By John Kapral, JD, CPA, LLM, Senior Director, Renewable Energy Tax Incentives & Credits
Heat pumps, ground loops, circulating pumps, controls and qualifying distribution equipment may be included in eligible basis for the commercial geothermal heat pump tax credit. Installation labor and properly allocated indirect costs may also qualify. The entire construction contract does not automatically qualify: each cost needs support in the project’s design, ownership and cost records.
This article covers the Investment Tax Credit under Section 48 for commercial and institutional geothermal heat pump projects, including projects owned by public school districts and other eligible tax-exempt entities using direct pay. It does not address the residential geothermal credit under Section 25D.
“Is the entire project amount eligible for ITC? If not, what elements are not?”
An ESCO working with a school district sent Walker Blue that question. Answering it means separating qualifying geothermal property from the broader construction scope, then determining the credit rate and how the owner may receive the value.
The amount that qualifies is the project’s eligible basis. That amount, rather than the total construction contract, is what the credit rate is applied to.
Is the geothermal heat pump credit still available?
Geothermal heat pump property has a separate Section 48 construction-start schedule extending through 2034, with base rates of 6%, 5.2% and 4.4% for the applicable periods. The five-times increased rates are 30%, 26% and 22%, respectively, where labor requirements or an applicable exception are satisfied. Project eligibility still depends on timing and other requirements. uscode.house.gov
For owners evaluating a project, the construction-start date, ownership arrangement, eligible costs and applicable compliance requirements should be reviewed together before an incentive estimate becomes part of the capital plan.
What does the geothermal heat pump credit cover?
Section 48 covers geothermal heat pump property that uses the ground, groundwater or other underground fluids as a thermal source or sink for heating or cooling a structure.
The functional-interdependence rules identify the qualifying unit of property. The integral-part rules address supporting property essential to its intended function. Ownership and the treatment of shared equipment also affect the analysis. www.ecfr.gov
An ESCO does not become entitled to the credit simply because it designs or installs a customer-owned system.
Which geothermal costs should be reviewed for eligible basis?
A geothermal basis review starts with these costs:
- Heat pumps.
- Ground-loop piping, drilling and grouting.
- Headers and piping connecting the ground loop to the heat pumps.
- Circulating pumps.
- Controls serving the geothermal system.
- Distribution equipment delivering geothermal heating and cooling into conditioned space.
- Excavation, trenching and backfill for the loop field.
- Electrical work serving the geothermal equipment.
- Installation labor and an allocated share of indirect costs.
Each item needs drawings, equipment schedules, ownership records and cost records behind it. Shared components require a review of their function, allocation and any additional rules that apply.
Can fan coils, ductwork and hydronic distribution qualify?
Walker Blue’s position is that eligible basis may extend from the ground loop and heat pumps through qualifying distribution equipment to the point where geothermal heating and cooling are delivered into conditioned space.
Depending on the design, that review may include fan coils and other terminal units, air handlers with coils served by the geothermal system, hydronic piping, ductwork, registers, diffusers and grilles.
The analysis follows function. Connection to a heat pump does not, by itself, establish eligibility.
The incremental-cost rule requires separate consideration where a component also serves a nonqualifying purpose. It should not be presented as an automatic requirement to subtract the cost of an entire conventional HVAC system from the geothermal installation. Hybrid arrangements also require a dual-use review. Treasury Regulation §1.48-14
How do the dual-use rules affect hybrid systems?
A supplemental boiler, chiller or cooling tower makes a component-level review important. Its presence alone does not determine the treatment of every connected component.
The analysis should identify which items use qualifying and nonqualifying energy, how those inputs will be measured and what records will support the claimed allocation.
Separate hot-water and chilled-water loops should not automatically be averaged across a building. Their configurations and inputs may require separate calculations.
Continued operation matters after filing. The dual-use regulations include annual measurement requirements and a recapture trigger when qualifying energy use falls below 50% during a subsequent measuring period within the recapture period. www.ecfr.gov
Metering points, control sequences and the records needed for those measurements should be considered during design.
Can electrical panels, feeders and transformers be included?
Electrical work serving geothermal equipment should be evaluated for its relationship to the qualifying system.
Appearing in the same construction contract is insufficient. The record should show what each item serves and how any shared cost is allocated between geothermal equipment and other building loads.
Useful records include panel schedules, single-line diagrams, equipment ratings and load calculations.
How should indirect costs be allocated?
General conditions and other indirect costs need their own review. A defensible allocation shows which costs were incurred and capitalized, how they relate to qualifying property and why the allocation method fits the project.
A contingency line in a budget is not evidence of an eligible expenditure. The review needs the underlying costs and their treatment in the final project accounts.
The same applies to bundled contracts. A single contract price does not remove the need to distinguish geothermal work from unrelated construction.
Which costs should be separated from the geothermal scope?
A basis review should separately identify the building and envelope, plumbing fixtures, duct cleaning, general site improvements and other construction outside the qualifying system.
Domestic hot water and pool equipment require their own analysis. A connection to the geothermal installation is insufficient to establish that they perform the qualifying function of heating or cooling a structure.
Parking lots illustrate why detailed cost records matter. Where a loop field is installed beneath a lot, separate:
- Excavation and backfill for the loop installation.
- Surface restoration above the loop.
- Broader repaving or improvements.
Restoration and broader improvements should receive their own review rather than being assumed eligible because the loop field lies beneath them.
