This article is part of our home tax credits series. The information contained in this article is not tax advice. You should consult a qualified tax professional before acting on the information in this article.

You probably already know that the 2009 energy tax credits were extended through the end of 2010. Those credits include 30% back, up to $1500, on insulation products installed in a primary residence.

While the credit is pretty broad, not all insulating products qualify. For example, insulated siding does not qualify under the rules of this credit, because its primary purpose is not insulation.

Let’s take a look at the basics of the insulation tax credit, the requirements for claiming the credit, and what types of insulation qualify. For more information, see energystar.gov.

Insulation Tax Credits Information

The insulation energy tax credit provides 30% back on the cost of insulation materials, up to a total credit of $1500 (equating to a $5000 purchase).  Installation cost (e.g., labor) is not covered for insulation.

The $1500 limit on this credit is an aggregate limit across all covered residential energy improvements. For example, if you claim a portion of the energy tax credit for installing qualifying windows, that would reduce the amount of credits you can take for insulation.

The limit on the credit is also an aggregate across both 2009 and 2010 tax years. In other words, if you take the full $1500 in 2009, you cannot can any credit in 2010.

How to Claim the Insulation Tax Credit

You claim the credit on Form 5695 when you file your tax return for the year the insulation was placed in service. Notice that this is not necessarily the same as the year you purchased the insulation.

Income Limits and Other Restrictions

• There is no income limitation on the credit.
• You do not need to itemize your taxes to take the credit.
• The credit only applies to principal residences. It does not apply for rental properties or second homes.
• The amount of the credit is limited by your tax liability (note: this is not the same as whether you get a refund). You cannot get more money back than you pay to the federal government.

What Types of Insulation Qualify for the Tax Credit?

The insulation tax credit is designed to provide a refund only for those products whose primary purpose is to insulate a structure (there is very specific language in the tax code we won’t go into here).

The good news is that the IRS makes manufacturers declare whether their product complies with the language in the tax code via a Manufacturers Certification Statement (MCS). You can usually find MCS statements for insulation products on the manufacturer’s web site. Here’s an example from Owens Corning. You can also call the manufacturer or look on the material packaging.

Almost all bulk insulation materials qualify for the credit, including fiberglass batt rolls, blow-in insulation (such as NuWool), spray foam insulation, rigid foam board insulation, and more.

Products designed to stop air flow can also qualify, inlcuding products like weather stripping, spray foam in a can, caulk designed to air seal, and house wraps.

Energy Savings from Insulating

Adding insulation in the right locations in your home can decrease your energy bill by more than 30%. For example, we saw a 33% energy savings from installing spray foam insulation in our basement.

Couple that with this energy tax credit and your payback period could be as short as 12 months. That makes this credit really worth a look!

Additional Credits

We’re exploring a variety of home-related tax credits in preparation for the coming tax filing season. If you can’t wait for our articles, you can find a basic listing of home tax credits over at Debt Free Adventure.

Note: This is general tax information, not advice. We always try to be accurate in the information we provide, but you should contact a certified tax accountant for assistance with your situation. This article does not cover all situations and nuances.

With tax season just around the corner, I figure a review of some of the home-based tax deductions and credits are in order. Up first, IRS tax treatment of the popular interest deduction for home equity loans and home equity lines of credit.

What are Home Equity Loans?

A home equity loan is a fixed term loan where a lump sum is borrowed at the outset of the loan and paid back according to some agreement (periodically, or in a balloon payment, for instace).

A home equity line of credit is an account that allows you to borrow money based on the equity of your home on demand. You can pay back and re-borrow the money over the life of the line.

For both of these loans, the term equity usually implies the loan was taken out after the purchase of the home (using the home’s equity as collateral). However, this isn’t always the case. It was not uncommon between 1999 and 2005 to see equity loans used as part of a purchase.

How Is Home Equity Interest Treated by the IRS?

In general, the IRS does not make a distinction between the deductibility of interest based on the form or name of a loan instrument.

Whether the debt is called a first mortgage, a second mortgage, a home equity loan, or a home equity line isn’t really important at all. What is important is the difference between what the IRS calls acquisition debt vs. equity debt.

