A tax credit is a tax incentive that allows a taxpayer to subtract a specific amount of money from the tax balance owed to the state. With a tax credit, a taxpayer can reduce his or her federal income tax liability. There are many types of tax credits available to taxpayers, including the Lifetime Learning Credit, Child and Dependent Care Credit, and American Opportunity Tax Credit. Investment tax credits (ITC) are credits that qualifying taxpayers can claim to reduce tax liability on certain investment-related costs.
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What Are Investment Tax Credits?
If you make economic development investments, you may qualify for investment tax credits, which allow you to reduce your income taxes. With these credits, you can deduct capital-related costs from your taxable income, which reduces your tax liability.
The government originally implemented ITC in 1962 to encourage individuals and entities to invest and strengthen the local economy. The federal government was attempting to motivate investors to keep their money in U.S. investments instead of foreign economies. However, the purpose of the ITC has changed over the years as the government identifies areas that need attention.
Types of Investment Tax Credits
The latest investment tax credits were implemented by the federal government to encourage investors to improve the environment. Most of the latest ITCs focus on utilizing alternative energy sources and rehabilitating buildings.
Advanced Energy Project
The advanced energy project tax credit was established to incentivize investing in sustainable energy projects, such as solar panels for residential and commercial properties. To qualify for the credit, the property itself must be certified and meet certain standards set by the Internal Revenue Service.
The investment must expand, establish, or re-equip a facility so that it produces a certain advanced energy property from renewable resources. The property may also be used to produce electric grids for renewable energy storage or transmission, sequester carbon dioxide, blend renewable fuels, or perform another function in the process of using renewable energy. A tax credit of 30% for the qualified investment is provided, if the taxpayer is eligible for this credit.
Advanced Rehabilitation Project
You may be eligible for the advanced rehabilitation project tax credit if you plan to rehabilitate a property that’s registered as a historical building. This investment tax credit was implemented by the government to ensure the preservation of historical architecture and buildings.
The property must meet other IRS guidelines, must be sustainably rehabilitated, and at least 75% of the external walls must be maintained after completion. For qualified expenditures on the rehab project, you can claim a 20% tax credit if the property is an income-producing certified historic structure.
Advanced Coal Project
The advanced coal project offers a tax credit to taxpayers invested in innovations and implementations of goal-based power generation technology. To qualify, the project must use coal-based generation technology to power a new electric generation unit or to repower an existing unit. The expenditures used to complete this project, including the property purchased by the taxpayer, can be claimed for this credit. The tax credit amount the taxpayer qualifies for can vary between 15% to 30%, depending on the project.
Advanced Gasification Project
With the advanced gasification project, you can receive a tax credit for investing in the implementation of gasification technology or innovations in the field. The total credits cannot exceed $650 million. The advanced gasification project tax credit offers a credit equal to 20% of the qualifying expenditures invested in the eligible project. If the project equipment fails to sequester at least 75% of its carbon dioxide emissions, the tax credit can be taken away by the IRS.
Investment Tax Credit Limitations
Taxes are always changing, and so are limitations. There are unique credit limitations associated with each type of investment tax credit. Using the investment tax credits discussed above as examples, you can see that these tax credits are usually between 15% and 30%. However, the IRS changes these tax credit limitations periodically to make certain industries more attractive to investors.
These tax credit limitation changes are also made to ensure the IRS can allocate credits throughout the industries that need them and reduce them in industries that are thriving. For example, the IRS reduced wind power investment tax credits by 20% for wind power facilities beginning construction in 2017 and by 60% for facilities that broke ground in 2019.
Recapture of Investment Tax Credit
You may be required to add back tax deductions from a previous year in a process known as “recapture.” Your investment tax credit may be recaptured if you:
- Dispose of the project.
- Cease work on the project
- Change the practices of the project so that it no longer meets IRS guidelines for the credit.
A recapture of your investment tax credit can also occur if the IRS orders an audit and finds you didn’t qualify for the investment tax credits you were awarded. If this occurs, you may be required to pay back the tax credit, plus penalties and interest.
How to Apply for the Investment Tax Credit
To obtain investment tax credits, you must complete and file the IRS Form 3468, Investment Credit, and provide all attachments as requested. If you file this form electronically and need to submit attachments to the IRS, you must mail these attachments, along with a completed IRS Form 8453, U.S. Individual Income Tax Transmittal.
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