What Costs Are Eligible For Geothermal Tax Credit?

Geothermal energy utilizes the constant temperature of the earth to provide heating and cooling for homes and businesses. Geothermal systems use underground pipes filled with water or antifreeze to transfer heat between the earth and a building. This makes geothermal systems extremely efficient and environmentally friendly.

The U.S. federal government has offered tax credits for geothermal system installation costs since 2008 to incentivize the use of this renewable energy source. The tax credit originally offered a 30% credit but has decreased incrementally over the years. The current tax credit, which was renewed in 2020, offers a 26% credit for systems installed through 2034.

The geothermal tax credit can be claimed by homeowners who install an eligible system in their primary residence or second home. Businesses who install commercial geothermal systems can also qualify for the credit. The 26% credit applies to the total installation costs, including equipment, labor, drilling, permits, and other associated expenses.

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Qualifying Property

To qualify for the geothermal heat pump tax credit, the geothermal heat pump system must meet specific requirements and be installed in a qualifying residence. According to the Energy Star, the geothermal heat pump property must use the ground or ground water as a thermal energy source to heat the residence or as a thermal energy sink to cool the residence. Only geothermal heat pump systems certified by the manufacturer to meet federal Energy Star requirements can qualify for the tax credit.

The residence where the geothermal system is installed must be located in the United States and used as a primary residence by the taxpayer claiming the credit. This includes single family homes, townhomes, rowhomes, and condominiums. According to the Enertech Blog, the tax credit can be claimed for a secondary residence such as a vacation home, but rental properties do not qualify. There are no income limits to claim the geothermal tax credit.

There are some limitations to the tax credit. According to the WaterFurnace brochure, the tax credit is limited to systems with rated capacities less than 6 tons of refrigeration. The total lifetime tax credit that can be claimed for geothermal installations is $2,000 for systems with capacities less than 0.5 tons and $6,000 for systems between 0.5 and 6 tons.

Eligible Costs

The geothermal tax credit covers a wide range of expenses related to the installation of a qualified geothermal heat pump system or ground loop. Some of the main costs that can qualify for the tax credit include:

Installation costs – Labor, equipment rental, permits, etc.
Drilling costs – Drilling the wells or trenches for the ground loop

Excavation costs – Digging trenches for ground loop piping
Piping – Purchasing and installing the pipes and fittings for the ground loop
Pumps and heat exchangers – For the geothermal heat pump unit itself

Materials – Components like insulation, concrete, rebar, backfill, etc.
Design and engineering – Consulting fees for system design

As long as these costs are directly related to the geothermal system installation and meet all other requirements, they can qualify for the tax credit. Keep documentation such as invoices and receipts for all related expenses.

Ineligible Costs

Not all costs associated with installing a geothermal heat pump qualify for the geothermal tax credit. According to the Enertech blog, the main costs that do not qualify are operating costs and financing costs.

Operating costs refer to the expenses involved in running and maintaining the geothermal system after it has been installed and is operational. This includes electricity costs to operate the heat pump and maintenance costs like repairs or replacing parts. Since the tax credit is intended to incentivize the initial adoption of the technology, ongoing operating expenses do not qualify.

Financing costs such as loan fees and interest payments are also not eligible for the credit. The tax credit only applies to direct expenses related to purchasing and installing the geothermal heat pump itself. Any additional costs to finance the system cannot be counted.

According to the EnergyStar website, other ineligible costs include ductwork, hot water tanks, and other conventional HVAC components that would be required regardless of the heat source. Only equipment and installation expenses unique to the geothermal system installation can qualify for the tax credit.

Credit Amount

The geothermal tax credit amount varies depending on the year the geothermal system was installed. For systems placed in service in 2022, the credit is equal to 26% of the costs of qualified geothermal heat pump property expenditures (SOURCE). This percentage was reduced from 30% in previous years. The credit will continue decreasing in future years, dropping to 22% for systems installed in 2023 and beyond (SOURCE).

To calculate the credit, add up all expenditures related to the geothermal system that qualify for the tax credit, then multiply that total by 0.26 for systems installed in 2022. This produces the total credit amount that can be claimed. For example, if a geothermal system cost $15,000 to install in 2022, the tax credit would be $15,000 * 0.26 = $3,900.

