Do Tankless Water Heaters Qualify for a Tax Credit?
A new tankless water heater may reduce your tax liability. Understand the specific equipment requirements and financial caps for claiming the federal energy credit.
Yes, certain tankless water heaters can qualify for a federal tax credit known as the Energy Efficient Home Improvement Credit. The rules for this credit were updated by the Inflation Reduction Act of 2022, which increased its value and extended its availability through 2032. The credit is designed to reward taxpayers for investing in specific types of property that reduce a home’s energy consumption.
Tax Credit Qualification Requirements
To be eligible for the tax credit, the tankless water heater must be installed in your principal residence, which is the home you live in most of the time. The property must be an existing home; new construction does not qualify for this particular credit. Rental properties are also excluded from this benefit, as the taxpayer must personally use the residence.
Specific performance standards must be met by the equipment itself. To be eligible, natural gas and propane tankless water heaters must meet or exceed ENERGY STAR requirements, which specify a Uniform Energy Factor (UEF) of 0.95 or greater. This rating measures the water heater’s energy efficiency. Many electric tankless water heaters do not meet the efficiency requirements, though some electric heat pump water heaters may fall under a separate credit category with different rules.
The timing of the installation is a factor. To qualify, the tankless water heater must have been “placed in service” on or after January 1, 2023. The term “placed in service” refers to the date the unit is fully installed and ready for use in the home. This means the purchase date alone is not sufficient; the installation must be complete within the qualifying timeframe, which extends through December 31, 2032.
Calculating the Tax Credit Amount
The tax credit is 30% of the total project cost, which includes the price of the tankless water heater and any associated installation labor fees. For a qualifying natural gas, propane, or electric heat pump water heater, the maximum credit you can claim is $2,000 per year.
This credit is part of the broader Energy Efficient Home Improvement Credit, which has a total potential annual limit of up to $3,200. This total is composed of two parts: a $1,200 annual limit for home envelope improvements like windows and insulation, and a separate $2,000 annual limit for larger equipment like heat pumps and water heaters.
Because these limits apply to different categories of improvements, you can claim credits for both in the same year. For example, if you claim a $2,000 credit for a new water heater, you could still claim up to $1,200 for new windows in the same year. These annual limits reset, allowing you to claim credits for new projects in subsequent years.
Information and Documentation Needed to Claim the Credit
You must gather specific documentation to substantiate your expenses, including detailed, itemized receipts from the purchase and installation. These receipts should clearly separate the cost of the water heater from the installation labor. You will also need a Manufacturer’s Certification Statement for your model, which is a document from the manufacturer attesting that the product qualifies.
Beginning in 2025, you must also report the product’s identification number on your tax return. You will use this information to complete IRS Form 5695, Residential Energy Credits, which calculates the total allowable credit. Retain all records with your tax files.
How to Claim the Credit on Your Tax Return
After calculating your credit on Form 5695, submit the form with your primary tax return, such as Form 1040. The final credit amount is transferred to Schedule 3 (Form 1040), which directly reduces your total tax liability for the year. The Energy Efficient Home Improvement Credit is nonrefundable.
This means the credit can reduce your tax liability to zero, but you will not receive any portion back as a cash refund if it exceeds what you owe. For instance, if you owe $1,500 in taxes and have a $2,000 credit, your tax bill is reduced to zero, but you will not receive the remaining $500. The unused portion cannot be carried forward to apply to a future tax year.