Has your property been upgraded for energy efficiency? If you’ve invested in solar panels, energy-saving windows, or other sustainable improvements, you may be eligible for significant tax credits. These credits provide a direct reduction of your tax bill, unlike deductions that only lower taxable income. The end of the year is an ideal time to review your property upgrades and ensure you’re taking full advantage of any green tax benefits available. For property placed in service between January 1, 2023, and December 31, 2032, individuals can claim an energy-efficient home improvement credit typically worth 30% of:
(1) The costs incurred for the installation of qualifying energy-efficient improvements;
(2) Eligible residential energy property expenses; and
(3) Costs associated with home energy audits.
However, there are certain annual limits on how much credit can be claimed. A qualifying energy efficiency improvement involves building components, such as insulation or windows and doors, that are expected to last at least five years. Eligible residential energy property expenditures cover the costs of items like water heaters, heat pumps, central air conditioners, furnaces, boilers, and electric system upgrades, including installation. A home energy audit involves an evaluation that identifies the most impactful and cost-effective energy efficiency improvements for your home.
For more details, the IRS provides a dedicated page for Home Energy Tax Credits, offering specific information on the energy-efficient home improvement credit and the residential clean energy credit. The page also links to frequently asked questions (FAQs). The Department of Energy’s website also has technical requirements for eligible expenditures.
To claim the energy-efficient home improvement credit, taxpayers use Form 5695 (Residential Energy Credits) and report it on their Form 1040.
General Rules for Energy Efficiency Home Improvement Credit
To qualify for the energy efficiency home improvement credit, the eligible expenses must be related to a taxpayer’s dwelling unit. A dwelling unit includes:
- A house, apartment, condominium unit (if the taxpayer is part of the condo management association), mobile home, houseboat, or any similar property used as living accommodations within a building or structure.
- A manufactured home that meets the Federal Manufactured Home Construction and Safety Standards (24 CFR part 3280).
- Any property classified as a dwelling unit in IRS guidance.
However, a dwelling unit does not include:
- Structures or properties attached to the dwelling unit.
- Portions of a unit used temporarily or exclusively for commercial purposes, such as a hotel, motel, inn, or similar establishment.
As outlined in IRS Frequently Asked Questions (FAQs) and proposed regulations, the credit applies only to qualifying expenses incurred for existing homes located in the U.S. This includes reconstructions or additions to a home but excludes new home construction. For any reconstruction or addition, the credit is applicable when the taxpayer begins using the reconstructed or post-addition dwelling unit. Taxpayers must maintain records detailing the costs of each qualified item.
A cost segregation study won’t substantiate costs unless the credit is limited to what the taxpayer directly paid or incurred for the addition or improvement work done by contractors.
For clarity, the IRS defines that an expenditure is made when the original installation of the qualified item is finished. Property is considered “placed in service” when it is ready for its intended function. The original use is the first use of the property, even if not by the taxpayer. The IRS specifies that the property must be new and not previously used.
Practical Note
The energy efficient home improvement credit can be confusing because different ownership and use tests apply to each expense category, such as:
- Qualified energy efficiency improvements: Must be installed in or on a property the taxpayer owns and uses as a primary residence.
- Residential energy property expenditures: The taxpayer must use the property as a residence, but ownership and primary residence status are not required.
- Home energy audits: The taxpayer must either own or use the property as a primary residence.
Caution
This credit is not available for properties the taxpayer does not use as a residence. For example, landlords cannot claim the credit for rental properties they do not live in. However, tenants may be able to claim the credit for eligible energy property expenses or home energy audit costs for rental properties.
Compliance Note
Taxpayers calculate the energy efficient home improvement credit on Form 5695 (Residential Energy Credits) and report it on Form 1040.
A taxpayer can rely on a manufacturer’s certification that a product qualifies for the credit, provided the IRS has not withdrawn the manufacturer’s right to certify the product. The taxpayer should retain this certification but does not need to submit it with their return.
If no manufacturer’s certification is available, the taxpayer can still qualify for the credit by demonstrating that the property meets the required standards.
Caution
It is essential not to confuse the energy efficient home improvement credit with the residential clean energy credit, which applies to equipment like solar energy property, fuel cells, and geothermal heat pump systems.