Does replacing heat pumps on an existing ground loop qualify?
It may, but the project needs a retrofit analysis before the owner includes a credit in its budget.
Begin by identifying the relevant unit of property, who owns its components, what existing equipment will remain and the value of that retained equipment.
The retrofit rules include an 80/20 test and distinguish new expenditures from retained-property value. The ownership rules also include a geothermal example showing why ownership of heat pumps alone can produce a different result from ownership of ground coils together with a heat pump. www.ecfr.gov
Keeping an existing loop can therefore change both the eligibility analysis and the valuation work required.
How does project size affect the credit?
The under-one-megawatt exception can support the five-times increased credit amount without satisfying the prevailing wage and apprenticeship requirements. The applicable increased rate still depends on construction timing.
For geothermal heat pumps, size is measured using thermal output. The regulations address heating and cooling capacity, nameplate ratings and aggregation of multiple properties into an energy project. Individual heat pumps should not automatically be evaluated as separate projects. www.ecfr.gov
The capacity calculation, equipment ratings and aggregation analysis belong in the supporting file.
Project size also affects the bonus and direct-pay analysis. Being below the threshold does not, by itself, establish that domestic-content or energy-community requirements are satisfied.
How does eligible basis become a tax credit?
Eligible basis is the first of three separate determinations.
First, determine the qualifying costs. Establish which components and expenditures belong in the calculation.
Second, determine the applicable rate. Review construction timing, labor requirements or exceptions, supported bonuses and financing adjustments.
Third, determine how the owner receives the value. Depending on its status and the applicable rules, the owner may use the credit against tax, transfer an eligible credit or elect direct pay.
A supported cost allocation does not establish every other condition required to claim or monetize the credit.
What should public owners know about direct pay?
An eligible public or tax-exempt owner may elect direct pay under Section 6417. It must satisfy the underlying credit requirements, complete IRS pre-filing registration and make a timely election on the appropriate return. www.irs.gov
Two additional items deserve attention in the estimate.
Domestic content
The domestic-content bonus and the domestic-content requirements affecting direct pay are separate questions.
Applicable payment reductions can be substantial where the requirement is not satisfied and no exception applies. Notice 2024-84 provides a transitional attestation procedure for qualifying exceptions; it is not an automatic waiver. The current procedure and its availability should be verified for the project’s construction-start date. www.irs.gov
Procurement records and the documentation supporting an exception should be planned early.
Tax-exempt bond financing
Financing must also be reviewed before the estimated payment is presented to the owner.
The Henry County example below illustrates why a bonus-adjusted credit rate may differ from the final rate after a financing adjustment. A reference to a “bond program” alone does not establish the bonds’ tax status or how proceeds were allocated to qualifying property.
How did eligible basis affect a Kentucky school project?
At the Henry County Board of Education’s administrative office in New Castle, Kentucky, Walker Blue reviewed construction costs and supporting documents to distinguish qualifying geothermal property from other work.
| Project measure | Reported amount |
|---|---|
| Total project cost | $937,030 |
| Substantiated eligible basis | $851,157 |
| Eligible basis as a share of total cost | Approximately 90.8% |
| Rate before financing adjustment, including domestic-content bonus | 40% |
| Tax-exempt bond reduction | 15% of the credit |
| Effective credit rate | 34% |
| Supported federal credit | Approximately $289,000 |
The example is not a benchmark for another installation. Its value is showing the separate work required to establish basis, determine the supported rate and account for financing.
Why should eligible-basis planning start during design?
Starting during design gives the owner and project team time to evaluate equipment selection, loop configuration, supplemental heating and cooling, ownership, financing and sourcing.
It also allows the team to plan records and measurement points while changes are still practical.
A later review may substantiate eligible costs, but its conclusions depend on the available documentation.
For a current project, assemble:
- Mechanical and electrical drawings.
- Equipment schedules, submittals and cut sheets.
- The schedule of values and detailed cost breakdown.
- Contracts, invoices and pay applications.
- Panel schedules and load calculations.
- Change orders.
- Shared-cost allocation records.
- Ownership and financing documents.
- Capacity calculations.
- Sourcing and other applicable compliance records.
The goal is a calculation that can be traced to the installed property, its function and the expenditures supporting it.
Frequently asked questions
Is the entire geothermal construction contract eligible?
Not automatically. The contract may contain qualifying property, shared equipment requiring an allocation and unrelated building work.
Do fan coils and ductwork qualify?
Walker Blue’s position is that they may qualify when integral to delivering geothermal heating or cooling into conditioned space. The design, ownership and applicable allocation rules must support their inclusion.
Can electrical panels and feeders be included?
They should be reviewed based on what they serve and their relationship to the qualifying system. Shared equipment needs a supported allocation.
Does replacing heat pumps on an existing loop qualify?
It may, depending on the relevant unit of property, ownership, retained-component value and applicable retrofit requirements.
Can a public school district receive a credit without owing income tax?
An eligible district may elect direct pay, subject to the credit’s requirements, registration and timely filing. Payment eligibility requires a separate review from eligible basis. www.irs.gov
Talk to Walker Blue about your geothermal project
Walker Blue reviews geothermal designs and project costs for owners, ESCOs and school districts, from early planning through final substantiation.
Contact Walker Blue to review potentially qualifying costs, allocation questions and the documentation needed before setting your project’s ITC expectations.
General educational information, not tax advice. Project treatment depends on qualification, timing and applicable requirements.