Here’s what the IRS says (reference Pub 936):

Home equity loans and lines that are used to build, buy, or improve a qualified property are treated as acquisition debt. (This is the same type of debt as almost all first mortgages).

That means that the interest is fully deductible, so long as:

• The loan is actually secured by a qualified property. Most all primary residences in the U.S. are qualified properties.
• You itemize deductions on your 1040.
• Your mortgage balances are 1,000,000 or less ($500,000 or less if Married Filing Separately), or the loan was taken prior to 10/13/1987 (presumably when these laws were written).
• Several other limitations that probably don’t apply to most, but are referenced in the pub.

Home equity loans or lines (or in fact a first mortgage) used for something other than buying, building, or improving a qualified property is called equity debt.

In this case, additional restrictions apply, including:

1. Interest is deductible on equity debt only up to the first $100,000 borrowed, and
2. The total amount borrowed (when considering all debt on the home) doesn’t exceed the fair market value (FMV) of the home.

That means if your equity debt totals $150,000, you can only deduct the interest paid on the first $100,000 borrowed.

What Does this Mean for Underwater Equity Lines?

In the last 3 years, many people have found themselves underwater in their mortgage, meaning that the FMV of their homes is less than the total debt they are carrying.

According to IRS regulations, any equity debt that exceeds the FMV of a home is no longer deductible. This rule was originally designed to prevent borrowers from writing off interest which, while legally secured by their home, isn’t really secured by it because there’s no equity available.

As written, this provision stands to put many people with an equity line out of a tax deduction because their homes lost value, not because they took a loan that exceeded the appraised value of their home.

Be Careful with Loan Payments and Draws from an Equity Line

One thing to be careful with is how you pay and re-draw funds from an equity line that you are considering acquisition debt (because you used the line to purchase the house).

If you pay down the line and then redraw funds for another purpose, the funds you redraw can only be considered acquisition debt if you use them to buy, build, or improve the home.

What do you think? What’s your favorite home-related tax deduction?

(photo credit: alan_cleaver2000)

The Maryland Homestead Tax Credit is a property tax credit designed to limit the impact of increased property valuation on a homeowner’s taxes. The credit applies only to primary residences (defined as the place you live for more than 6 mos. of the year).

The credit effectively limits the increase in your property taxes to 10% per year.

For example, say your house was worth $200,000 in 2007 and was just reassessed at $300,000 (wouldn’t you be lucky in this market?!) If the property is not your primary residence, your property taxes will be assessed on the full $300,000. If the property is your primary residence and you apply for the homestead credit, your taxes will only be on $220,000, 10% more than the prior year. The taxes will increase each year at 10% until the new assessment value is reached.

The Credit Applies to State and Local Taxes

By law, the homestead tax credit provisions compel the State and all local jurisdictions to limit property tax increases to 10% per year.

Maryland Homestead Credit Qualification Rules

• The house must be your primary residence for 6 months of the year, including July 1 of the application year. The state comptroller’s office attempts to verify this by checking Motor Vehicle Administration (MVA) records, voting registration, and the address on your MD state income tax. The only exception is if the owner vacates the property to get special care (e.g., an elderly person is placed in a nursing home for part of the year).
• The property was not transfered to new ownership. (If it was, the new owners must apply).
• The property was not subject to zoning changes.
• The property was not materially improved. (for instance, by building a house on a previously vacant lot).
• The previous assessment was not erroneous. (meaning, it wasn’t completely ridiculous or in error).

The Credit is not Automatically Applied

This credit is not automatic. You must apply. We think MD could streamline this process by allowing a homeowner to apply at settlement or via their income tax filing. Why they didn’t do this is a mystery to us, except that there’s surely some additional revenue collected just because people put off the application process.

Once you’ve applied once, though, the credit does carry forward each year.

How to Apply

You can apply online. You can also return the form MD sends with your property tax assessment.

The Effect of the Homestead Credit on Rent

Since the Homestead Tax Credit does not apply to rental properties, Landlords who receive a substantially increased property valuation will likely pass these taxes on to their tenants. In fact, most lease agreements provide for an increase in rent when the tax position of the property changes.

(Spirited Photo Credit: rwkvisual at the Westchester County Tax Rally)