Claiming the Credit for Residential Energy-Efficient Property

Editor: Albert B. Ellentuck, Esq.

Taxpayers can claim a residential energy-efficient property (REEP) tax credit for 30% of the cost of eligible solar water heaters, solar electricity property, fuel cell property, small wind energy property, and geothermal heat pump property (Sec. 25D).

Through Dec. 31, 2016, an individual taxpayer will be allowed a tax credit in an amount equal to the sum of (Sec. 25D):

1. 30% of the qualified solar electric property expenditures made by the taxpayer during the tax year;
2. 30% of the qualified solar water heating property expenditures made by the taxpayer during the tax year;
3. 30% of the qualified fuel cell property expenditures made by the taxpayer during the tax year;
4. 30% of the qualified small wind energy property expenditures made by the taxpayer during the tax year; and
5. 30% of the qualified geothermal heat pump property expenditures made by the taxpayer during the tax year.

Credit Limitations

The credit allowed for any tax year with respect to qualified fuel cell property cannot exceed $500 with respect to each half kilowatt of capacity of qualified fuel cell property (as defined in Sec. 48(c)(1)) for which qualified fuel cell property expenditures are made. However, no credit will be allowed unless the property is certified for performance by the nonprofit Solar Rating Certification Corp. or a comparable entity endorsed by the state in which the property is installed (Sec. 25D(b)(2)).

Tax Liability Limitation and Carryover of Unused Credit

The REEP credit is a nonrefundable personal credit. The total amount of nonrefundable personal credits cannot exceed the sum of (1) the taxpayer’s regular tax liability, reduced by any foreign tax credit allowable, and (2) alternative minimum tax (AMT) for the tax year (Sec. 26(a)). This means that the credit can be used to offset both regular tax and AMT. When the credit exceeds this limitation, the excess can be carried forward to the succeeding tax year (Sec. 25D(c)).

Qualified Expenditures

For the residential energy-efficient property credit, qualified expenditures include the following (Sec. 25D(d)):

1. A qualified solar water heating property expenditure for property to heat water for use in a dwelling unit located in the United States and used as a residence by the taxpayer, if at least half of the energy used by the property for that purpose is derived from the sun. To qualify for the credit, this expenditure must be properly certified by an entity endorsed by the government of the state in which the property is installed.
2. A qualified solar electric property expenditure for property that uses solar energy to generate electricity for use in a dwelling unit located in the United States and used as a residence by the taxpayer.
3. A qualified fuel cell property expenditure for qualified fuel cell property (as defined in Sec. 48(c)(1)) installed on or in connection with a dwelling unit located in the United States and used as a principal residence (within the meaning of Sec. 121; vacation and rental homes do not qualify) by the taxpayer.
4. A qualified small wind energy property expenditure for property that uses a wind turbine to generate electricity for use in connection with a dwelling unit located in the United States and used as a residence by the taxpayer.
5. A qualified geothermal heat pump property expenditure for qualified geothermal heat pump property installed on or in connection with a dwelling unit located in the United States and used as a residence by the taxpayer. Qualified geothermal heat pump property includes any equipment that uses the ground or groundwater as a thermal energy source to heat the dwelling unit or as a thermal sink to cool the dwelling unit. To qualify for the credit, this expenditure must meet the Energy Star program requirements in effect at the time the expenditure is made. (For more on geothermal heat pump property expenditures, see Pinneau and Windram, “How to Claim the Residential Energy-Efficient Property Credit for Geothermal Heat Pump Property,” 46 The Tax Adviser (April 2015).)

Note: The Sec. 121 principal residence requirement does not exist for qualified solar water heating, solar electric, small wind energy, or geothermal heat pump expenditures (only the term residence is used). Practitioners should be alert for additional regulatory guidance to determine whether expenditures for qualified property installed in a vacation (or second) home used by the taxpayer will qualify for the credit. The instructions to Form 5695, Residential Energy Credits, indicate that if a taxpayer and spouse own and live apart in separate homes, the credit limits will apply to each spouse separately.

Expenditures for labor costs properly allocable to the on-site preparation, assembly, or original installation of qualified property and for piping or wiring to interconnect the property to the dwelling unit will also qualify for the credit (Sec. 25D(e)(1)).

Expenditures that are properly allocable to a swimming pool, hot tub, or any other energy storage medium that has a function other than the function of such storage do not qualify for the credit (Sec. 25D(e)(3)).

An expenditure is treated as made when the original installation of the item is completed (Sec. 25D(e)(8)(A)). An expenditure in connection with the construction or reconstruction of a structure is treated as made when the original use of the constructed or reconstructed structure by the taxpayer begins (Sec. 25D(e)(8)(B)).

Joint Occupancy

In the case of any dwelling unit that is jointly occupied and used during any calendar year as a residence by two or more individuals, the maximum amount of qualified fuel cell property expenditures that may be taken into account by all those individuals with respect to the dwelling unit during that calendar year will be $1,667 in the case of each half kilowatt of capacity of qualified fuel cell property (as defined in Sec. 48(c)(1)) for which qualified fuel cell property expenditures are made (Sec. 25D(e)(4)).

The qualified fuel cell expenditures allocated to any individual in a joint occupancy situation for the tax year in which that calendar year ends shall be an amount equal to the lesser of:

1. The amount of the expenditures made by such individual with respect to the dwelling unit during that calendar year; or
2. The maximum allowable amount of the expenditures (described above) multiplied by a fraction (a) the numerator of which is the amount of such expenditures with respect to such dwelling made by the individual during that calendar year, and (b) the denominator of which is the total of the expenditures made by all those individuals with respect to the dwelling during that calendar year.

Cooperative Housing and Condominiums

An individual who is a tenant-stockholder (as defined in Sec. 216) in a cooperative housing corporation will be treated as having made his or her tenant-stockholder’s proportionate share (as defined in Sec. 216(b)(3)) of any expenditures, for purposes of calculating the credit, of that corporation (Sec. 25D(e)(5)).

An individual who is a member of a condominium management association with respect to a condominium that the individual owns will be treated as having made the individual’s proportionate share of any expenditures, for purposes of calculating the credit, of that association (Sec. 25D(e)(6)(A)).

Allocation of Expenditures

If less than 80% of the use of an item is for nonbusiness purposes, only that portion of the expenditures for the item that is properly allocable to use for nonbusiness purposes shall be taken into account (Sec. 25D(e)(7)).

Example: C spends $5,000 to install solar panels to generate electricity for the building in which he lives. Fifty percent of the electricity is used for his dwelling unit and the other 50% for an office he maintains in the building. Since only 50% of the qualified expenditure is used for nonbusiness purposes, the credit is $750 ($5,000 × 50% × 30%).

Variation: If C only used 15% of his building for his business, he would be eligible for the full credit of $1,500 ($5,000 × 30%).

Basis Adjustments

If a credit is allowed, the increase in the basis of the property that would result from the expenditure is reduced by the amount of the credit allowed (Sec. 25D(f)).   

This case study has been adapted from PPC’s Guide to Tax Planning for High Income Individuals, 16th Edition, by Anthony J. DeChellis and Patrick L. Young, published by Thomson Reuters/Tax & Accounting, Carrollton, Texas, 2015 (800-431-9025; tax.thomsonreuters.com).