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The time to consider geothermal energy is now

May 23, 2023

You may have long assumed that installation of a geothermal heating and cooling system is too cumbersome and costly to be a viable clean energy option for you. But it’s time to give this green technology a serious rethinking for your commercial and residential projects.

The environmental benefits of geothermal can be dramatic: As a renewable energy source drawing on naturally occurring steam and hot water beneath the earth’s surface, a geothermal system offers a constantly available energy supply without burning fossil fuels that produces about 75% less carbon dioxide emissions than oil or gas.

Recently the purchase and installation of geothermal heat pumps has become significantly more cost-effective for businesses and homeowners thanks to an assortment of improved tax incentives.

Improved federal tax credit

Under the Inflation Reduction Act of 2022 (IRA), the federal tax credit for residential geothermal system installations was increased from 26% to 30%, effective January 1, 2023. The 30% tax credit runs through 2032 and then gradually reduces until expiring in 2034. Today’s credits are far more valuable than the initial energy investment tax credits that included geothermal, which were first made available in 2008.

Commercial construction projects with systems under 1 megawatt in size are similarly eligible to receive the full 30% tax credit.

Projects over 1 megawatt in size that begin during 2023, and no later than January 1, 2025, will receive a base tax credit of 6%. However, they can qualify for the full 30% tax credit if certain labor requirements are met, including an assurance that all laborers and mechanics involved in the construction or maintenance of a project for five years after its completion are paid prevailing wages or greater, as required under the law. The prevailing wages requirement does not apply to projects that began earlier than January 29, 2023.

The federal credit is applied the year you place the system in service, so the sooner you get started the sooner you will reap the benefit. It’s also wise to explore any state or local credits, rebates, low-interest loans or other green energy incentives available for your project.

In addition, the IRA offers two bonus credits for projects of any size, one related to use of domestic steel/iron materials and the other dependent on project location within an energy community (these could be a brownfield site or an area historically reliant on coal, oil or natural gas extraction coupled with high unemployment).

Incentives for nonprofits

Nonprofits and other nontaxable entities can also benefit under the IRA. They can monetize the tax credits they receive when installing solar or geothermal systems. These clients can elect to be treated as having made a tax payment equal to the value of the tax credit they would otherwise be eligible to claim. The option effectively makes this tax credit refundable for these entities through direct pay.

The act also allows eligible taxpayers to transfer or sell all or a portion of their eligible tax credits to an unrelated taxpayer. The buyer of the credit can offset their income tax with this credit. The IRA extends the carryback period to utilize credits up to three years and any remaining credits can be carried forward.

Section 48 of IRA: Transfer of credits

IRA tax incentive Direct pay from the U.S. government Optional transfer incentive
  • Section 48 Investment Tax Credit (projects constructed in 2023 or 2024)
  • Section 48E Clean Electricity Investment Tax Credit (projects constructed in 2025 or later)
  • Section 45Y Clean Electricity Production Tax Credit (projects constructed in 2025 or later)
Direct pay eligibility is limited to state/local governments, tribes, rural electric coops and nonprofits.

Who can transfer:

  • All business taxpayers that are not eligible for direct pay
  • E.g., REITs, partnerships, corporations

Who can receive:

  • Any unrelated third party that pays taxes (the transferee taxpayer) and that buys the credit amount in cash

Source: The Real Estate Roundtable

The costs of these systems are depreciated over a five-year asset class life as energy property. As such, they are also eligible for bonus depreciation as a further incentive.

Other key advantages

Here are some other key advantages that can make geothermal a desirable option in new construction:

  • It’s always available:Like other renewables, the supply is unlimited, but unlike wind and solar, it is not dependent on daylight or affected by weather conditions.
  • It’s more reliable than conventional systems: There are fewer mechanical systems that can fail or need replacement. The pump that pushes coolant fluid through the pipes is the only component that needs maintenance.
  • It’s space saving: Compared to large wind turbines and solar panels, it’s a far more compact system. Because pipes are buried in the ground with few components above ground, much less is required inside a building for mechanical systems.
  • It runs silently: There are no mechanical noises such as those in boiler and furnace systems.

To be clear, geothermal doesn’t eliminate the need for any other energy sources for a building. Pairing geothermal with solar panels (for which tax incentives are also available) can help get carbon emissions closer to net zero. But you may still need to be connected to other utilities for a gas stove or other appliances. A backup conventional energy source (especially in bigger buildings in colder, northern climates) fills the energy gap when solar panels can’t meet the full electrical needs of users. In hotter climates, you may need a backup system to pull electricity for air conditioning.

What are the costs?

Geothermal system cost per square foot: $8-$19

Average cost: $13.50 per square foot

Construction costs: $6 million for 40,000 square feet

Install price for geothermal system: $540,000

While these systems cost roughly 40% more at the start than conventional HVAC systems, they have a faster payback period than traditional heating and cooling systems through lower energy bills, plus the cost-reduction benefits of the tax credit which would amount to about $162,000.

Here’s an example of the estimated cost savings between geothermal and a traditional system for a 40,000 square-foot apartment building:

Cost of geothermal vs. traditional heating and cooling system

10,000 gallons of fossil fuels: $30,000

65,000 kilowatt-hours of electricity: $10,000

The bottom line: a roughly 67% overall dollar savings for geothermal users.

Ongoing maintenance requirements and costs with a geothermal heat pump system — as opposed to maintaining a boiler or furnace and an air conditioning system — are also dramatically lower. With fewer mechanisms in a geothermal system, parts don’t wear out or need regular cleaning or replacement.

Broad applications

Geothermal power systems can be installed in almost any type of building: from manufacturing facilities and warehouses to shopping malls, public buildings and multifamily structures for cooling and heating.

How Wipfli can help

Geothermal contractors are more available than ever but determining the right company to use along with ensuring you are taking advantage of all possible tax incentives can be challenging. Wipfli professionals are ready to work with construction firms, developers, architects and engineers to help you make informed decisions about who to work with and how to make the most of the available federal, state and local energy incentives. Consider a cost segregation study that can offer additional depreciation deductions and other financial benefits. Building owners can gain confidence in making cost-effective decisions that also help the environment.

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Steven A. Barnes
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Teri Samples, CPA
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