Additionally, the post-2023 energy efficient home improvement credit should not be confused with the previous version of the credit for properties placed in service before 2023, known as the Pre-2023 Nonbusiness Energy Property Credit.
Lastly, the general business credit now includes a new energy efficient home credit for contractors who build energy-efficient homes.
| Aspect | IRC §25C – Energy Efficiency Home Improvement Credit | IRC §25D – Residential Clean Energy Credit |
|---|---|---|
| Credit Percentage | 30% | 30% |
| Annual Limit on Credit Amount | Yes; subject to a total cap, plus specific restrictions for some expenses | Only applicable to fuel cell systems |
| Eligible Expenditures | 1. Energy-saving upgrades 2. Energy-related property 3. Energy audits | 1. Solar power systems 2. Solar water heaters 3. Fuel cell technology 4. Small wind energy systems 5. Geothermal heating pumps 6. Energy storage solutions |
| Eligible for Labor Cost Coverage | Energy-related property only | Yes |
| Qualified Property | Limited to existing homes | Both new and existing homes qualify |
| Homeownership Requirement | Limited to improvements made by homeowners | No |
| Principal Residence Requirement | Only applies to upgrades in the primary residence | Limited to fuel cell systems only |
| Credit Carryforward Option | Not allowed | Allowed |
| Credit Expiration Date | Ends in 2032 | Expires in 2034 (rate reduction starts after 2032) |
| Required IRS Form | Form 5695, Residential Energy Credits | Form 5695, Residential Energy Credits |
Credit Amount Overview
The energy efficiency home improvement tax credit generally covers 30% of the taxpayer’s qualified expenses, with some limits. The credit may be affected by the following factors:
- Annual Credit Cap
- Specific Expense Limits
- Business Use of the Property
Here’s a breakdown of these limitations:
1. Annual Credit Cap
The total annual credit is capped as follows:
- $2,000 for qualified electric or natural gas heat pump water heaters, heat pumps, and biomass stoves/boilers.
- $1,200 for all other qualifying expenses.
As a result, the total maximum allowable credit per year cannot exceed $3,200. (See Example 3 below for more detail.)
2. Limits for Specific Expenses
Certain expenses are subject to individual caps:
- $600 for all exterior windows and skylights.
- $500 for exterior doors (with a $250 limit per door).
- $600 for qualifying energy property (except for heat pump water heaters, heat pumps, and biomass stoves/boilers, which are covered by the $2,000 limit).
- $150 for home energy audits.
Example 1
Pat installs two exterior doors for $1,000 each. Without any limits, the credit would be $300 per door, or $600 for both doors. However, due to the $250 limit per door, the total credit for the doors is $500.
Pat also spends $2,200 on windows and skylights. Without limits, 30% of this amount would be $660. But, the $600 limit reduces the credit to $600.
Additionally, Pat purchases a central air conditioner for $5,000. Normally, 30% would be $1,500, but the $600-per-item limit reduces the credit to $600.
The total credit would be $1,700 ($500 for doors, $600 for windows, $600 for the air conditioner). However, the $1,200 aggregate credit limit reduces the total credit to $1,200.
Example 2
If Pat instead spends $5,000 on an electric heat pump (which is exempt from the $600-per-item limit), the 30% credit would be $1,500. This brings Pat’s total credit to $2,600 ($500 for the doors + $600 for the windows + $1,500 for the heat pump).
Example 3
If Pat spends $8,000 on an electric heat pump and $600 on an energy audit, the calculations change:
- The energy audit gets a maximum credit of $150 (the $180 potential is reduced by the $150 limit).
- The electric heat pump credit is capped at $2,000, despite the $2,400 potential.
Thus, the total credit is $3,200 ($2,000 for the heat pump + $1,200 for the doors, windows, and audit).
Example 4
Ann spends $600 on an energy audit and $800 each for three exterior windows. Without limits, her potential credit would be:
- $180 for the audit (30% of $600).
- $720 for the windows (30% of $2,400 total).
However, due to the $150 cap on the audit and the $600 aggregate limit for the windows, Ann’s total credit is $750.
