Guide to the Energy Efficient Home Improvement Tax Credit

The Energy Efficient Home Improvement Credit (EEHIC) gives taxpayers a federal tax credit worth up to 30% of the cost of home energy efficiency improvements.

There are several different federal tax incentive programs for renewable energy and energy efficiency, including the Investment Tax Credit for solar panels and wind energy, and the clean vehicle credit for electric vehicles. The EEHIC covers a broad range of energy efficiency-related upgrades, including heating and cooling equipment, hot water heaters, insulation, air sealing, energy efficient doors and windows, and home energy audits.

Because it’s a federal tax credit, you’ll need to fill out the appropriate form when it comes time to file. I know that filling out your tax return can be stressful and annoying, but the paperwork required for this tax credit is quite simple. The IRS is obviously the authoritative source for information, but the goal of this article is to give you the basics in simple terms.

What is the Energy Efficient Home Improvement Credit?

The EEHIC gives taxpayers a 30% tax credit on the energy efficiency-related home upgrades listed later in this article.

This means that to calculate the size of your credit, take the cost of the upgrade and multiply by 30%. (Labor costs can not always be included: read more about that later.)

This is not a rebate, but a tax credit used to reduce the federal taxes that you owe. This means that you deduct the value of the credit from your federal taxes owed. If the credit is larger than your federal taxes, you won’t be able to use all of the credit that year.

Let’s say that you did a $1,000 qualifying upgrade to your home. The tax credit is worth 30%, so your EEHIC would be $300. You would deduct that $300 from the federal tax you owe. However, let’s say that you only owe $250 in federal taxes. You would be able to use a maximum of $250 of your credit to reduce your taxes to $0, and you would have $50 in credit left over.

Unused EEHIC tax credit can be carried forward to the next year

If your EEHIC tax credit is more than the taxes you owe that year, you can fortunately take the leftover credit and use it next year. This is referred to as credit carryforward by the IRS, and in the 2023 IRS Form it’s referred to on lines 12 and 16.

This might be useful for people who may have a lower federal tax burden, such as retired and lower income households.

Which IRS Form do you need to claim this credit?

The form you need to claim the Energy Efficient Home Improvement Credit is IRS Form 5695. It’s called the Residential Energy Credits form, and it’s also the same form to claim a tax credit for solar panels, wind turbines, geothermal heat pumps, and home battery storage. The EEHIC is claimed in Part II of the form, starting on page 2.

Here is the link to the IRS website that has the instructions and Form 5695 in PDF format:

About Form 5695, Residential Energy Credits (IRS.gov)

What are qualified expenses under the energy efficiency tax credit?

There are two categories of upgrades that qualify for the EEHIC. The first is energy efficiency improvements, which are called Qualified Energy Efficiency Improvements. The second is efficient heating and cooling equipment, which the IRS calls Residential Energy Property Expenditures.

The full list of qualifying upgrades is listed below.

Eligible Qualified Energy Efficiency Improvements

When you fill out the two-page part of the IRS form to claim this tax credit, you’ll see that it’s divided into two sections. The first is Section A, which is for Qualified Energy Efficiency Improvements. This is for projects that improve the “building envelope” of your home, which includes insulation and air sealing materials, and ENERGY STAR doors and skylights.

Here’s the list of eligible upgrades and the maximum tax credit you can claim for each.

What is the IECC standard for insulation?

The insulation requirements refer to a standard established by the International Energy Conservation Code. The IECC standard sets out recommended insulation levels for homes according to the climate zone¹. Climate zones number from 1 to 8, where Zone 1 is hot and humid and Zone 8 is Subarctic and Arctic. There are also subcategories for marine, dry, and moist climates. Here’s a climate zone map of the United States:

The recommendations below are for retrofit installations (which means upgrading an existing home). New homes should be built to a good insulation standard, so the tax credit is intended to encourage owners of older homes to upgrade their insulation to a modern standard. The specifications below are the most recent IECC standard set in 2021.

Here are the recommended insulation levels for attics and floors:

“Floor” refers to a slab-on-grade floor, which is a slab of concrete on top of the ground. A lot of heat loss can occur through the bottom floor of a home, which can be reduced by adding a layer of rigid foam insulation, such as expanded polystyrene (EPS) or extruded polystyrene (XPS).

The recommendations for wall insulation depends on whether there is existing insulation in the wall, or the wall cavity is empty. If there’s no insulation in the wall, cellulose insulation can be blown in for a vast improvement in R-value.

Explanation about wall insulation

It’s more complicated and can be expensive to upgrade an existing home to the recommended insulation standard than it is to meet those standards when the house is newly built, which is why this tax credit exists.

There are three types of insulation mentioned in IECC standard, and they have different applications.

Rigid insulation, also known as foam board insulation, is useful for adding insulation to a wall when you can’t upgrade the insulation inside the wall cavity. It can be added underneath exterior siding or on the interior of an existing wall. As a practical matter, you would only add it to the interior of an existing wall in a utility-oriented space such as a basement or crawl space. That recommendation is reflected in the table above.

Batt insulation is the common “pink stuff” that you might be familiar with – fiberglass batts that are placed inside an open wall cavity. In a retrofit, this would only be an option if you are doing a renovation that requires opening up your walls.

Finally, blow-in cellulose insulation is an excellent choice for attics and empty wall cavities. If your walls have no insulation at all, blow-in insulation is added by drilling into each wall cavity a hole that is large enough to accommodate the small hose use.

