[Code of Federal Regulations]
[Title 26, Volume 1]
[Revised as of April 1, 2003]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.23-2]

[Page 38-45]
 
                       TITLE 26--INTERNAL REVENUE
 
     CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY
 
PART 1--INCOME TAXES--Table of Contents
 
Sec. 1.23-2  Definitions.

    For purposes of section 23 or former section 44C and regulations 
thereunder--
    (a) Energy conservation expenditures--(1) In general. The term 
``energy conservation expenditure'' means an expenditure made on or 
after April 20, 1977, and before January 1, 1986, by a taxpayer for 
insulation or any other energy-conserving component, or for labor costs 
allocable to the original installation of such insulation or other 
component, if all of the following conditions are satisfied:
    (i) The insulation (as defined in paragraph (c)) or other energy-
conserving component (as defined in paragraph (d)) is installed in or on 
a dwelling unit that is used as the taxpayer's principal residence when 
the installation is completed. See Sec. 1.23-3(e) for the definition of 
principal residence.

[[Page 39]]

    (ii) The dwelling unit is located in the United States (as defined 
in section 7701(a)(9)).
    (iii) The construction of the dwelling unit was substantially 
completed before April 20, 1977. See Sec. 1.23-3(f) for the definition 
of the terms ``construction'' and ``substantially completed''. In the 
case of expenditures made with respect to the enlargement of a dwelling 
unit, the construction of the enlargement must have been substantially 
completed before April 20, 1977.
    (2) Examples. The application of this paragraph may be illustrated 
by the following examples:

    Example 1. In 1978, A spent $500 for the purchase and installation 
of new storm windows to replace old storm windows, $100 to reinstall old 
storm windows, and $150 to transfer a A's house insulation which had 
been installed in A's garage. Only the $500 spent for new storm windows 
qualifies as an energy conservation expenditure. The $100 spent to 
reinstall storm windows and the $150 spent to transfer insulation to A's 
house do not qualify since the only installation costs that qualify are 
those for the original installation of energy conservation property the 
original use of which commences with the taxpayer.
    Example 2. In June 1977, B purchased for B's principal residence a 
new house that was substantially completed before April 20, 1977. 
Pursuant to B's request the builder installed storm windows on May 1, 
1977, the cost of this option being included in the purchase price of 
the house. The portion of the purchase price of the residence allocable 
to the storm windows constitutes an energy conservation expenditure. 
However, no other part of the purchase price may be allocated to energy 
conservation property (insulation and other energy conserving 
components) installed before April 20, 1977. To qualify as an energy 
conservation expenditure, an expenditure must be made (i.e., 
installation of the energy conservation property must be completed) on 
or after April 20, 1977.

    (b) Renewable energy source expenditures. The term ``renewable 
energy source expenditures'' means an expenditure made on or after April 
20, 1977, and before January 1, 1986, by a taxpayer for renewable energy 
source property (as defined in paragraph (e)), or for labor costs 
properly allocable to the on-site preparation, assembly, or original 
installation such property, if both of the following conditions are 
satisfied:
    (1) The renewable energy source property is installed in connection 
with a dwelling unit that is used as the taxpayer's principal residence 
when the installation is completed. See Sec. 1.23-3(e).
    (2) The dwelling unit is located in the United States (as defined in 
section 7701(a)(9)).

Additionally, the term ``renewable energy source expenditures'' includes 
expenditures made after December 31, 1979, and before January 1, 1986, 
for an onsite well drilled for any geothermal deposit (as defined in 
paragraph (h)), or for labor costs properly allocable to onsite 
preparation, assembly, or original installation of such well, but only 
if the requirements of paragraphs (b) (1) and (2) of this section are 
met and the taxpayer has not elected under section 263(c) to deduct any 
portion of such expenditures or allocable labor costs.

