Heat pump federal tax credits: everything you need to know

There’s a big push across the country for electrification, energy efficiency, and reducing carbon emissions. For homeowners, one of the best ways to check all three of these boxes is to install a heat pump.

If you don’t know anything about heat pumps you can read my primer on heat pumps to learn the basics, but in a nutshell a heat pump has the same basic components of an air conditioner, but is able to provide both heating and cooling. In the summer, it works the same as an air conditioner by taking heat from inside a building and dumping it outside. In the winter, a heat pump switches into heating mode and does the opposite: it takes heat from outdoors - even when it’s cold - and moves it inside.

The technology behind heat pumps keeps improving: the latest cold-climate heat pumps work even in sub-arctic conditions. In fact, the countries with the highest per-capita sales of heat pumps are Norway, Finland, and Sweden.

Because of the benefits, many incentives for US households are now available, with the tax credits from the Inflation Reduction Act being the most significant. Known as the Energy Efficient Home Improvement Credit, homeowners can take a tax credit of up to 30% off the installed cost of a heat pump, up to a maximum of $2,000.

On top of that, there are numerous incentives offered by state governments, local governments, and utility companies around the country. These are separate from the federal tax credit, so you can stack these savings together. In the end, you can end up paying significantly less than the original invoice price.

What is the federal tax credit for heat pumps?

The Energy Efficient Home Improvement Credit (EEHIC) was introduced into law by the Inflation Reduction Act of 2022, which provides tax credits for numerous home improvements including solar panels, insulation, energy efficient windows and door, and more. Those are outside the scope of this article, so read the full instructions with the tax credit to learn more.

For heat pumps, the credit is worth 30% of the final invoice price of the system, up to a maximum of $2,000 in one year. This means that labor costs are included in calculating the eligibility.

According to HomeAdvisor, the average cost of a heat pump is about $6,000, so 30% of that would knock $1,800 off the final cost. (My own heat pump installation cost about $6,500, so HomeAdvisor’s estimate sounds right to me.)

One point worth noting is that the tax credit can be taken every year. While this probably doesn’t help most homeowners, there are some scenarios where you might benefit.

If you have multiple homes, you could install a heat pump in each one and receive a credit for each as long you do the work in separate years.

Another way to take advantage of this is by installing a mini-split heat pump system yourself. While this may seem intimidating, it’s a more feasible project than you might think. (Especially given that the electrical work should be made by licensed contractor, not yourself.) In this scenario, you could install your mini-split system over the course of a couple years. For example, you might install a system for upstairs bedrooms one year, claim the 30% tax credit, and then install another system for downstairs and claim the credit again. By doing this, not only do you save on labor, but claim a much larger tax credit than you normally could.

EEHIC tax credits aren’t rebates

One big caveat to keep in mind is that the Energy Efficient Home Improvement Credit is not a rebate. This means that you don’t receive it at the time that you purchase your system.

Instead, you pay your contractor for the full cost of the invoice. Keep all your records, and then apply for the tax credit when it comes time to file your income taxes. You can then use this tax credit to deduct the amount of federal tax that you owe.

For example, let’s say that you owe $3,000 in federal taxes on your next filing. If your Energy Efficient Home Improvement Credit is worth the maximum of $2,000, you would end up owing only $1,000 in taxes.

This is an important point for people who don’t pay very much in federal taxes. (This could be the case if you’re retired, have a lower income, or have other significant tax deductions in the same year.) You can only use the tax credit to reduce your taxes owed. It’s not paid out to you in full. This means that if you owe zero federal taxes, you won’t be able to claim any benefit from the Energy Efficient Home Improvement Credit.

If this is your situation, one beneficial thing is that you can carry forward any unused credit to the next year. For example, if you have a total of $2,000 in tax credit available but can only use $1,000 this year, you can carry forward the remaining $1,000 credit to the next year. The IRS instructions aren’t clear about how many years you can do this, so if you need more than two years to spend all of your tax credit, you should check with your tax professional.

Are ground-source (geothermal) heat pumps eligible for the federal tax credit?

