The $5,000 State Tax Credit for the purchase of a new home passed in the 
last Special Legislative Session went into effect July 26th, 2009 and will last for all homes closed before the $25,000,000 is exhausted or July 26th, 2010.
The Kentucky Department of Revenue has a form the buyer must fill out at closing and fax in within seven days. You can access that form and additional information at www.revenue.ky.gov.
You are correct that it applies only to your Kentucky tax liability. If your individual or joint tax liability is $0.00 then there is no benefit. If your tax liability is $3,200 your credit is $3,200. If your tax liability is $6,000 then your credit is the full $5,000. The Federal credit is for the entire $8,000 or $6,500 depending on which you qualify and provides more savings. You cannot claim the Kentucky credit if you qualify for either of the Federal credits.
Credit only applies to a tax liability. If you do not owe any tax amount on your KY State Tax Return then the credit is useless. You will not get a $5000 refund like some would have you believe.