Understanding IRS sections 25C and 25D for energy-efficient home improvements and residential clean energy credits

Internal Revenue Code sections 25C and 25D offer homeowners valuable insights into maximizing tax savings through energy-efficient home improvements. The eligibility criteria and filing procedures can be complex, but they empower homeowners to make informed decisions and leverage available incentives to reduce their tax burden while contributing to a more sustainable future.

IRC Section 25C

The Energy Efficient Home Improvement Credit (EEHIC) outlined in IRC section 25C provides homeowners with a tax credit for making energy-efficient upgrades to their homes. This federal tax credit grants individuals the ability to deduct 30% of expenses related to qualified energy efficiency improvements, residential energy property expenditures and home energy audits from their taxes.

The credit is capped at $1,200 annually for all qualifying expenses combined. However, for specific high-efficiency items such as heat pumps, biomass stoves and boilers, a higher cap of $2,000 is applicable. Specific expenditure caps include $600 for windows and skylights, $500 for all exterior doors collectively, and $150 for home energy audits. These amounts reflect the maximum that can be claimed for each category within the overall annual limit.

To qualify, improvements must be made to the taxpayer's principal residence within the U.S., and they must meet specified energy efficiency standards. Consequently, landlords are unable to utilize this credit for properties that they rent out. Rebates or subsidies that reduce the purchase price of these systems must be deducted from the total eligible expenses. This credit is nonrefundable, meaning it can only reduce a taxpayer's obligation to zero and cannot result in a refund.

Further, properties used exclusively for business purposes are not eligible for the credit. However, if a home is used partly for business, the eligibility for the credit adjusts based on the extent of business use. Homeowners can claim the full credit for eligible clean energy expenses if the business use of the home does not exceed 20%. If business use exceeds 20%, the credit amount that can be claimed must be proportionally allocated based on the percentage of expenses attributable to non-business use. Also, newly constructed homes are ineligible for this credit.

This credit is scheduled to remain available through Dec. 31, 2032.

Eligibility under Section 25C

Eligible improvements include the installation of exterior doors, windows, skylights and insulation materials or systems, all of which must meet specific energy efficiency requirements. Homeowners can claim 30% of these costs, with caps of $250 per door (up to $500 total for all doors), $600 for windows and skylights, and no specific cap mentioned for insulation and air sealing, provided these are compliant with the defined standards.

Additionally, the credit covers 30% of the cost for home energy audits, up to $150, allowing homeowners to evaluate their energy usage. Residential energy property that qualifies for the credit includes central air conditioners and natural gas, propane or oil water heaters and furnaces, as well as certain electrical system upgrades like panelboards and feeders essential for installing energy-efficient systems, with a limit of $600 for each item.

Moreover, heat pumps, including electric or natural gas heat pump water heaters, and biomass stoves and boilers, are also eligible. These items must also adhere to specified energy efficiency standards and allow for a credit of 30% of the total cost, including installation.

Section 25C energy efficiency requirements

As aforementioned, to be eligible for the EEHIC, specified energy efficiency standards must be met. Exterior doors and windows, including skylights, are required to meet applicable Energy Star requirements. Insulation materials or systems, along with air sealing materials or systems, must conform to the International Energy Conservation Code (IECC) standards that were effective at the start of the year, two years prior to their installation.

For heating and cooling equipment such as electric or natural gas heat pumps, heat pump water heaters, central air conditioners, and natural gas, propane, or oil water heaters, furnaces, and hot water boilers, the equipment must meet or exceed the highest efficiency tier set by the Consortium for Energy Efficiency (CEE) in effect at the beginning of the year of installation. Details and listings of qualifying equipment can be found in the CEE Directory of Efficient Equipment.

Oil furnaces or hot water boilers qualify either by meeting or exceeding 2021 Energy Star efficiency criteria and being rated for use with fuel blends that consist of at least 20% of an eligible fuel, or, if installed after Dec. 31, 2026, achieving an annual fuel efficiency rate of not less than 90 and being rated for use with fuel blends of at least 50% of an eligible fuel. Biomass stoves or boilers are required to have a thermal efficiency rating of at least 75%, measured by the higher heating value of the fuel.

Additionally, panelboards, sub-panelboards, branch circuits or feeders must be installed according to the National Electric Code and have a load capacity of 200 amps or greater.

Labor costs for section 25C

Labor costs associated with the onsite preparation, assembly or original installation of residential energy property such as central air conditioners, water heaters, furnaces, heat pumps, biomass stoves, boilers and electrical system upgrades can be included in the credit calculation. However, labor costs for the installation of energy efficient building envelope components like insulation, windows, skylights and doors cannot be included. For these components, if a fixed price is paid, taxpayers must make a reasonable allocation between the qualifying cost of the property and the non-qualifying labor costs.

Notice 2024-19

On April 5, 2024, the Department of Treasury and the Internal Revenue Service issued Announcement 2024-19, which delineated the federal income tax treatment for costs incurred in purchasing and improving energy-efficient properties. This announcement also covers the tax implications of the Home Energy Rebate Programs established under the Inflation Reduction Act (IRA).