Eligibility as a renewable energy source expenditure does not depend on 
the date of construction of the dwelling unit. Thus, such an expenditure 
may be made in connection with either a new or an existing dwelling 
unit. Renewable energy source expenditures need only be made in 
connection with a dwelling, rather than in or on a dwelling unit. For 
example, a solar collector that otherwise constitutes renewable energy 
source property is not ineligible merely because it is installed 
separately from the dwelling unit. The term ``renewable energy source 
expenditure'' does not include any expenditure allocable to a swimming 
pool even when used as an energy storage medium or to any other energy 
storage medium whose primary function is other than the storage of 
energy. It also does not include the cost of maintenance of an installed 
system or the cost of leasing renewable energy source property.
    (c) Insulation. The term ``insulation'' means any item that 
satisfies all of the following conditions:
    (1) The item is specifically and primarily designed to reduce, when 
installed in or on a dwelling or on a water heater, the heat loss or 
gain of such dwelling or water heater. To qualify as insulation the item 
must be installed between a conditioned area and a nonconditioned area 
(except when installed on a water heater, water pipe,

[[Page 40]]

or heating/cooling duct). Thus for example, awnings do not qualify as 
insulation. For purposes of this section the term ``conditioned area'' 
means an area that has been heated or cooled by conventional or 
renewable energy source means. Insulation includes materials made of 
fiberglass, rock wool, cellulose, urea based foam, urethane, 
vermiculite, perlite, polystyrene, and extruded polystyrene foam.
    (2) The original use of the item begins with the taxpayer.
    (3) The item can reasonably be expected to remain in operation at 
least 3 years.
    (4) The item meets the applicable performance and quality standards 
prescribed in Sec. 1.23-4 (if any) that are in effect at the time the 
taxpayer acquires the item. The term ``insulation'' shall not include 
items whose primary purpose is not insulation (e.g., whose function is 
primarily structural, decorative, or safety-related). For example, 
carpeting, drapes (including linings), shades, wood paneling, fireplace 
screens (including those made of glass), new or replacement walls 
(except for qualifying insulation therein) and exterior siding do not 
qualify although they may have been designed in part to have an 
insulating effect.
    (d) Other energy-conserving components. The term ``other energy-
conserving component'' means any item (other than insulation) that 
satisfies all of the following conditions:
    (1) The original use of the item begins with the taxpayer.
    (2) The item can reasonably be expected to remain in operation for 
at least 3 years.
    (3) The item meets the applicable performance and quality standards 
prescribed in Sec. 1.23-4 (if any) that are in effect at the time of the 
taxpayer's acquisition of the item.
    (4) The item is one of the following items:
    (i) A furnace replacement burner. The term ``furnace replacement 
burner'' means a device (for oil and gas-fired furnaces or boilers) that 
is designed to achieve a reduction in the amount of fuel consumed as a 
result of increased combustion efficiency. The burner must replace an 
existing burner. It does not qualify if it is acquired as a component 
of, or for use in, a new furnace or boiler.
    (ii) A device for modifying flue openings. The term ``device for 
modifying flue openings'' means an automatically operated damper that--
    (A) Is designed for installation in the flue, between the barometric 
damper or draft hood and the chimney, of a furnace; and
    (B) Conserves energy by substantially reducing the flow of 
conditioned air through the chimney when the furnace is not in 
operation. Conditioned air is air that has been heated or cooled by 
conventional or renewable energy source means.
    (iii) A furnace ignition system. The term ``furnace ignition 
system'' means an electrical or mechanical device, designed for 
installation in a gas-fired furnace or boiler that automatically ignites 
the gas burner. In order to qualify, the device must replace a gas pilot 
light. Furthermore, it does not qualify if it is acquired as a component 
of, or for use in, a new furnace or boiler.
    (iv) A storm or thermal window or door. The terms ``storm or thermal 
window'' and ``storm or thermal door'' mean the following:
    (A)(1) A window placed outside or inside an ordinary or prime 
window, creating an insulating air space.
    (2) A window with enhanced resistance to heat flow through the 
glazed area by multi-glazing.
    (3) A window that consists of glass or other glazing materials that 
have exceptional heat-absorbing or heat-reflecting properties. For 
purposes of this subdivision (iv), the term ``glazing material'' does 
not include films and coatings applied on the surface of a window.
    (B)(1) A second door, installed outside or inside a prime exterior 
door, creating an insulating air space.
    (2) A door with enhanced resistance to heat flow through the glazed 
area by multi-glazing.
    (3) A prime exterior door that has an R-value (a measurement of the 
ability of insulation to resist the flow of heat) of at least 2 
throughout.

