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How The Federal Geothermal Tax Credit Works

Sustainable Living Bryson Buehrer January 20 9 minutes reading time

*Due to the recent changes of the Inflation Reduction Act (2022), the information below is no longer completely accurate. the geothermal tax credit was increased to 30% until 2032. Click here for the most recent information on the geothermal tax credit.

If you're here, you're probably pretty interested in geothermal. Who reads an article about tax credits if they're not looking to install the most efficient heating and cooling system available? Whether you call it the geothermal tax credit or the ground source heat pump tax incentive, there's one thing on which we can all agree: government paperwork and taxes aren't always as clear-cut as we'd like!

If you're looking to save money on geothermal in 2022, hopefully, we can answer some of your questions surrounding the 26% geothermal tax credit incentive!et-21-calculator-taxes-financing-numbers-stock-photography

What is the Geothermal Tax Credit?

The 2022 geothermal tax credit has been around in various forms since 2005. It's gone through cycles of expiration and extension over the last 15+ years, most recently expiring at the end of 2016 and undergoing reinstatement in 2018. This instability is why we encourage so many home and business owners to act fast if they feel geothermal is right for them! The savings can start before you even install the system.

Upon its reinstatement in 2018, the tax credit had initially allowed homeowners to get 30% of the system's installation cost as a credit to their federal income taxes. Over time, however, the credit decreases in size. The incentive represents 26% of systems installed throughout 2022 as a credit to your taxes, dropping to 22% at the start of 2023.

If you're installing geothermal, all you have to do is fill out a form (instructions here) stating the amount you spent when you file the year's income taxes. If the system installation is complete by the end of 2022, you can claim 26% of the installation cost on your taxes!

Very often, this equates to thousands of dollars in savings for anyone who takes advantage of this amazing opportunity and effectively allows geothermal to pay for itself even faster than it would normally. As long as you still own the property where the system was installed, you can claim the full amount of the credit based on the installation year.

Do I qualify for the geothermal tax credit?

Installation Before 2024

At the time of writing, as long as the system is installed on or before December 31st, 2023, you'll be eligible for some version of the tax credit, depending on the year the system was put in place.

If the geothermal system is installed as part of new construction or the renovation of a home, it is considered "installed" when the taxpayer moves into the structure.

Efficiency Criteria

To be eligible to claim the tax credit, the installed technology must meet Energy Star requirements, meaning the unit must meet or exceed some specified energy standards. All Enertech-manufactured geothermal heat pumps are Energy Star certified, meaning that they are over 45% more energy efficient than "standard options," as Energy Star puts it. In fact, our geothermal heat pumps operate at efficiencies upwards of 400%, well exceeding the Energy Star minimums.

Not all geothermal heat pumps are qualified, so be upfront with your installer to ensure that the system being installed will meet those standards.

Requirements for Residency

To qualify for the tax credit, you must own the home where the geothermal heat pump is installed. However, it can be a secondary home or vacation home as long as it's in the United States - it does not need to be your primary residence.

The credit cannot be claimed for rental properties unless you live in the home for a significant part of the year. So, if you live in a secondary home for 7 months of the year, and rent the property for the remaining 5 months, you can claim the tax credit for the portion of the year in which you reside in the structure.

How The Tax Credit Applies to Your Tax Liability

The Geothermal Tax Credit is classified as a non-refundable personal tax credit. It is an amount that is applied to your tax liability (what you owe to the IRS) in order to reduce or eliminate what you owe. Let's break down what that means.

Tax Credit: It's a dollar-for-dollar reduction on the income tax you owe. In order to qualify for the Federal Tax Credit, you must have some level of tax burden to benefit. If the amount of tax credit you receive after the installation of your geothermal system is $5,000, and you owe $4,000 in income tax to the IRS, your tax burden will be eliminated for that year. Where does that extra $1,000 go? We'll get into that later.

Non-refundable: Some tax credits are non-refundable, meaning that you can still get the full amount of the credit, even if the credited amount exceeds your tax liability. On a refundable tax credit, you would receive a refund  of $1,000 from the above example. 