Claiming the Credit

The geothermal heat pump tax credit must be claimed in the same year the qualified geothermal heat pump property was installed and placed into service. This is true even if the expenses were paid in a different year (according to Energy Star).

Taxpayers are subject to a lifetime limit that caps the cumulative value of the credit they can claim. The lifetime limit depends on when the property was installed:

Property installed from 2006 to 2016: $2,000 lifetime limit
Property installed from 2017 to 2021: $5,000 lifetime limit
Property installed from 2022 onwards: No lifetime limit

If the cumulative value of geothermal credits a taxpayer has claimed in previous years exceeds the lifetime limit applicable during their installation year, they cannot claim any additional credits. However, they can still claim any portion of the lifetime limit they have not yet used up (Enertech Blog).

Recapture Rules

If a taxpayer disposes of geothermal heat pump property before the end of the recapture period, which is usually five years from the date the equipment was placed in service, the tax credit may have to be partially recaptured. The recapture amount is based on a sliding scale, with full recapture if the property is disposed of within a year of being placed in service, 80% recapture in the second year, and so on until there is no recapture after the fifth year.^[1] This applies if the taxpayer sells the home or building where the geothermal system was installed. An exception is made if the disposal is due to the death of the taxpayer or an involuntary conversion, such as a home destroyed by natural disaster.^[2]

Interaction With Other Credits

The geothermal tax credit can be combined with the federal solar tax credit, allowing homeowners to claim both incentives when installing a combined geothermal and solar system. However, there are some limitations:

The total amount of credits claimed cannot exceed the tax liability for the year. For example, if a taxpayer owes $5,000 in federal taxes, but has $6,000 in eligible geothermal and solar credits, they can only claim $5,000 in credits for that tax year. The remaining $1,000 could be carried forward to the next tax year.^[1]

Additionally, the basis used to calculate the credits must be reduced by any grants or subsidized energy financing received. For example, if a geothermal system cost $30,000 but had a $5,000 state rebate, the geothermal tax credit basis would be $25,000.

Homeowners should consult a tax professional to maximize credits and avoid exceeding the annual tax liability limits when combining multiple energy-related tax incentives.

[1] https://www.energy.gov/eere/solar/homeowners-guide-federal-tax-credit-solar-photovoltaics

Recent Changes to Geothermal Tax Credits

In August 2022, significant changes were made to geothermal tax credits with the passing of the Inflation Reduction Act. This legislation extended and expanded tax credits for geothermal heat pump installations.

The most notable change is that the 30% tax credit for geothermal systems has been extended through 2032. Previously, this credit was set to phase down and expire after 2023. Now, homeowners can continue claiming the full 30% credit for many more years.

The legislation also makes the tax credit refundable for tax year 2022-2032. This means if the credit exceeds a taxpayer’s tax liability for the year, they will receive a refund of the remainder. Previously, the credit could only be used to offset tax liability.

Finally, the act lifts the lifetime limit on tax credits for geothermal projects. Before, homeowners were capped at claiming a maximum of $2000 in credits over their lifetime. This cap has now been removed through 2032, allowing taxpayers to claim the full 30% credit on multiple geothermal system installations.

Overall, the Inflation Reduction Act significantly improves and extends geothermal tax credits for homeowners. The full details can be found in the text of the legislation itself (Enertech blog). With these long-term extensions in place, geothermal energy continues to be a smart investment for many homeowners.

Conclusion

The geothermal tax credit provides a significant incentive for homeowners to install energy-efficient geothermal heat pump systems. With the credit recently increased to 30% until 2032, there is no better time to reap the benefits. Key points to remember are that the credit applies to costs like drilling, ground loop pipes, installation labor, and associated equipment. While the geothermal system itself does not qualify, nearly all other costs up to $15,000 do. By claiming the credit, homeowners can offset the high upfront price of these systems, saving thousands of dollars in taxes. Given the energy savings and environmental benefits geothermal heat pumps provide, this credit makes investment highly attractive. Homeowners considering a system should educate themselves on the details and consult a certified installer to maximize utilization of the geothermal tax credit.