Rinnai on demand hot water heaters seem to be the standard; at least that's what the contractors use on the projects for my work (housing development). They make units with other brand names, so ask the plumbing contractor for their recommendation.

I investigated on-demand HW, but it would have required re-routing the gas lines and costing $4k. This was in 2008; there were no tax incentives that year. A good, well-insulated 50-gallon tank heater is very efficient, and cost $800, so I went with that.

My parents recently had two on-demand hw heaters installed, at $3k each. Each is eligible for a $1500 credit, so they ended up getting both for $3k (or they will when they file their taxes).

FWIW, my plumber explained to me that new traditional hw heaters are very, very efficient, particularly the electric ones. The gas ones require venting, which increases heat loss. The electric ones are like huge thermoses. You could do even better by installing solar thermal system to heat up the water by the sun before it goes into the hot water heater, making less work for the hw heater.

Just some info in case on-demand doesn't work out for you for whatever reason. In either case, if you can do it by the end of the year, you can get a tax credit, so start calling. Contractors are pretty busy with people trying to get their efficient appliances installed by the end of the year for tax purposes.