Example 5
Ben buys two exterior doors for $800 and $900, and a natural gas hot water boiler for $2,500. The credit without limits would be:
- $510 for the doors.
- $750 for the boiler.
However, the limits apply as follows:
- The doors’ credit is capped at $490 ($240 for one door and $250 for the other).
- The boiler’s credit is capped at $600.
Ben’s total credit is $1,090 ($490 for the doors and $600 for the boiler).
3. Business Use of Property
If a property is used less than 80% for residential purposes (e.g., part of the property is used for a home office or rental), the credit is limited to the portion of the expenses used for the residential part. For instance, if 75% of the property is used as a home and 25% as rental property, the credit would be limited to 75% of the qualifying expenses.
Note: If business use does not exceed 20%, no allocation of expenses is necessary.
4. Subsidies, Grants, and Rebates
Subsidies, incentives, and rebates related to qualified property may reduce the credit:
Public Utility Subsidies: Generally, subsidies provided by public utilities for energy conservation measures are not included in gross income, and therefore, they do not count toward the taxpayer’s credit. However, this rule doesn’t apply to net metering credits (payments for excess electricity sent back to the grid).
Rebates: Rebates from manufacturers, distributors, or contractors reduce the taxpayer’s expenditures and, thus, the amount eligible for the credit. For example, if a taxpayer spends $400 on qualifying property and receives a $100 rebate, the credit should only be calculated on the $300 expenditure.
Example: If Dave receives a $2,000 rebate for a whole-house retrofit, he can allocate the rebate between two expenses. For a $3,000 heat pump (rebated by $1,200) and $2,000 in insulation (rebated by $800), he can claim $1,800 for the heat pump and $1,200 for the insulation.
Caution
Rebates and subsidies received by contractors are treated differently and may be included in the contractor’s income and subject to reporting requirements.
State Energy-Efficiency Incentives
State incentives typically do not affect the federal tax credit unless the incentive qualifies as a rebate under federal law. State credits related to purchasing qualifying property do not impact the energy efficiency home improvement credit calculation.
Energy Efficiency Improvements for Tax Credit
One of the key eligible expenses for the energy-efficient home improvement credit is energy efficiency improvements. To qualify for the credit, an energy-efficient building envelope component must meet the following criteria:
Location and Ownership: The improvement must be installed in or on a dwelling unit (including manufactured homes) located in the United States. The taxpayer must own and use the home as their primary residence.
Longevity: The component must be expected to remain in service for at least five years.
Original Use: The property must be used for the first time by the taxpayer, even if the property will be used differently by the taxpayer.
Taxpayers can rely on proposed regulations that define “original use” as the first use of the property, whether or not that use aligns with the taxpayer’s intended use of the property.
Important Considerations
The tax credit only applies to amounts paid for purchasing the energy efficiency improvement itself. It does not cover costs associated with preparing, assembling, or installing the components. For example, if a taxpayer pays a fixed price for an installed energy-efficient component, they must reasonably allocate the cost between the qualifying purchase price and the non-qualifying labor or installation costs.
Eligible Energy-Efficient Building Envelope Components
The following are eligible for the credit under energy-efficient building envelope components:
Insulation and Sealing Materials: These must be specifically designed to reduce heat loss or gain in a dwelling and must meet the prescriptive criteria established by the International Energy Conservation Code (IECC) standard in effect two years prior to the year the component is placed into service.
Exterior Windows (including Skylights): These must meet the Energy Star most efficient certification requirements.
Exterior Doors: These must meet the relevant Energy Star standards.
The IECC sets minimum energy conservation standards for new buildings across the United States, and these standards are developed by the International Code Council. The Energy Star program, managed by the U.S. Environmental Protection Agency, establishes guidelines for windows, skylights, and doors based on applicable climate zones. For more details about the Energy Star program and climate zones, taxpayers can visit EnergyStar.gov.
Additional Notes
- Exterior Siding: This is not considered an eligible building envelope component for the credit.
- Metal and Asphalt Roofs: Roofs made of metal and asphalt, which could have qualified for the pre-2023 credit, do not qualify for the post-2022 credit.
