This week, Gail explains how to calculate the tax credit you’ll get by making your home more energy-efficient.

Hi, Gail —

I read your recent article about the new law that gives you tax breaks for making your home more energy efficient and replacing older appliances with ones that use less energy. You said the maximum credit you can get for this is $500. Can you tell me how to figure this? We need a new hot water heater and they happen to be on sale in a nearby store. We’re also thinking of putting additional insulation in our attic.

Thanks,

Rita

Dear Rita —

If you’ve been to any hardware or home improvement store lately you can’t miss those end-of-aisle displays reminding you that winter is coming and urging you to buy weather sealing or insulation. However, under the Energy Tax Incentives Act, you won’t qualify for any tax credits if the items are installed or, as the law states, “placed in service,” this year. They only apply to qualified energy-saving changes you make in 2006 and 2007, as I explained in this column and this column.

“It’s a matter of proof,” says George Jones, a tax analyst with CCH’s Washington office. In other words, it’s up to the taxpayer to prove that he/she is entitled to the credit. Because this legislation was enacted in August, the IRS is still working out the details of implementing and enforcing the various provisions. So at this point, we don’t know exactly what type of “proof” the IRS is going to require.

If you were audited, how would you prove to the IRS that, although you bought the insulation this fall, you didn’t actually lay it in your attic until next year? “That’s a problem,” says Jones. “If it’s in your garage you could take a picture of it with the daily newspaper sitting next to it.” As long as the newspaper has a 2006 date, that would be one way to demonstrate that the insulation wasn’t “placed in service” until then. But you might still have to prove the picture was really taken in [your] garage.

On the other hand, “if it’s not self-installed, it’s easy to prove” when something is placed in service, according to Jones. He says even if you buy your new hot water heater now to take advantage of the sale, you’ll meet the requirement for the tax credit if the invoice from your plumber states it was installed in 2006 or 2007. Bill Prindle, Deputy Director of Energy Policy at the American Council for an Energy-Efficient Economy (ACEEE) takes a more cautious approach saying, “You’re safest if your financial and installation records both show a 2006 date.”

Keep in mind that even if you comply with the timing requirements of this law, you’re not eligible for a tax credit if the equipment you’re installing isn’t “qualified.” There could be a reason the hot water heater you’re looking at is on sale- the dealer might be trying to get rid of it because it doesn’t meet the new, stringent requirements for energy use. You can check these out by visiting the ACEEE website: http://aceee.org/press/Tax_incentive05.pdf

But don’t walk away from a great deal on a new hot water heater just because it doesn’t qualify for the tax credit. As Prindle points out, depending upon the sale price, you could end up saving more that the credit is worth.

The tax credit for residential energy-efficient improvements is a lifetime maximum of $500. In other words, if you get a $500 tax credit in 2006, you’re not eligible for another $500 in 2007. However, if you don’t use the entire credit next year, you can claim the balance the following year.

In addition to the lifetime maximum credit, each type of improvement has a cap. (See the Web site above.) The maximum credit for a water heater that meets the standards is $300. For insulation, the credit is equal to 10 percent of the cost, up to $500.

Let’s say your total cost to purchase and install your hot water heater is $700. You buy $1500 worth of insulation.

The energy tax credit you can claim on your 2006 income taxes is $450: $300 + $150 (10 percent x $1500). That leaves you $50 toward any energy-saving steps you take in 2007.

Remember: a tax credit is a dollar-for-dollar reduction in your federal tax bill and this one is not phased out at higher income levels.

Hope this helps!

Gail

If you have a question for Gail Buckner and the Your $ Matters column, send them to: moneymatters@foxnews.com, along with your name and phone number.

Gail Buckner and Foxnews.com regret that all letters cannot be addressed and that some might be combined in order to more completely address a topic.

To access Gail's past columns, simply use our new "Search" function: type in "Buckner" and you'll be able to get all Your $ Matters columns since April 2001.

The views expressed in this article are those of Ms. Buckner or the individual commentator. You should consult your own financial adviser for advice regarding your particular financial circumstances. This article is for information only and is not an offer of the sale of any mutual fund or other investment.