For purposes of this subdivision, ``multi-glazing'' is an arrangement in 
which two or more sheets of glazing material are affixed in a window or

[[Page 41]]

door frame to create one or more insulating air spaces. Multi-glazing 
can be achieved by installing a preassembled, sealed insulating glass 
unit or by affixing one or more additional sheets of glazing onto an 
existing window (or sash) or door. For purposes of this subdivision, a 
storm or thermal window or door does not include any film applied on or 
over the surface of a window or door.
    (v) Automatic energy-saving setback thermostat. The term ``automatic 
energy-saving setback thermostat'' means a device that is designed to 
reduce energy consumption by regulating the demand on the heating or 
cooling system in which it is installed, and uses--
    (A) A temperature control device for interior spaces incorporating 
more than one temperature control level, and
    (B) A clock or other automatic mechanism for switching from one 
control level to another.
    (vi) Caulking and weatherstripping. The term ``caulking'' means 
pliable materials used to fill small gaps at fixed joints on buildings 
to reduce the passage of air and moisture. Caulking includes, but is not 
limited to, materials commonly known as ``sealants'', ``putty'', and 
``glazing compounds''. The term ``weatherstripping'' means narrow strips 
of material placed over or in movable joints of windows and doors to 
reduce the passage of air and moisture.
    (vii) Energy usage display meter. The term ``energy usage display 
meter'' means a device the sole purpose of which is to display the cost 
(in money) of energy usage in the dwelling. It may show cost information 
for electricity usage, gas usage, oil usage, or any combination thereof. 
The device may measure energy usage of the whole dwelling, or individual 
appliances or systems on an instantaneous or cumulative basis.
    (viii) Components specified by the Secretary. The Secretary (or his 
delegate) may, in his discretion, after consultation with the Secretary 
of Energy and the Secretary of Housing and Urban Development (or their 
delegates), and any other appropriate Federal officers, specify by 
regulation other energy-conserving components for addition to the list 
of qualified items. See Sec. 1.23-6 for the procedures and criteria to 
be used in determining whether an item will be considered for addition 
to the list of qualified items by the Secretary.

The term ``other energy-conserving component'' is limited to items in a 
category specifically listed in section 44(c)(4)(A) (i) through (vii) or 
added by the Secretary.
    (e) Renewable energy source property--(1) In general. The term 
``renewable energy source property'' includes any solar energy property, 
wind energy property, geothermal energy property, or property referred 
to in subparagraph (2), which meets the following conditions:
    (i) The original use of the property begins with the taxpayer.
    (ii) The property can reasonably be expected to remain in operation 
for at least 5 years.
    (iii) The property meets the applicable performance and quality 
standards prescribed in Sec. 1.23-4 (if any) that are in effect at the 
time of the taxpayer's acquisition of the property.

Renewable energy source property does not include heating or cooling 
systems, nor systems to provide hot water or electricity, which serve to 
supplement renewable energy source equipment in heating, cooling, or 
providing hot water or electricity to a dwelling unit, and which employ 
a form of energy (such as oil or gas) other than solar, wind, or 
geothermal energy (or other forms of renewable energy provided in 
paragraph (e)(2) of this section. Thus, heat pumps or oil or gas 
furnaces, used in connection with renewable energy source property, are 
not eligible for the credit. In order to be eligible for the credit for 
renewable energy source property, the property (as well as labor costs 
properly allocable to onsite preparation, assembly or installation of 
equipment) must be clearly identifiable. See Sec. 1.23-3(l) for 
recordkeeping rules.
    (2) Renewable energy source specified by the Secretary. In addition 
to solar, wind, and geothermal energy property, renewable energy source 
property includes property that transmits or uses another renewable 
energy source that the Secretary (or his delegate) specifies by 
regulations, after consultation with

