2021 Form 5695 Instructions for Residential Energy Credits

Homeowners who make specific energy-efficient improvements to their properties can reduce their tax bill by claiming residential energy credits. The Internal Revenue Service (IRS) requires using Form 5695, Residential Energy Credits, to calculate these tax benefits. This form covers two separate credits, each with distinct rules and qualifying expenditures.

Qualifying Improvements for Residential Energy Credits

Energy Efficient Home Improvement Credit

The Energy Efficient Home Improvement Credit is for improvements made to a taxpayer’s main home. Qualifying property includes items that improve the thermal envelope of the residence, such as insulation materials, specific exterior doors, and exterior windows and skylights that meet energy efficiency standards.

This credit also applies to high-efficiency heating, ventilation, and air conditioning (HVAC) systems, including qualified heat pumps, biomass stoves, and boilers. These improvements must be placed in service in an existing home that serves as the taxpayer’s principal residence.

Residential Clean Energy Credit

The Residential Clean Energy Credit targets larger-scale renewable energy installations. Eligible equipment includes:

• Qualified solar electric property to generate electricity.
• Qualified solar water heaters, provided at least half of the energy used is from the sun.
• Geothermal heat pumps that meet federal Energy Star program requirements.
• Small wind energy property that uses a wind turbine to generate electricity.
• Qualified fuel cell property.

These improvements can be made to a new or existing home that you use as a residence.

Required Information and Documentation

Cost Basis

Taxpayers must determine the cost basis for their improvements, as rules differ between the credits. For the Energy Efficient Home Improvement Credit, the treatment of labor costs varies. For building envelope improvements like windows and doors, only the material cost is eligible. For equipment like heat pumps and boilers, the installation cost is included.

In contrast, the Residential Clean Energy Credit is more expansive. For items like solar panels or geothermal heat pumps, the calculation includes the equipment cost plus expenses for site preparation and installation. Sales tax paid on eligible expenses can be included in the cost basis for both credits.

Manufacturer’s Certification Statement

For many improvements under the Energy Efficient Home Improvement Credit, taxpayers need a manufacturer’s certification statement. This is a signed document from the manufacturer attesting that the item meets the energy efficiency requirements for the tax credit. Taxpayers must keep this document for their records.

Calculating the Credits and Completing Form 5695

Part I – Residential Clean Energy Credit

Part I of Form 5695 calculates the Residential Clean Energy Credit. For property placed in service from 2022 through 2032, the credit is 30% of the total qualified costs, including materials and installation. Taxpayers enter the costs for each property type, add them together, and multiply the total by 0.30 to find the credit amount.

For example, a $20,000 solar panel installation generates a $6,000 credit. This part of the form also accounts for any credit carried forward from a prior year. The rate will decrease to 26% in 2033 and 22% in 2034.

Part II – Energy Efficient Home Improvement Credit

Part II calculates the Energy Efficient Home Improvement Credit, which involves multiple limits. The credit is 30% of the cost of qualified improvements but is subject to an overall annual limit of $1,200.

There are also specific annual limits for certain property types. The credit for all exterior windows and skylights is capped at $600 per year, and the credit for exterior doors is capped at $500. A separate, higher annual limit of $2,000 applies to qualified heat pumps, biomass stoves, and boilers.

Credit Limitation

The totals from both parts of the form are combined to determine the total potential residential energy credit. This amount may be limited by the individual’s overall tax liability, which is calculated using a worksheet in the form’s instructions.

The final credit is nonrefundable, meaning it can reduce tax liability to zero, but no portion is paid out as a refund. If the credit is larger than the tax liability, the unused portion of the Residential Clean Energy Credit can be carried forward to the next tax year; the Energy Efficient Home Improvement Credit cannot.

Filing and Record Keeping

The final credit amount from Form 5695 is transferred to Schedule 3 (Form 1040), Additional Credits and Payments. To formally claim the credit, the completed Form 5695 must be attached to your Form 1040 or Form 1040-SR when you file your annual tax return.

After filing, you must maintain records to substantiate your claim in the event of an IRS inquiry or audit. You should keep a copy of your filed tax return and all supporting documentation for several years. This includes purchase receipts, invoices detailing labor and material costs, and the signed Manufacturer’s Certification Statements. These certification statements are for your records and are not submitted with your tax return.