income depending on the accelerated depreciation method was used. Capital gains in and of themselves are not an AMT item, but nonetheless they can result in AMT being paid. This is because the AMT exemption amount is phased out for taxpayers at certain income levels, so this additional income can have the result of reducing the exemption which in turn increases taxable income for purposes of the Alternative Minimum Tax.