Residential Energy Property Expenditures for Tax Credit
The second category of qualified expenses under the energy-efficient home improvement credit includes residential energy property expenditures. These expenses cover both the purchase price and labor costs related to the installation, assembly, or on-site preparation of qualified energy property that meets the following criteria:
Installation Location: The energy property must be installed in or in connection with a dwelling unit located in the United States that the taxpayer uses as their residence.
Original Use: The property must be initially placed in service by the taxpayer.
In most cases, “installation” and “placed in service” are considered synonymous, as the installation process typically makes the property ready for its designated function.
Practical Note
The credit for energy property expenditures is more generous than the credit for energy efficiency improvements for two key reasons:
- The credit includes labor costs associated with installing the energy property.
- The credit is available for any home the taxpayer uses as a residence, which includes vacation homes or homes occupied as a tenant.
Eligible Energy Property Items
The following items qualify as energy property eligible for the credit:
- Electric or Natural Gas Heat Pump Water Heaters
- Electric or Natural Gas Heat Pumps
- Central Air Conditioners
- Natural Gas, Propane, or Oil Water Heaters, Furnaces, and Hot Water Boilers
- Biomass Stoves and Boilers
- Oil Furnaces and Hot Water Boilers
- Electric System Improvements and Replacements (also called “enabling property”)
Categories of Qualified Energy Property
Categories 1–4: Energy property in these categories, including central air conditioners, heat pumps, and various types of water heaters, must meet or exceed the highest efficiency tier established by the Consortium for Energy Efficiency (CEE) standard. The CEE is a non-profit organization that sets energy performance specifications for HVAC and water heating equipment in the U.S. and Canada.
Category 5: Biomass stoves or boilers must use biomass fuel to heat a residence or its water. The stove or boiler must have a thermal efficiency rating of at least 75% when measured by the higher heating value of the fuel. The U.S. Environmental Protection Agency (EPA) maintains a database providing thermal efficiency ratings for wood stoves.
Category 6: Oil furnaces and hot water boilers are eligible for the credit if:
- They are placed in service before January 1, 2027, and meet the 2021 Energy Star efficiency criteria and are rated for use with fuel blends containing at least 20% eligible fuels by volume.
- They are placed in service after December 31, 2026, and achieve a minimum of 90% annual fuel utilization efficiency, with a rating for use with fuel blends containing at least 50% eligible fuels.
Eligible fuels include biodiesel, renewable diesel, second-generation biofuels, and clean transportation fuels produced after 2024.
Category 7: Electric System Improvements and Replacements These improvements involve upgrading or replacing electrical panels, sub-panels, branch circuits, or feeders to support the installation of qualified energy property or energy efficiency improvements. The system must have a load capacity of at least 200 amps. The improvement or replacement must be installed along with the corresponding energy property or efficiency improvement, in compliance with the National Electric Code.
These electric system improvements are referred to as “enabling property,” and the associated energy property or efficiency improvements are referred to as “enabled property.”
Under proposed regulations, enabling property must be installed in the same tax year as the enabled property. However, taxpayers may use a safe harbor provision. If enabling property and enabled property are installed in consecutive years, the taxpayer can treat both installations as occurring in the later tax year.
Example
Cleo installs a new electrical panel (enabling property) in Year 1, and in Year 2, she installs an electric heat pump water heater (enabled property). If she uses the safe harbor rule, both the panelboard and water heater are considered installed in Year 2 for tax credit purposes. Without the safe harbor, the panelboard would not qualify for the credit, as it was installed before the water heater.
Caution
The rules for enabling and enabled property do not alter the manufacturer’s responsibility to provide identification numbers for both types of property, as discussed in other sections of the IRS guidelines.
Home Energy Audit Expenses for Tax Credit
The final category of eligible expenses under the energy-efficient home improvement credit pertains to home energy audits. A home energy audit involves an inspection and a written report for a dwelling unit located in the United States that the taxpayer owns or uses as a primary residence. The audit must meet the following criteria:
Identification of Improvements: The report must identify the most significant and cost-effective energy efficiency improvements for the home, along with estimates of the energy and cost savings from these improvements.
Qualified Auditor: The audit must be conducted and the report must be prepared by a home energy auditor who meets the certification requirements set forth by the IRS in their regulations or guidance.
For the audit report to qualify for the credit, it must:
- Be signed and prepared by the certified home energy auditor.
