What is the Inflation Reduction Act (IRA) and what does it mean for Geothermal Systems?
The Inflation Reduction Act (IRA) of 2022 enhances the federal income tax credits and incentives offered for installation of geothermal heat pump (GHP) energy property in commercial buildings. It also offers a new direct payment option for non-taxable entities, such as non-profit schools and government buildings. For taxable businesses, there also are new carryback and transfer provisions as well as accelerated depreciation benefits.
What is the ITC?
ITC stands for Investment Tax Credit. The business ITC for geothermal heat pumps (GHPs) was included as a part of the Energy Improvement and Extension Act of 2008. This legislation added geothermal heat pumps to the definition of energy property under section 48(1) of the Internal Revenue Code with a 10% tax credit. This was extended by Bipartisan Budget Act of 2018 and most recently enhanced and further extended by the IRA of 2022 referenced above. The ITC is extended under a two-tier structure in place with a base credit rate of 6% (or 1/5 of the bonus rate) and a bonus rate of 30%. The ITC for GHP energy property is effective for projects that begin construction prior to January 1, 2035. In 2033 the base rate drops to 5.2% and the increased rate to 26%, while in 2034 they decline to 4.4% and 22%.
How can I qualify for a 10% bonus tax credit?
In order to qualify for the 10% domestic bonus tax credit, steel and iron used in the Geothermal Heat Pump system must be made in the United States. To be considered being manufactured in the United States, at least 40% of the total cost of the components and subcomponents of the project must be mined, produced, or manufactured in the United States. Geothermal Heat Pump projects meet the domestic content requirements; however, the Department of Treasury is developing more guidance that is expected to be released in mid-2023.
The Domestic Content Bonus is NOT available for GHP projects completed before January 1, 2023.
We're talking about tax savings, but I'm a nonprofit. Does this still apply to me?
YES! While usually nonprofits have been unable to use the ITC, the IRA of 2022 now offers a direct pay option. Direct Pay provides a refundable credit equal to the Geothermal Heat Pump project ITC including any domestic content bonus.
What if I plan to transfer or sell my property after installing the Geothermal System?
The ITC can be transferred (including the domestic content) to an unrelated taxpayer. Consideration must be paid in cash, is not included in the income of the transferor, and is not deductible to the transferee. For more information, please consult your tax professional.
What if I don't have enough tax liability this current year?
The IRA extends the ITC carryback period to 3 years. The credit must originate in a tax year that begins after December 21, 2022. Unused portions of the credit can be carried forward.
I think the tax credits are great, but can I depreciate the balance of my cost at a faster rate?
Energy property is classified as a 5-year property in section 168€ (3)(B)(vi) of the Internal Revenue Code, meaning the cost of the property can be deducted on an accelerated MACRS basis. For depreciation purposes, the system cost basis must be reduced by one half of the energy tax credit. In the example of a C-corporation in a 26% overall (federal plus state) tax bracket receiving a 40% ITC (includes the domestic content bonus), MACRS depreciation provides an additional tax savings equal to 20.8% of the energy property basis over the first 5 years, or optionally most within the first year. By comparison, conventional heating and cooling systems are generally depreciation on a 39-year straight line basis and would provide only 3.33% of the basis in tax savings over the first 5 years. The tax benefits for pas-through entities such as S-corporations could be must higher due to the higher marginal tax rates for individuals.
Energy property is eligible for first year bonus depreciation. The bonus allowance is 100% in 2022, 80% in 2023, 60% in 2024, 40% in 2025, 20% in 2026 and phases out in 2027.
What qualifies for the tax credit? What does "energy property" mean exactly?
The tax credit can be claimed on equipment which uses the ground or ground water as a thermal energy source to heat a structure or as a thermal energy sink to cool a structure. This equipment is called “qualified energy property”. The structure must be located in the United States. Qualified energy property costs that are eligible for the credit include the cost of installation AND equipment used in distribution of the heating/cooling BTUs (piping, air-handling units, terminal units, ductwork and diffusers.
You cannot claim the credit on equipment used for any purpose other than heating or cooling a structure or on equipment that has been used before, so using this credit for process heating or cooling in an industrial setting or for rental/refurbished equipment.
When should I do it?
The credit can be claimed on spending for projects where construction has started before January 1, 2035. There is no time limit on when the construction must be completed for Geothermal Heat Pump projects.
I installed more than just a Geothermal Loop and Heat Pump; can I get credit for my whole system?
YES! The cost basis includes the direct costs associated with the purchase and installation of the energy property as well as any indirect costs that may be partly or fully devoted to its construction (including taxes). This includes equipment like: pumps, Geothermal Heat Pipes, distribution piping and ductwork ground heat exchangers or wells, and controls along with the associated installation labor and materials. This also includes portions of the electrical, plumbing, design and contractor fees or permits specifically related to the geothermal property. Utility rebates can also reduce the cost basis.
What if I can't meet my entire buildings heating/cooling needs with a Geothermal System?
If a Geothermal Heat Pump property contains a source of energy other than from the ground or ground water, portions of the system that carry both forms of energy may be considered dual use equipment. Usually this includes ductwork downstream of the Geothermal Heat Pump. The incidence of an auxiliary energy source solely for emergency back-up purposes is not considered in this determination (such as a backup natural gas boiler). Otherwise, if more than 25% of the annual energy (not peak energy) comes from the auxiliary source, any dual use equipment in the system may no longer be eligible for inclusion in the ITC cost basis. These comments are based on an interpretation of a 1979 code definition of energy property for direct use geothermal energy such as hot water for heating. There have been no further guidelines published by the IRS since that time. The IRS may not apply this language in the same way to geothermal energy property and, as such, this interpretation is offered on a precautionary basis for those developing hybrid geothermal energy projects.
What if I owe regular and alternative taxes?
The ITC can be used to offset both regular income taxes and alternative minimum taxes (AMT).
Do I need to own the property that I'm installing the system on?
Yes, geothermal energy tax credits and depreciation deductions can only be claimed by the owner of the property, including utilities that on energy property.
How do I claim the credit? Who do I contact for further information?
Please visit www.irs.gov to download the IRS Form 3468. Please consult your tax professional for further detailed tax guidance, or reach out to Vyron for additional information on products that can help you qualify for tax credits.