ENERGY STAR doors, windows, and skylights

Energy efficient doors and double- and triple-glazed windows can significantly reduce heat loss compared to older doors and windows. For example, a triple-glazed window with advanced low-emissivity (low-E) coatings can have 6 times or less heat loss compared to a single-pane window.

ENERGY STAR is a federal certification that a product meets strict energy efficiency guidelines set by the US Environmental Protection Agency (EPA). This certification makes it easy for consumers: just look for the blue ENERGY STAR logo.

Unlike insulation where energy efficiency is measured in R-value (and higher R-values mean better insulating value), the insulating value of doors and windows is measured as U-factor. Lower U-factor values mean less heat loss.

The ENERGY STAR certification for windows is also based on solar heat gain coefficient (SHGC), which is the resistance of the glass to allowing infrared (heat) radiation pass through. Low solar heat gain is good in hot climates because it reduces the greenhouse effect of windows and helps to keep your home cooler.

Similar to the IECC standard for insulation, the ENERGY STAR standard for doors and windows is based on climate zone. You can simply look for the blue logo, but if you are interested in the details the minimum U-factor and SHGC specifications are published on the energystar.gov website².

Central air conditioner, water heater, furnace, boiler, and electric panel tax credits

Section B of the IRS form covers Residential Energy Property Expenditures, which includes heat pumps, central air conditioners, furnaces and boilers, electric panel upgrades, and biomass (wood) stoves. You can take 30% off the total cost of the upgrade. Home energy audits can also receive a credit for the full cost up to $150.

Each of the following upgrades have a $600 limit per item:

• Central air conditioner
• Natural gas, propane, or oil water heater
• Natural gas, propane, or oil furnace or hot water boiler

If you need an electric panel upgrade to support one of these upgrades, you can take a tax credit on it, also up to a maximum of $600.

Finally, you can take a tax credit on the full cost of a home energy audit (ie. not just 30%) up to $150.

Out of the above upgrades, you could take multiple tax credits in the same year – say, an air conditioner and a water heater for $600 each – up to a total of $1,200.

Heat pump and biomass (wood) heater tax credits

Under Section B, you can also claim tax credits for heat pumps and biomass heaters. Biomass in this context means organic matter that is burned for heat. While a variety of biomass made be used in industrial settings, for home heating biomass really just means wood and wood pellets.

There are three types of heating-related equipment eligible:

• Heat pumps for space heating and cooling
• Heat pump hot water heaters
• Biomass (wood) fireplaces, stoves, and boilers

Heat pumps are a main focus of this website, so I’ve already written about the tax credit for heat pumps, including understanding the minimum efficiency ratings (SEER2 and HSFP2) needed. You can learn all this in detail in my article Heat pump federal tax credits: everything you need to know.

Heat pump hot water heaters, also known as hybrid hot water heaters, use electric heat pumps instead of natural gas or electric resistance heating to create hot water for your home. They look much like a conventional hot water tank, but have a small heat pump mounted on top. You can read more about hybrid hot water heaters in my article.

Finally, high efficiency wood and wood pellet stoves are eligible for the credit as well. High efficiency wood stoves, in contrast to older fireplaces, use technology such as catalytic converters and a secondary chamber that burns waste gases that would otherwise escape as dirty particulates into the air.

Any of combination of this equipment is eligible for a 30% credit, up to a maximum of $2,000 per year.

Energy efficiency requirements for the Residential Energy Property Expenditures

All of the eligible equipment have energy efficiency requirements that must be met to qualify for the tax credit.

AFUE is annual fuel utilization efficiency, which is the thermal efficiency of the equipment as a percentage of the heat energy in the fuel. For example, a natural gas furnace with an AFUE rating of 95% is able to capture 95% of the energy created by burning gas to heat your home. The remaining 5% of the heat is lost up the flue. Modern high efficiency furnaces are extremely efficient compared to older models: the best furnaces have an AFUE rating of 99%.

Wood stoves and fireplaces also have efficiency ratings. An ordinary fireplace might be only around 15% efficient, but high efficiency models can be more than five times better. Look for an efficiency rating of 75% or better to qualify for the credit. Note that EPA ratings for fireplaces relate to particulate matter emissions rather than efficiency. This means that it’s possible to find a wood fireplace that is EPA rated but has an efficiency less than 75%, which would not qualify for the credit, so be sure to read the product specifications carefully.

Can you claim installation labor costs?

Labor costs are eligible for the residential energy property expenditures (for heat pumps, furnaces, and wood stove) but not for home energy efficiency upgrades.

This means that if you install insulation, air sealing, doors, windows, or skylights in your home, you can only claim a credit for the cost of the product, and not the labor cost to have it installed.

Bottom line: the EEHIC is a great way to save money on making your home more efficient and comfortable

Adding up the tax credits in Section A and B, a homeowner can take up to $3,200 in energy efficiency tax credits in a year. That’s a huge financial incentive.

If you have an old furnace, this credit can make a big difference in choosing to upgrade sooner or to spend a little more money to get ENERGY STAR rated equipment.

Heat pumps in particular are an upgrade that is growing in popularity because they are replace both a central air conditioner and a furnace, while also reducing potential furnace safety hazards like carbon monoxide poisoning. To learn more about heat pumps, you can explore the other articles I’ve written.

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