Since the Geothermal Tax Credit is non-refundable, you would not receive a refund if your credit exceeds your tax bill. Fortunately, this incentive allows the homeowner to utilize their credit balance over multiple years. As long as the credit is active, you can continue to apply your credit balance to your tax bill! For example, if your credit amounts to $8,000 in 2022 but your liability is only $4,000 per year, you can use the tax credit all the way through 2023.

How can I claim the Geothermal Tax Credit?

After installing the geothermal system and when you're ready to file your federal income taxes, simply fill out one additional form. The form is titled IRS Form 5695, which you can view the step-by-step instructions to fill out here

The basic process for claiming your geothermal tax credit is this:

  • Determine if the installed system and your residence at the property meets the criteria in the previous section of this article
  • Figure the amount of any of the following credits you are also claiming
    • Credit for the elderly or the disabled.
    • Nonbusiness energy property credit (Part II of this form).
    • Adoption credit.
    • Mortgage interest credit.
    • District of Columbia first-time homebuyer credit.
    • Alternative motor vehicle credit.
    • Qualified plug-in electric drive motor vehicle credit.
  • Within Form 5695, enter the amounts you paid for any qualified geothermal heat pump property
  • Complete the Residential Energy Efficient Property Credit Limit Worksheet (found here)
  • Determine if you are able to utilize all of the credit in the current tax year and record that number. You may still file Form 5695 in the current tax year, even if your are unable to use the entire amount of the credit.

If you get a head start on filing your personal income taxes, make sure you check with a tax professional that you have the most updated version of the form for filing purposes. We always recommend working with a qualified tax professional when dealing with credits and incentives, as they can not only ensure that your tax credit is filed properly, but they're often aware of other local, state, and federal incentives you may be eligible for.

If you're self-filing and have further questions on the form, you can reach out to the Internal Revenue Service directly through their website or by giving them a call at 1-800-829-1040.

What expenses are covered under the Federal Geothermal Tax Credit?

The Geothermal Tax Credit, filed through form 5695, covers expenses associated with the installation of ground source heat pumps. This includes labor, onsite preparation, equipment, assembly, and the necessary piping and wiring used when connecting the system to the home. Certain electrical upgrades may also be eligible.

Additional add-on components, such as ductwork, are not covered by the tax credit.

Solar PV technology and its associated costs are also eligible for the 26% tax credit, so this is the perfect time to set your home up for the ultimate combination of efficiency and comfort!

How long will the tax credit last?

As we mentioned before, the geothermal tax credit goes through cycles of reinstatement, expiration, and renewal within the U.S. legislative process. In 2019, the tax credit was renewed at 30% of the total system cost, which dropped to 26% in 2020. This number will carry through until the end of 2022, and drops to 22% in 2023. After that, the incentive has expired and would presumably be up for renewal in future years.

All that to say, if you're considering installing geothermal in your home, NOW is the best time to do so. The technology is already a fantastic addition to your home, but you certainly don't want to miss out on getting a significant portion of the system's install cost back in your pocket!

What other incentives are available to me for geothermal?

The tax credit is not the only incentive available, as there are other credits and even rebates available in many different areas. They can even vary by the homeowner's utility! 

For example, in New York, the Clean Heat Program is managed and administered by the homeowner's utility, and are calculated as a monetary rebate based on the installed heat pump's total heating capacity in BTUH (British Thermal Units per Hour). Depending on the size of your geothermal heat pump and the utility that fuels your home, it's not uncommon for homeowners with an average-sized home to see rebate amounts of $10,000!

In South Carolina, the homeowner can receive an additional tax credit, on top of the 26% Federal program, that can amount to an additional $3,500 of the system cost as a credit to your income tax.

These incentives are constantly changing, and new ones seemingly pop up every day. Do your research and talk to a qualified professional, and you'll be on the road to savings and comfort in no time!

Interested in how much you could save with geothermal and solar PV?

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Bryson Buehrer
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