Both ground-source and air-source heat pumps are eligible for federal tax credits.

Ground-source – also known as geothermal – heat pumps are more efficient than air-source units and don’t suffer from seasonal changes in efficiency because the ground a few feet below the surface stays roughly the same temperature all year. However, they are significantly more expensive, often costing tens of thousands of dollars. In comparison, an air-source unit costs around $6,000 on average.

However, the Inflation Reduction Act might change this because geothermal units have a big advantage when it comes to tax credits. Under these new rules, geothermal heat pumps are eligible for a 30% tax credit with no total limit. Unlike air-source heat pumps that are eligible for a maximum $2,000 credit, ground-source units can qualify for much more.

For example, let’s say that your geothermal heat pump system costs $20,000. (This wouldn’t be an unusual price because of the significant costs involved in installing the ground-loop system.) With this federal tax credit, you would be eligible to take a $6,000 credit. If your system costs $30,000 (which could be the case if you have a really large system or ground conditions that make the installation difficult) you could take a $9,000 credit.

That goes a long way toward reducing the cost disadvantage of ground-source heat pumps. If you have a large home to heat and cool and experienced contractors in your area, geothermal is an option you should consider.

If you are applying for this tax credit, be aware that it falls under a different name. The relevant credit is known as the Residential Clean Energy Credit, and is the same program for solar and battery storage. Just like the Efficient Home Improvement Credit, any unused Residential Clean Energy Credit can be rolled over to the next tax year, which is helpful because the size of the credit can be substantial.

Figuring how which heat pumps are eligible for the tax credit

Not every heat pump is eligible for the federal tax credit. To qualify, the system must meet minimum efficiency requirements. Figuring out what those requirements are can be pretty confusing. For example, if you read the instructions that come with the IRS form for claiming the tax credit, you have this line:

Line 29a. Enter the amounts you paid for electric or natural gas heat pumps that achieve the highest efficiency tier established by the CEE that is in effect as of the beginning of the calendar year in which the property is placed in service.

This raises more questions like: Who is the CEE, and what exactly is the efficiency tier that they’re describing?

The CEE is the Consortium for Energy Efficiency, who describe themselves as “a consortium primarily of utility efficiency program administrators from across the United States and Canada”. Basically, they are a non-profit organization with a mission to promote energy efficiency. If you do a little searching on their website, you’ll find this explanation:

On August 16th, 2022, the Inflation Reduction Act of 2022 was passed, naming CEE tiers as the basis for federal tax credits across several product categories through 2032. The Act cites products “which meet or exceed the highest efficiency tier (not including any advanced tier)”. The tax credit eligible tier may be Tier 1, 2, or 3, depending on the product category.

That’s more informative, but it still doesn’t help you make a product decision because heat pumps generally don’t list a CEE Tier designation. Instead, you have to dig further to find a PDF on their website with the specifications described¹. Click on the first link labelled “CEE_ResHVAC_ElectricSpecs_01Jan2023” to download the file.

The eligibility criteria differ between northern and southern US states, and ducted and non-ducted (ie. ductless mini-split) heat pumps. According to the IRS instructions, heat pumps in the “highest efficiency tier” established by the CEE are eligible. However, caution is required when reading the specs in this PDF because a different webpage published by the CEE² explains that the CEE Advanced Tier is an “aspirational energy efficiency performance” target. This means that it’s not relevant for the purposes of this tax credit. Instead, we only need to consider CEE Tier 1 and Tier 2 specifications, depending on the product and region.

Interestingly, if you visit the EnergyStar.gov website, it publishes eligibility criteria that is different from the CEE. Because the IRS instructions specifically refer to the CEE and not Energy Star (which is usually an authoritative source), I think we can treat the CEE information as being correct. I’ve reached out Energy Star for an answer about this discrepancy and will update this article if I hear back.

SEER2 and HSFP2 ratings for tax credit eligible heat pumps

Here are the minimum specifications that air-source heat pumps need to meet to be eligible for the Energy Efficient Home Improvement Credit. The requirements differ for ducted and ductless heat pumps, and households in northern and southern states.