[[Page 42]]

the Secretary of Energy and the Secretary of Housing and Urban 
Development (or their delegates), and any other appropriate Federal 
officers, to be of a kind that is appropriate for the purpose of heating 
or cooling the dwelling or providing hot water or (in the case of 
expenditures made after December 31, 1979) electricity for use within 
the dwelling. For purposes of this section, references to the 
transmission or use of energy include its collection and storage. See 
Sec. 1.23-6 for the procedures and criteria to be used in determining 
when another energy source will be considered for addition to the list 
of qualified renewable energy sources.
    (f) Solar energy property--(1) In general. The term ``solar energy 
property'' means equipment and materials of a solar energy system as 
defined in this paragraph (and parts solely related to the functioning 
of such equipment) which, when installed in connection with a dwelling, 
transmits or uses solar energy to heat or cool the dwelling or to 
provide hot water or (in the case of expenditures made after December 
31, 1979) electricity for use within the dwelling. For this purpose, 
solar energy is energy derived directly from sunlight (solar radiation). 
Property which uses, as an energy source, fuel or energy which is 
indirectly derived from sunlight (solar radiation), such as fossil fuel 
or wood or heat in underground water, is not considered solar energy 
property. Materials and components of ``passive solar systems'' as well 
as ``active solar systems'', or a combination of both types of systems 
may qualify as solar energy property.
    (2) Active solar system. An active solar system is based on the use 
of mechanically forced energy transfer, such as the use of fans or pumps 
to circulate solar generated energy, or thermal energy transfer, such as 
systems utilizing thermal siphon principles. Generally, this is 
accomplished through the use of equipment such as collectors (to absorb 
sunlight and create hot liquids or air), storage tanks (to store hot 
liquids), rockbeds (to store hot air), thermostats (to activate pumps or 
fans which circulate the hot liquids or air), and heat exchangers (to 
utilize hot liquids or air to heat air or water).
    (3) Passive solar system. A passive solar system is based on the use 
of conductive, convective, or radiant energy transfer. In order to 
qualify as a passive solar system, a solar system used for heating 
purposes must contain all of the following: a solar collection area, an 
absorber, a storage mass, a heat distribution method, and heat 
regulation devices. The term ``solar collection area'' means an expanse 
of transparent or translucent material, such as glass which is 
positioned in such a manner that the rays of the sun directly strike an 
absorber. The term ``absorber'' means a surface, such as a floor, that 
is exposed to the rays of the sun admitted through the solar collection 
area, which converts solar radiation into heat, and then transfers the 
heat to a storage mass. The term ``storage mass'' means material, such 
as masonry, that receives and holds heat from the absorber and later 
releases the heat to the interior of the dwelling. The storage mass must 
be of sufficient volume, depth, and thermal energy capacity to store and 
deliver adequate amounts of solar heat for the relative size of the 
dwelling. In addition, the storage mass must be located so that it is 
capable of distributing the stored heat directly to the habitable areas 
of the dwelling through a heat distribution method. The term ``heat 
distribution method'' means the release of radiant heating from the 
storage mass within the habitable areas of the dwelling, or convective 
heating from the storage mass through airflow paths provided by openings 
or by ducts in the storage mass, to habitable areas of the dwelling. The 
term ``heat regulations devices'' means shading or venting mechanisms 
(such as awnings or insulated drapes) to control the amount of solar 
heat admitted through the solar collection areas and nighttime 
insulation or its equivalent to control the amount of heat permitted to 
escape from the interior of the dwelling.
    (4) Components with dual function. To the extent that a passive or 
active solar system utilizes portions of the structure of a residence, 
only the materials and components whose sole purpose is to transmit or 
use solar radiation (and labor costs associated with

[[Page 43]]

