If you would like to make your existing home more energy efficient and get some help paying for the improvements, you need to know about the Energy Tax Incentives Act of 2005. The new law provides a $500 lifetime credit against your federal income tax for the cost of certain energy-saving home improvements that you make to your home after December 31, 2005 and before January 1, 2008. Up to $200 of the tax credit may be applied to windows.

As you may know, a tax credit is far more favorable than a deduction of the same amount. Deductions only reduce the amount of income that is subject to tax. A tax credit, on the other hand, is a dollar for dollar reduction of the tax due when you file your income tax return. So, if you are in the 28% income tax bracket, the new $500 credit is equivalent to a tax deduction of nearly $1800!

Here are highlights of the new provisions:

There is an overall lifetime cap on the credit of $500, and a maximum of $200 of the credit may be applied to qualified window expenditures. Subject to those limitations, you may receive a credit for the sum of the following:

Building Envelope Components. Ten (10%) percent of your expenditures for so called "building envelope components" will qualify for the tax credit. Building envelope components include the following:

• any insulation material or system which is specifically and primarily designed to reduce the heat loss or gain of a dwelling unit when installed in or on such dwelling unit,
• exterior windows (including skylights),
• exterior doors, and
• any metal roof installed on a dwelling unit, but only if such roof has appropriate pigmented coatings which are specifically and primarily designed to reduce the heat gain of such dwelling unit.

To qualify for the credit, the building envelope components must be installed in or on a dwelling unit (including a manufactured home) located in the United States that is owned by you and used by you as your principal residence. Installation of envelope components in a second or vacation home or rental property therefore will not qualify for the new tax break.

Only new components are eligible for the credit and the components must reasonably be expected to remain in use for at least 5 years.

Energy efficient property expenditures. Amounts paid for "residential energy property expenditures" will also qualify for the credit up to the following specific limits:

• Up to $50 for any advanced main air circulating fan;
• Up to $150 for any qualified natural gas, propane or oil furnace or hot water boiler;
• Up to $300 for any item of "energy-efficient building property." This includes certain qualifying electrical heat water pumps, electric heat pumps, geothermal heat pumps, central air conditioners and natural gas, propane or oil water heaters.

Expenditures for labor costs for onsite preparation, assembly or original installation may be included. Improvements must be installed in or in connection with a dwelling unit located in the United States that is owned by you and used by you as your principal residence.

There are energy efficiency standards described in the new law that your home improvements must meet, so some investigation on your part will be necessary to be sure that the improvements will qualify for the credit. For this reason, if you hire a third party to do the work, your written agreement with the contractor should include the contractor's guaranty that the installed property will meet the energy efficiency standards of the new law.

There is one potential trade-off, if you use the credit. Many improvements to your home will increase your "tax basis" in the property, and this increased tax basis may, in turn, reduce the amount of capital gain that is realized if you sell your home at a profit. The increase in tax basis that would otherwise result from energy efficient improvements that qualify for the credit will be reduced by the amount of the allowed credit. Since the tax credit decreases your tax basis, you are likely to have more capital gain at the time of sale. This will not affect you if all of the capital gain realized at the time of sale is protected by the $250,000 exclusion ($500,000 for married couples) for gains realized on the sale of your principal residence. But even if there is an increase in the taxable capital gain realized when you sell your home, it will almost certainly be outweighed by the advantage of using the new income tax credit currently.

Like so much of the Internal Revenue Code, the new provisions encouraging energy efficient home improvements seem unnecessarily complicated, but we have to consider the source - Congress! However, a bit of patience and careful planning will bring you some very real tax savings and help the environment to boot!