- Include the auditor’s name, employer identification number (EIN), or another relevant taxpayer identification number.
- Confirm that the auditor is certified by a recognized certification program and include the name of that program.
Qualified Home Energy Auditor
The audit must be performed by a certified home energy auditor, or under their supervision. The auditor must be certified by a qualified certification program at the time of the audit. Additionally, the audit should follow the guidelines outlined in the Jobs Task Analysis developed by the Department of Energy (DOE) and validated by the industry.
However, a transition rule allows home energy audits conducted during the calendar year 2023 to be exempt from these certification and program requirements.
Additional Notes
- The DOE website provides a list of qualified certification programs, which are the only programs authorized to certify home energy auditors.
- The National Renewable Energy Laboratory (NREL) offers resources such as the Single-Family and Multifamily Energy Auditor Job Task Analysis, which are key to understanding the qualifications required for auditors.
Documentation Requirements
To claim the home energy audit credit, the taxpayer must submit the required documentation with their return. This includes:
- The certified home energy auditor’s signed report.
- Any other information required by the IRS for Form 5695 (Residential Energy Credits).
The taxpayer must retain the signed report from the certified auditor as part of their tax records. Failure to include any required information will be considered a mathematical or clerical error by the IRS, potentially disqualifying the credit.
Operation of the Energy Efficiency Home Improvement Credit
The energy efficiency home improvement credit is a nonrefundable personal credit, which means it can be used to offset regular tax liability (after any foreign tax credits are applied) and alternative minimum tax (AMT) liability. However, if the credit amount exceeds the taxpayer’s federal tax liability, the excess is not refunded or carried forward to future years and is lost.
Compliance Note
The instructions for Form 5695 include a worksheet to help taxpayers calculate the nonrefundable personal credit limit.
The credit also reduces any increase in the taxpayer’s basis in the property that would normally occur due to the qualified expense.
Amount of Qualified Expense
Sales tax is generally included in the total cost of qualified property for the credit because it is part of the amount paid by the taxpayer. If the property is financed through the seller, the credit is based on the full cost of the property that the taxpayer is contractually obligated to pay. However, the credit does not include interest payments, origination fees, or any additional charges such as extended warranties.
The credit cannot be claimed for any amounts covered by subsidized energy financing from federal, state, or local programs, including subsidies, rebates, or other incentives.
Multiple Residences and Taxpayers
Taxpayers can claim the credit for expenditures on more than one dwelling unit, with each unit’s credit computed separately. The credit limits discussed earlier apply individually for each taxpayer.
For cooperative housing corporations (CHCs), an individual tenant-shareholder is considered to have paid a proportionate share of the CHC’s qualifying expenses based on their stock ownership. Non-individual tenant-stockholders are not eligible for the credit.
Similarly, condominium owners who are part of the management association are treated as having paid a proportionate share of the association’s expenses. The proportionate share may be calculated using methods determined by the association’s governing body, including using state law, the association’s governing documents, or the square footage of common elements in the condominium. The governing body must maintain consistency in determining these shares, keep appropriate records, and notify owners of their allocable share and the identification numbers for any specified property.
For dwelling units shared by two or more taxpayers who are not married, each individual is allocated the amount of the credit corresponding to their qualified expenses. If the total credit for all occupants exceeds the allowable limit, each taxpayer must determine their share based on the proportion of expenses they personally paid. This is calculated by multiplying the applicable credit limit by a fraction: the numerator is the amount the occupant paid, and the denominator is the total amount paid by all occupants.
Married Taxpayers
Married taxpayers who live in separate principal residences can each claim the credit individually, with the credit limits applying separately to each spouse.
If a married couple resides separately and files separate returns, each spouse completes their own Form 5695. For couples who live separately but file a joint return, the Form 5695 instructions provide guidance on how to properly report the credit.
Compliance Note
For married couples who live separately but file jointly, detailed instructions are provided in the Form 5695 guide for how the credit should be reported.
Conclusion
Disclaimer: This article provides general information about the energy-efficient home improvement credit and its requirements. It is not intended as tax advice. Taxpayers should consult with a qualified tax professional or refer to IRS guidelines for specific advice regarding their individual circumstances.
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