Rebates received by homeowners under these programs are not included in taxable income, as they are treated as adjustments to the purchase prices of the energy-efficient installations or improvements, consistent with historical IRS rulings. If a rebate is received post-purchase, it must be reflected as an adjustment to the property's cost basis, thereby reducing the basis by the amount of the rebate.

For business taxpayers, such as contractors who receive payments from these rebates for the provision of goods or services, these payments must be included in their gross income and are subject to the usual tax reporting requirements, contingent upon meeting specific income thresholds. Additionally, there is a requirement to coordinate with the section 25C tax credit; taxpayers must deduct the amount of any rebate received from their qualified expenditures when calculating eligible tax credits for energy-efficient home improvements to prevent double benefit claims.

Timing and filing

Section 25C stipulates that taxpayers can only claim the credit in the year when the qualifying improvements are installed. Purchases of items like exterior doors or insulation cannot be claimed until they are installed, regardless of the purchase date. Moreover, the installed components must be expected to remain in use for a minimum of five years. There is no lifetime limit on this credit, allowing taxpayers to claim it annually for qualifying improvements. However, if the credit amount exceeds the taxpayer's liability in a given year, the excess cannot be carried forward to future tax years. To claim the credit, taxpayers must file Form 5695, Residential Energy Credits Part II, with their tax return, ensuring they do so in the year the improvements are installed.

IRC section 25D

The Residential Clean Energy Credit (RCEC) as described in IRC section 25D provides a federal tax credit for homeowners who make qualifying clean energy upgrades to their residences. This credit allows individuals to deduct specific percentages of expenses related to the installation of clean energy systems, including solar, wind, geothermal and certain battery storage technologies. Homeowners can claim a tax credit equal to 30% of the costs for systems installed from 2021 to 2032, with a gradual step-down in credit value planned for installations made through 2034.

There are specific limitations within the credit structure. For example, the credit for fuel cell installations is capped at $500 per half kilowatt of capacity. Additionally, solar water heating systems must be certified for performance by an endorsed entity like the Solar Rating Certification Corporation.

Unused portions of the credit can be carried forward to subsequent tax years, which is beneficial for taxpayers who might exceed the credit cap in a single year. The credit applies only to expenses on properties located in the U.S. that are used as a residence by the taxpayer.

Expenditures related to swimming pools, hot tubs or other energy storage mediums not directly linked to the clean energy systems are not eligible. Furthermore, expenditures are generally considered to be made when the installation is complete, or in the case of new construction, when the taxpayer first uses the structure.

This credit is scheduled to phase out by the end of 2034, with the credit rate decreasing after 2032.

Eligibility under section 25D

The RCEC allows homeowners to claim a 30% credit on costs associated with various clean energy installations. Eligible expenditures include solar electric property expenditures such as solar panels, solar water heating property expenditures including solar water heaters, as well as costs related to fuel cell properties. Additionally, small wind energy property expenditures like wind turbines, geothermal heat pump property expenditures, and battery storage technology expenditures are also covered under this credit.

Section 25D energy efficiency requirements

Similar to the EEHIC, the RCEC must abide by energy efficiency requirements. Solar water heating systems are required to be certified for performance by the non-profit Solar Rating Certification Corporation or another entity endorsed by the state government where the property is installed. Geothermal heat pump systems must adhere to the current Energy Star program requirements at the time of purchase. Additionally, battery storage technology included in this credit must have a minimum capacity of three kilowatt-hours. However, while traditional roofing materials and structural components are generally not eligible, solar roofing tiles and shingles that also function as solar electric collectors do qualify for the credit.

Labor costs for section 25D

Taxpayers are permitted to include labor costs that are properly associated with the onsite preparation, assembly or original installation of the qualified property. This also extends to the costs of piping or wiring necessary to connect the qualifying property to the home.

Timing and filing

A taxpayer may not claim the credits until the year the property is installed. To claim the RCEC, taxpayers must file Form 5695, Residential Energy Credits Part I, alongside their tax return in the year the improvements are installed. Additionally, if the credit amount exceeds the taxpayer's liability in that year, the unused portion of the credit can be carried forward to reduce tax liability in future tax years.

Miscellaneous guidelines

When claiming the EEHIC and RCEC, there are specific considerations that impact eligibility and the practical application of the credit. Firstly, the property installed must be new; used property does not qualify for the credit. Secondly, as aforementioned, the credits are nonrefundable, meaning they can only reduce the taxpayer's owed federal income tax to zero for the year they are claimed. If the credit amount exceeds the taxpayer’s tax liability, the excess amount cannot be refunded or carried forward to future tax years.

Additionally, taxpayers who are subject to the Alternative Minimum Tax (AMT) are still eligible to claim these credits. The credits can offset both regular tax and AMT, broadening their applicability. Regarding subsidies, if a taxpayer receives a subsidy from a government or public utility for the purchase or installation of qualifying energy-efficient property, the amount of the subsidy must be subtracted from the cost of the property when calculating the credit. This adjustment ensures that the credit is only applied to the actual amount invested by the taxpayer. Finally, for a home energy audit to qualify for the credit, it must include a thorough inspection and a written report detailing significant and cost-effective improvements. The auditor must meet specific requirements set by the IRS.

Contact our specialists today to learn more about ensuring your eligibility.

The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.