As you can see, you should look for a heat pump with at least a SEER2 rating of 15.2 for ducted systems and 16 for ductless mini-splits.

There are separate specification for northern and southern states because the heating and cooling requirements differ by climate zones. Here’s a map that shows which states fall into north and south categories:

There are a few things that require explanation, especially the acronyms. These specs, such as SEER2 and HSPF2, refer to the heating and cooling performance of heat pumps. These can be confusing, so you can read my article Heat Pump Terminology Explained for an overview. The most common ones that consumers will see listed for their products are SEER2 and HSPF2.

SEER2 refers to Seasonal Energy Efficiency Ratio, which measures cooling performance in air conditioners and heat pumps. HSPF2 is Heating Seasonal Performance Factor, which tells you how much heat the unit will generate for every kilowatt-hour of electricity the unit consumes. New heat pumps and air conditioners will use version 2 of the specification, which is more stringent than the previous version.

Higher numbers are better. SEER2 and HSPF2 are listed on the EnergyGuide label, which looks like this:

Both numbers correspond to the amount of electricity the heat pump consumes to move a given amount of heat energy. If you’re interested in this calculation behind this, that’s also described in my heat pump terminology article.

The other specifications – EER2 and COP – refer to Energy Efficiency Ratio and the Coefficient Of Performance. Both numbers are additional ways of measuring energy efficiency, but unfortunately for consumers finding these specifications for any product can be difficult. Most product brochures for residential heat pumps don’t list these numbers, and I’ve also found that they are also rarely found on manufacturers’ websites.

So what does this mean if you’re trying to ensure that your heat pump is actually eligible for the tax credit? Fortunately for consumers SEER, EER, HSPF and COP are all related. For example, SEER evaluates the performance of the heat pump at different outdoor temperatures. In contrast, EER is a measurement of performance at a single temperature.

This means that SEER is a more realistic measurement of cooling performance. It’s a similar story for COP @ 5°F, which is measurement of heating performance at a single temperature. While useful, the HSPF2 number is more representative of real-world heating performance over a complete season.

Which ground-source (geothermal) heat pumps are eligible for a federal tax credit?

If you have a geothermal heat pump, the situation is much simpler. Any Energy Star rated heat pump will qualify. Unlike air-source heat pumps, it doesn’t matter which climate zone you live in.

Bottom line: SEER2 and HSPF2 are the numbers to pay attention to

The bottom line is that if a heat pump meets the SEER2 and HSPF2 numbers in the table above, it should be considered eligible for the tax credit. Any ducted or ductless heat pump with a SEER2 rating of at least 16 and an HSPF2 rating of at least 9.5 will qualify, no matter which state you live in. Be sure to consult with your HVAC contractor because they may have access to additional specifications that can clarify this for certain.

It’s unfortunate that this issue is so confusing for consumers. It would be better if it was simple as looking for an Energy Star certification. Thankfully, there is a Energy Star label for cold climate heat pumps³, which are high performance heat pumps that will meet the guidelines for the Energy Efficient Home Improvement Credit.

However, not all heat pumps are cold climate models, so the best advice I can give is to look for the EnergyGuide label (which is different from the blue Energy Star logo!) to find the SEER2 and HSPF2 ratings.

How do you claim the tax credit for your heat pump?

Once you’ve established that your heat pump is eligible for a federal tax credit, you can use IRS Form 5695 Residential Energy Credits to make your claim⁴.

The form has two parts. Part I is for the Residential Clean Energy Credit, which applies to geothermal heat pumps, solar arrays, and battery storage.

Part II is the Energy Efficient Home Improvement Credit, which is the section for air-source heat pumps, air conditioners, windows, doors, and insulation. The form is short, and should take you only a few minutes to complete.

When is the tax credit available?

Prior to the Inflation Reduction Act, heat pumps were eligible for only a $500 tax credit. With the IRA, heat pumps installed on January 1, 2023 and later are eligible.

When will the tax credit for heat pumps expire?

Under the current law, the federal tax credit for heat pumps will expire on December 31, 2032 unless renewed again by Congress.

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