Inflation Reduction Act: Heat Pumps Are The Future (2023)

Under the Inflation Reduction Act, heat pumps are eligible for various rebates and tax incentives. President Biden’s Inflation Reduction Act (IRA) was signed into law on August 16, 2022, to lower energy costs, increase cleaner energy production, and reduce carbon emissions by half by 2030,according to the White House. Decarbonizing our nation’s 142 million homes—which made up 20% of U.S. carbon emissions in 2020—is essential to addressing the climate crisis.

The IRA allocates over ten billion dollars in rebates, market incentives, and tax credits for homeowners to make energy-efficiency upgrades, including HVAC equipment, water heaters, and home weatherization projects. A significant portion (about 40%) will go to low-and moderate-income households.

Heat pump installation garners the most notable credits and rebates in the plan. A heat pump is an energy-efficient, cost-effective heating and cooling system. Heat pump installation can be more costly than other HVAC systems, but IRA provisions make it more affordable to homeowners.

Rebate Programs and Tax Incentives:

• High-Efficiency Electric Home Rebate Act (HEEHRA)

• Home Owner Managing Energy Savings (HOMES) Rebate Program

• Energy Efficient Home Improvement Tax Credit (25C)

• Clean Energy Tax Credit (25D)

• Reinstated and Improved Builder Tax Credit (45L)

Only low- and moderate-income households qualify for the HEEHRA program. Low-income families with total annual incomes less than 80% of the local median income are eligible for 100% discounts on the project costs, up to $14,000. Moderate-income households with total annual incomes of 80 to 150% of the local median income are eligible for 50% discounts on the project costs, up to $14,000.

Eligible projects include electrical panel upgrades, electrical wiring improvements, weatherization, and installation of Energy Star-qualified appliances. Discounts cover equipment and installation costs.

Home Owner Managing Energy Savings (HOMES) is a new program introduced by the IRA that will distribute 4.3 billion dollars to state energy offices to oversee the program. The HOMES program will offer post-installation rebates for energy-saving household improvements to cover labor, installation, and equipment costs.

Eligibility is based on the performance of whole-home energy efficiency and electrification improvements post-installation. There are no income requirements, but household income and how energy savings are determined (modeled or measured) are factors in determining the rebate’s amount.

As of publication, the U.S. Department of Energy has yet to distribute the funds to the state offices. Program rollouts are expected to begin after the states receive funding in late 2023 to early 2024. While the program is set to run until September 30, 2031, the duration depends on the number of funds available within each state and the number of rebates distributed.

The HOMES rebate covers upgrades that make houses more energy-efficient, such as solar panels, new windows, and heat pumps. Homeowners cannot receive both HOMES and HEEHRA rebates for the same upgrades.

Eligibility is based on actual energy-saving improvements modeled (by computer software) or measured. Every household, regardless of income level, is eligible. Low- and moderate-income households and households that demonstrate higher energy savings stand to receive higher rebate amounts. Returns are also determined by whether energy savings are modeled or measured.

Low- to moderate-income households can receive returns on 80% of the project’s costs, up to $4,000, for modeled energy savings of at least 20% and up to $8,000 for energy savings of at least 35%. Other households can receive 50% of project costs up to $2,000 for modeled energy savings of at least 20% and up to 4,000 for energy savings of at least 35%.

Households with measured energy savings over 15% can receive $2,000 per KwH saved or 50% returns on project costs with no cap. Low- to moderate-income households with measured energy savings over 15% can receive $4,000 per KwH saved or 80% of the project costs with no cap.

Tax credits differ from rebates. Whereas rebates translate into cash discounts, homeowners claim tax credits when filing federal income tax returns. The IRA modifies and extends three existing tax credits and allows homeowners to make claims for energy-efficient improvements and properties through 2032 or 2034.

The Energy Efficient Home Improvement Tax Credit (25C) modifies and extends an existing tax credit through 2032. The modifications increase the credit rate from 10% to 30% and the limit from a $500 lifetime limit to a $1,200 annual limit for most qualified improvements. The change to a yearly limit means that homeowners can claim the annual credit for improvements between 2023 and 2032. Furthermore, the act broadens the category of qualified energy efficiency upgrades.