installing such materials and components) are included within the term 
``solar energy property''. Accordingly, materials and components that 
serve a dual purpose, e.g., they have a significant structural function 
or are structural components of the dwelling (and labor costs associated 
with installing such materials and components) are not included within 
the term ``solar energy property''. For example, roof ponds that form 
part of a roof (including additional structural components to support 
the roof), windows (including clerestories and skylights), and 
greenhouses do not qualify as solar energy property. However, with 
respect to expenditures made after December 31, 1979, a solar collector 
panel installed as a roof or portion thereof (including additional 
structural components to support the roof attributable to the collector) 
does not fail to qualify as solar energy property solely because it 
constitutes a structural component of the dwelling on which it is 
installed. For this purpose, the term ``solar collector panel'' does not 
include a skylight or other type of window. In the case of a trombe wall 
(a south facing wall composed of a mass wall and exterior glazing), the 
mass wall (and labor costs associated with installing the mass wall) 
will not qualify. However, the exterior (non-window) glazing will 
qualify. Any shading, venting and heat distribution mechanisms or 
storage systems that do not have a dual function will also qualify.
    (g) Wind energy property. The term ``wind energy property'' means 
equipment (and parts solely related to the functioning of such 
equipment) which, when installed in connection with a dwelling, 
transmits or uses wind energy to produce energy in a useful form for 
personal residential purposes. Examples of equipment using wind energy 
to produce energy in a useful form are windmills, wind-driven 
generators, power conditioning and storage devices that use wind to 
generate electricity or mechanical forms of energy. Devices that use 
wind merely to ventilate do not qualify as wind energy property.
    (h) Geothermal energy property. The term ``geothermal energy 
property'' means equipment (and parts solely related to the functioning 
of such equipment) necessary to transmit or use energy from a geothermal 
deposit to heat or cool a dwelling or provide hot water for use within 
the dwelling. With respect to expenditures made after December 31, 1979, 
the term ``geothermal energy property'' also means equipment (and parts 
solely related to the functioning of such equipment) necessary to 
transmit or use energy from a geothermal deposit to produce electricity 
for use within the dwelling. Equipment such as a pipe that serves both a 
geothermal function (by transmitting hot geothermal water within a 
dwelling) and a non-geothermal function (by transmitting hot water from 
a water heater within a dwelling) does not qualify as geothermal 
property. A geothermal deposit is a geothermal reservoir consisting of 
natural heat which is from an underground source and is stored in rocks 
or in an aqueous liquid or vapor (whether or not under pressure), having 
a temperature exceeding 50 degrees Celsius as measured at the wellhead 
or, in the case of a natural hot spring (where no well is drilled), at 
the intake to the distribution system.
    (i) Subsidized energy financing--(1) In general. The term 
``subsidized energy financing'' means financing (e.g., a loan) made 
directly or indirectly (such as in association with, or through the 
facilities of, a bank or other lender) during a taxable year beginning 
after December 31, 1980, under a Federal, State, or local program, a 
principal purpose of which is to provide subsidized financing for 
projects designed to conserve or produce energy. For purposes of this 
paragraph (i), financing is made when funds that constitute subsidized 
energy financing are disbursed. Subsidized energy financing includes 
financing under a Federal, State, or local program having two or more 
principal purposes (provided that at least one of the principal purposes 
is to provide subsidized financing for projects designed to conserve or 
produce energy), but only to the extent that the financing--
    (i) Is to be used for energy production or conservation purposes, or
    (ii) Is provided out of funds designated specifically for energy 
production or conservation.

[[Page 44]]


Loan proceeds meet the use test of paragraph (i)(l)(i) of this section 
only to the extent that the loan application, the loan instrument, or 
any other loan-related documents indicate that the funds are intended 
for such use. However, loan proceeds designated for the purchase either 
of property that contains ``insulation'' or any ``other energy-
conserving component'' or of ``renewable energy source property'' as 
defined in paragraphs (c), (d), and (e), respectively, of this section 
meet the test of paragraph (i)(l)(i) of this section. Financing is 
subsidized if the interest rate or other terms of the financing 
(including any special tax treatment) provided to the taxpayer in 
connection with the program or used to raise funds for the program are 
more favorable than the terms generally available commercially. In 
addition, financing is subsidized if the principal obligation of the 
financing provided to the taxpayer is reduced by funds provided under 
the program. The source from which the funds for the program are derived 
is not a factor to be taken into account in determining whether the 
financing is subsidized. If a public utility disburses funds for the 
financing of energy conservation or renewable energy source property 
under a program that obtains the funds through sales to the utility's 
ratepayers, the program is not considered to be a Federal, State or 
local program even though the utility is a governmental agency, and, 
thus, the funds are not subsidized energy financing. Subsidized energy 
financing does not include a grant includible in gross income under 
section 61, nontaxable grants, a credit against State or local taxes 
made directly to the taxpayer claiming the credit provided for in 
section 23, or a loan guarantee made directly to the taxpayer claiming 
the credit provided for in section 23.
    (2) Examples. The provisions of this paragraph (i) may be 
illustrated by the following examples:

