In October 2008, under section 48(a) of the Internal Revenue Code, geothermal heat pumps were included to the definition of “energy property”. This produced a 10% tax credit for costs associated with geothermal equipment “placed in service” (defined by the IRS as made ready and available for use) through the end of 2016. Because Geothermal equipment is classified as 5-year depreciable property under section 168(e)(3)(B)(vi)(I) of the Internal Revenue Code, it can be deducted on an Modified Accelerated Cost Recovery System (MACRS) basis. The basis must be reduced by one half of the tax credit for depreciation purposes. For a corporation in a 35% tax bracket, the MACRS depreciation provides additional tax savings equal to 33.25% of the energy property spending within the first 5 years, with the greatest tax benefit at the beginning. By comparison, conventional heating and cooling systems usually depreciate over a 39-year straight line basis and would only provide 4.5% in tax savings over the first 5 years.

Equipment that uses the ground or ground water as an energy source for heating and cooling a building is eligible for the tax credit. The structure must be located in the United States and only its owner can claim tax credits or depreciation deductions. The taxpayer must take legal title of the equipment and have all necessary licenses and permits needed for its operation. If an owner can’t use the tax credits, other options exist such as sale-I ease backs, partnership “flip” structures, or energy purchase contracts.

The credit can’t be claimed for spending on equipment used for a purpose other than space conditioning, on previously used equipment, or on equipment that’s used by tax exempt organizations like schools, government agencies, or charities. This also precludes tax-exempt entities from leasing energy property.

Use IRS Form 3468 to claim the Energy Credit. Please note that as of March 2009, this form has not yet been updated to reflect the October 2008 changes. The tax credit can be used to offset both regular income taxes and alternative minimum taxes (AMT). If the tax credit exceeds the income tax liability, the loss can be carried back one taxable year and the remaining balance can be carried into future years.

Under The American Recovery and Reinvestment Act of 2009, businesses have the ability to enhance tax savings by accelerating depreciation on a geothermal system. Energy property placed in service between 2008 and 2009 is eligible for a special 50% first-year “bonus” depreciation. The remaining depreciation follows the 5-year MACRS schedules. Energy property may also be eligible for the section 179 deduction, which allows small businesses to write-off 100% of the purchase price the year it was bought, to a maximum of $250,000 for 2009. Conventional heating and cooling systems aren’t eligible for bonus depreciation nor the section 179 deduction. IRS Publication 946 provides guidance on how to depreciate property and the section 179 deduction.

All commercial and private buildings are eligible for a 10% grant in lieu of tax credit for geothermal projects started between 2009 and the end of 2010. A check is written from the government to the building owner within 60 days of completion. This option is provided as alternative in order to improve cash flow. Eligibility requirements for the grant are the same as requirements for the credit.

A tax deduction of $1.80 per square foot is available to building owners of new or existing buildings who install (1) interior lighting; (2) building envelope, or (3) heating, cooling, ventilation, or hot water systems that reduce the building’s total energy and power cost by 50% or more in comparison to minimum requirements set by ASHRAE Standard 90.1-2001. Deductions of $0.60 per square foot are available for lighting, building envelope, or heating and cooling systems that provide at least 1/3 of the 50% savings target. Energy savings must be calculated using software approved by the IRS. While deductions are available primarily to building owners, tenants may be eligible if they make construction expenditures. In the case of energy efficient systems installed on or in government property, tax deductions will be given to the person primarily responsible for the systems’ design. Deductions are taken in the year when construction is completed.