How much you can save: The amount you'll save varies by project. Some projects have specific annual caps. Homeowners can claim 30% of qualified heat pump installation costs up to $2,000.

Qualifying projects: No income requirements exist, but this credit can only be claimed if it offsets tax liability and can't be combined with other federal programs.

This credit includes energy-efficient windows, doors, insulation, furnaces, boilers, central air conditioners, water heaters, and heat pumps. Particular projects must be Energy Star-qualified.

The Clean Energy Tax Credit modifies and extends an existing tax credit through 2034. The 25D modifications increase the credit rate from 10% to 30% and include additional qualified renewable energy projects. 25D is retroactive to the beginning of 2022 and can be claimed as the year the project is completed.

How much you can save: The amount you’ll save and the annual caps vary by project. Homeowners can claim 30% of qualified heat pump installation costs up to $2,000. For heat pump space and water heaters installed in 2022, homeowners can claim $300.

Qualifying projects: Solar electric and water heating, wind energy, battery storage technologies, electric panel and circuit upgrades for new electrical equipment, home energy audits, and geothermal heat pumps.

The 45L credit has been amended to include eligible new or remodeled homes that meet one of Energy Star’s home program requirements or the Department of Energy Zero Energy Ready Home (ZERH) program requirements. 45L offers two tiers of credits with higher credits for homes that meet ZEHR’s demands. 45L’s modifications apply to homes acquired between January 1, 2023, and December 31, 2032.

How much you can save: Homes that meet Energy Star Residential New Construction Program or Energy Star Manufactured New Homes Program requirements can claim up to $2,500. Homes that meet ZEHR program requirements can claim up to $5,000.

Qualifying projects: Homes must meet the programs’ minimum requirements for duct systems, water and space heating efficiency, thermostats, lighting, indoor air quality, heat pump and electric vehicles readiness, insulation, windows, doors, etc. Results must be field-tested and verified by an approved rater.

State governments and local utility companies have existing heat pump incentives and rebate programs. As of publication, the DOE has yet to issue the IRA guidelines, and it is unclear how state initiatives can be combined with federal initiatives. It will be up to the discretion of each state or the DOE. State and federal rebates could theoretically be combined if the state rebates don’t rely on federal funding, and nothing in the IRA excludes homeowners from additionally capitalizing on state initiatives.

Homeowners might be eligible for tax credits on previously installed Energy Star-qualified heat pumps. Homeowners can claim $300 for all Energy Star-qualified air-source heat pumps and most Energy Star-qualified heat pump water heaters installed between January 1, 2022, and December 31, 2022.

Homeowners can claim 26% of Energy Star-qualified (at the time of expenditure) geothermal heat pump installation costs for systems installed between January 1, 2020, and December 31, 2022.

Use IRS Form 5695 to claim 2022 tax credits.

Homeowners should claim tax credits on federal income tax returns. IRS Form 5695 was used in previous years for similar energy credits programs. At the time of publication, it’s unknown whether the same form will be used for 2023 and beyond.

State energy offices or utility companies will administer rebate programs. Funding has not been distributed to the states at the time of publication, and therefore, rebates are not currently available to consumers. The federal government intends to publish guidelines to the states in the summer of 2023. The states will set up and administer the programs after funding is received. Program rollouts are expected to begin in late 2023 to early 2024.

The wording in the IRA suggests that rebates should be available at the point of sale, but it’s unknown if rebates will be given retroactively. The IRA authorizes states to provide Home Efficiency rebates for projects beginning on or after the law was enacted. The states will be responsible for outlining how they will determine that the program requirements have been met for upgrades made before the program was set up. The IRA does not allow states to retroactively offer Home Electrification and Appliance rebates.

In the meantime, the IRA savings calculator can help you estimate how much you can save on energy efficiency upgrades with IRA incentives.