    Example 1. State A has a farm and home loan program. The program is 
used to provide low interest mortgage loans. In 1984 State A's 
legislature enacted statutory amendments to its farm and home loan 
program in an effort to encourage energy conservation-type measures. Low 
interest loans for such improvements were made available to qualified 
purchasers and owners under the farm and home loan program. The energy 
conservation measures subsidized by the program include energy 
conserving components and renewable energy source devices. State A's tax 
exempt bonds are the source of funds for loans under the program. 
Although the 1984 legislation authorizing loans for energy conserving 
components and renewable energy source improvements did not diminish the 
original purpose of the farm and home loan program, the 1984 legislation 
added another principal purpose to the program. Therefore, State A's 
program which has two principal purposes, one of which is the 
conservation or production of energy, is considered as providing 
subsidized energy financing for purposes of section 23 (c)(10) of the 
Code, to the extent that financing is provided by State A out of funds 
designated specifically for energy production or conservation. State A's 
program will also be considered as providing subsidized energy financing 
to the extent that the loan proceeds are to be used for energy 
production or conservation purposes. Loan proceeds meet the use test of 
the preceding sentence only to the extent that loan application, the 
loan instruments, or any other loan-related documents indicate that the 
funds are intended for such use.
    Example 2. The United States Department of Energy disburses funds to 
State B that the Department received from settlements from alleged 
petroleum pricing and allocation violations. State B establishes a 
program under which B will use the funds to make loans at below market 
interest rates directly to qualified applicants for the purchase of 
renewable energy source property. B's loans are subsidized energy 
financing.
    Example 3. State C establishes a program under which C will make 
loans at below market interest rates directly to qualified applicants 
for the purchases of renewable energy source property. The program is 
funded with money that State C was able to borrow after it obtained a 
loan guarantee from a Federal agency. C's loans provided under the 
program are subsidized energy financing.
    Example 4. Company D is an electric utility that is a Federal 
agency. D purchases its electricity from another federal agency, 
transmits the electricity over its own distribution system, and sells 
the electricity to numerous local public utilities that in turn sell the 
electricity to their customers. D wishes to start a program under which 
D will make loans at below market interest rates directly to customers 
of the local utilities for the purchase of renewable energy source 
property from D. The local public utility will act as the collection 
agent for repayment of the loans. The loans will be repayable over a 
period of time not in excess of 15 years. Under law, D must cover its 
full costs through its own revenues derived from the sale of power and 
other services. While D may borrow by sale of bonds to the United

[[Page 45]]

States Treasury, D must borrow at rates comparable to the rates 
prevailing in the market for similar bonds. Thus, the subsidized loans 
made under D's program will be financed by the profits from the sale of 
electricity to consumers and not by the federal government. D's program, 
which is substantially the same as that carried out by private 
(investor-owned) utilities, is not considered to be a Federal, State or 
local governmental program. Therefore, D's loans are not subsidized 
energy financing.
    Example 5. The Solar Energy and Energy Conservation Bank (Bank) 
disburses funds to State E. E disburses a portion of the funds to 
Financial Institution F. Both the Bank and State E make these 
disbursements under a program the principal purpose of which is to 
provide subsidized financing for projects designed to conserve or 
produce energy. F uses the funds to reduce a portion of the principal 
obligation on loans it issues to finance energy conservation or solar 
energy expenditures. Taxpayer G borrows $3,000 from F in order to 
purchase a solar water heating system. F uses $500 of the funds it 
received from the Bank to reduce the principal obligation of the loan to 
G to $2,500. The amount of subsidized energy financing to G is $3,000.
    Example 6. State H allows a tax credit to Financial Institution J 
under a program the principal purpose of which is to provide loans at 
below market interest rates directly to qualified applicants for the 
purchase of renewable energy source property. J receives a credit each 
year in the amount of the excess of the interest that would have been 
paid at private market rates over the actual interest paid on such 
loans. The State H tax credit arrangement is an interest subsidy. Thus, 
any low-interest loans made pursuant to this credit arrangement are 
subsidized energy financing.

[T.D. 7717, 45 FR 57716, Aug. 29, 1980. Redesignated and amended by T.D. 
8146, 52 FR 26670, July 16, 1987]