Looking at Geothermal HVAC for the Investment Tax Credit

Geothermal Heat Pumps (GHPs): Efficient Heating and Cooling Across the U.S. 

Geothermal heat pumps (GHPs), also known as ground-source heat pumps, utilize the steady temperatures found underground to provide both heating during the winter and cooling during the summer. As these constant subsurface temperatures are accessible nationwide, GHP systems offer an energy-efficient, low-carbon solution to heat and cool various types of buildings—from homes to businesses—in all 50 U.S. states. Geothermal HVAC

GHPs are adaptable for installation in both new buildings and retrofits, and the availability of the Investment Tax Credit (ITC), along with other financial incentives, has made these systems a more feasible option for a wide range of properties. 

According to regulatory definitions, geothermal heat pump equipment involves using the ground, groundwater, or other underground fluids as a thermal energy source to heat structures or as a thermal energy sink to cool them. 

Geothermal Systems in Brief 

Geothermal systems take advantage of the earth’s consistent underground temperatures by using wells drilled from shallow depths to several hundred feet below the surface. Through a series of pipes, water circulates to either gather or release heat from the ground, providing a renewable source of thermal energy. 

This thermal exchange occurs as water moves through underground loops connected to an HVAC system, allowing for efficient heating and cooling inside the building. Key components typically include a compressor, heat exchanger, and fan. In cooling mode, the system transfers heat from the building to the ground; in heating mode, it reverses, drawing warmth from below to heat the indoor space. 

Geothermal setups come in various forms, like open-loop and closed-loop configurations, each tailored to factors like well placement, depth, pipe arrangement, and pump choice. Although geothermal heat pump technology has been around since the 1940s, modern advancements have made it versatile enough to serve anything from a residential home to large commercial facilities. 

The effectiveness of these systems often relies on having enough land area and favorable subsoil for the wells or bore fields. In the right conditions, geothermal solutions are especially valuable for places needing significant heating and cooling, such as schools and hospitals. 

The Investment Tax Credit (ITC) for Geothermal Systems 

Under Internal Revenue Code Section 48, the ITC provides a dollar-for-dollar tax credit applicable to geothermal systems. Although GHP systems have qualified for the ITC since 2008, the Inflation Reduction Act (IRA) has increased these benefits substantially, including a direct pay option, allowing certain entities to receive cash instead of a tax credit. 

Calculating the ITC for Geothermal Projects

The ITC calculation involves three primary steps:

Incorporating Dual Use Equipment for Hybrid Geothermal Systems 

For hybrid geothermal systems incorporating supplemental energy sources to perform its function (i.e. supplemental boiler), the dual use rule under existing § 1.48-9 applies. Dual use equipment, defined as any equipment that processes both geothermal and non-geothermal energy sources, qualifies for the ITC if at least 75% of the energy input is geothermal. This “75-percent Cliff” allows backup energy sources without disqualifying the system, as long as geothermal sources supply the majority of the energy. 

Recent Proposed Regulations to Modify Dual Use Requirements

Recent feedback to the Treasury Department and IRS has spurred discussions on alternatives to the stringent 75-percent Cliff rule. Some industry voices have suggested a “50-percent Cliff” model, where properties receiving over 50% of their energy from qualifying sources would still qualify for the full section 48 credit. For those with 50% or less qualifying energy input, the ITC basis would decrease incrementally instead of excluding the property entirely. This proposed approach would help mitigate the “all-or-nothing” risk, providing more predictability for taxpayers on credit eligibility. 

The 50-percent Cliff, however, would require precise tracking of energy sources, which could elevate compliance costs. Our in-house team of cost segregation engineers and energy specialists can streamline this process, helping clients measure and substantiate the energy input for each source accurately. This expertise ensures that hybrid systems have a smoother path to ITC eligibility, and it also supports broader access to credits under the dual-use rule. 

If a project doesn’t meet the baseline 30% credit requirements, note that the domestic content and energy community bonus credits will reduce to 2%. 

Direct Pay for Tax-Exempt Entities under the IRA 

The IRA introduces a distinctive opportunity for tax-exempt organizations, including nonprofits, schools, and local governments, to turn clean energy credits like the ITC into direct cash reimbursements. This provision allows eligible entities to receive payments that could cover up to 50% of geothermal system costs—an appealing option for institutions such as public schools and universities, which often have significant heating and cooling needs alongside sustainability goals. 

Given the complexity of ITC requirements, working with a tax advisor experienced in IRA provisions is key to maximizing benefits and ensuring proper claims for geothermal investments. 

Cross-Over with Other Incentives

Installing geothermal heat pumps not only opens the door to the ITC but also qualifies the energy property for accelerated depreciation benefits, offering a financial advantage that extends beyond tax credits. Under Section 168 of the Internal Revenue Code, qualified energy property, including geothermal heat pumps, is classified as a 5-year property, allowing for accelerated depreciation. This means the property’s cost can be recovered over a much shorter period than the standard 39-year life for HVAC systems in commercial buildings. For tax payers  with the tax appetite to leverage this, there’s also a one-time bonus depreciation of 60% in the first year (for 2024), based on the property’s reduced basis (after accounting for half of the energy tax credit). 

Additionally, for those pursuing geothermal installations, a 179D Energy Efficient Commercial Building Deduction may also be beneficial. This incentive applies to both new and existing buildings that meet certain ASHRAE efficiency standards and allows for a deduction of up to $5.81 per square foot, provided the project satisfies prevailing wage and apprenticeship requirements. The deduction is available to building owners for for-profit entities, while designers of tax-exempt buildings (e.g., nonprofits, tribal governments) can claim the deduction. 

By combining the accelerated MACRS depreciation, one-time bonus depreciation, and potential 179D deduction, you can maximize financial benefits for geothermal projects—especially valuable for projects with substantial energy demands and sustainability goals. Our in-house cost segregation and energy engineering teams are here to assist with all phases, from assessing eligibility to substantiating these deductions and credits. 

How Leyton Can Assist 

Leyton’s commercial real estate team, consisting of tax professionals and engineers, is dedicated to helping organizations evaluate, calculate, and claim ITCs for geothermal systems across various facility types. Discover how Leyton can support your journey toward maximizing these benefits for your clean energy investments.