U.S. Sen. Michael Bennett (D-Calif.) has submitted a letter to the Department of the Treasury urging the modification of part of an Internal Revenue Service (IRS) rule. The rule does not allow owners of different components of a geothermal heat pump (GHP) system to claim a tax credit for the operation of those components.

Furthermore, Bennett has enlisted 13 senators (all Democrats) to add their names to the letter, which is dated Oct. 3, 2024. They are, Richard Blumenthal (Conn.); Sherrod Brown (Ohio); Tammy Duckworth (Ill.); Richard Durbin (Ill.); Kirsten Gillibrand (N.Y.); Amy Klobuchar (Minn.); Edward Markey (Mass.); Bernie Sanders (Vt.); Brian Schatz (Hawaii); Tina Smith (Minn.); Chris Van Hollen (Md.); Elizabeth Warren (Mass.); and Peter Welch (Vt.).

The letter urges Treasury Sec. Janet Yellen to ensure that a final rule that governs the “investment tax credit (ITC)”—found in section 48 of the Internal Revenue Code—will allow “different taxpayers who own separate, functionally interdependent or integral components of a GHP system to be eligible to claim the ITC for the equipment they own.”

In the letter, the senators praise GHP systems and urge that more of them need to be deployed. 

“GHPs are among the most energy efficient heating and cooling systems available for buildings. Increasing their deployment holds enormous potential to lower energy bills for American families and businesses and to reduce emissions,” according to the letter.  

Nonetheless, the senators also express concern about aspects of a proposed rule—Definition of Energy Property and Rules Applicable to the Energy Credit (REG-132569-17)—published in the Federal Register as a notice of proposed rule-making (NPRM) on Nov. 22, 2023, in that it would amend the regulations relating to the energy tax credit for the taxable year in which eligible energy property is placed in service.

The proposed rule not only “would amend the regulations relating to the energy credit for the taxable year in which eligible energy property is placed in service,” it also “withdraws and re-proposes, for additional clarity, portions of previously proposed regulations regarding the increased energy credit amount available if prevailing wage and registered apprenticeship requirements are met.”

In a reflection of what the senators say, the proposed regulation would:

• •Update the types of energy property eligible for the energy credit, including additional types of energy property added by that law.
• Clarify the application of new credit transfer rules to the energy credit recapture rules applicable to failures to satisfy the prevailing wage requirements, including notification requirements for eligible taxpayers; and include qualified interconnection costs in the basis of some lower-output energy properties.

The proposed rule also provides “additional requirements and rules generally applicable to energy property, such as rules regarding functionally interdependent components; property that is an integral part of an energy property; application of an ‘80/20 Rule’ to retrofitted energy property; dual use property; separate ownership of components of an energy property; property that could be eligible for multiple federal income tax credits; and the election to treat qualified facilities eligible for the renewable electricity production credit instead as property eligible for the energy credit.”

The proposed regulation describes different types of energy properties and technologies that are eligible for the tax credit including geothermal heat pump equipment, and that “energy distribution equipment and components of a building’s heating and/or cooling system (can be considered) as components of geothermal heat pump equipment,” and “such equipment may be integral to the function of the geothermal heat pump equipment, to heat or cool a structure. Thus, energy distribution equipment may be considered geothermal heat pump equipment.”

However, it also said the “functional interdependence test” would be applied ‘to determine whether components are included as part of geothermal heat pump equipment.”

The section of the proposed regulation on “functional interdependence” said “components of property are functionally interdependent if the placing in service of each component is dependent upon the placing in service of each of the other components in order to generate or to store electricity, thermal energy, or hydrogen, or otherwise perform its intended function.”

“Energy property, with certain exceptions, includes all components necessary to generate or store electricity or thermal energy for transmission, distribution, or use up to (but not including) the stage that transmits, distributes, or uses electricity or thermal energy,” the rule said.

The document includes an explanation that details why some taxpayers who own an energy property are eligible to claim the tax credit and others are not. According to the document, a taxpayer who owns an energy property is eligible for the tax credit only to the extent of the taxpayer’s eligible basis in the energy property. In the case of multiple parties who hold ownership shares in an energy property, each party is eligible for the tax credit to the extent of their “fractional ownership interest.”

The document also said, “transmission and distribution equipment are not functionally interdependent components of an energy property, nor are they an integral part of an energy property.” But, if a taxpayer owns both the unit of energy property and at least a portion of the related power conditioning and transfer equipment, that taxpayer would be able to calculate the tax credit on the eligible basis of the energy property.

In the case of multiple parties that hold ownership shares in an energy property, each party is eligible for the tax credit to the extent of its fractional ownership interest. If power conditioning and transfer equipment owned by one taxpayer is an integral part of an energy property owned by an unrelated taxpayer, the taxpayer who owns the power conditioning and transfer equipment would not be eligible for the tax credit but the taxpayer who owns the energy property would be eligible for the tax credit.

However, the senators say if owners of separate components of a GHP system are prevented from claiming the ITC, and that “would severely inhibit the adoption of home-based and community-scale GHP systems, which typically involve multiple owners.”

The letter describes basic GHP-system nomenclature, which it links to why the owners of separate components of a GHP system should be allowed to claim the ITC. The letter said “a GHP system typically includes a ground loop (or heat exchanger) outside the building as well as a heat pump(s) and conditioning distribution system (piping and ductwork) inside the building—these components typically have different owners.

“Treasury’s interpretation in the NPRM is that these pieces of equipment are functionally interdependent yet distinct components of the same system. As drafted, the agency proposes excluding multiple taxpayers who own those distinct components of a GHP system from claiming a tax credit under the ITC unless the two taxpayers share more than 50 percent overlapping ownership of the equipment.”

The senators oppose that interpretation of the ITC by the IRS, saying such an interpretation “runs antithetical to congressional intent in passing updates to the ITC, which was to promote the wide-scale adoption of GHPs and other clean-energy technologies.”

The senators urge modification of “the proposed guidance and issue a final rule that acknowledges the unique ownership structure of GHP systems and allows who separately own the components of a geothermal heat pump system to fully leverage” the tax credits provided under section 48 of the ITC. “This will ensure, as Congress intended, that we maximize the deployment of GHP technology and its associated energy reliability and cost savings benefits,” the letter said.

The senators are not the not the only entities concerned about the proposed rule.

Industry insider Ryan Dougherty, president of the Geothermal Exchange Organization, told The Driller the proposed rule as written would be “a huge problem for the industry because it flies in the face of both existing and emergent business models that are predicated upon joint system ownership.”

Under the proposed rule, “if taxpayer ‘A’ owns the ground loop portion of the system and taxpayer ‘B’ owns the heat pump portion of the system, neither party is eligible for any portion of the investment tax credit,” Dougherty said.

“This is particularly troublesome for the nascent thermal energy network sector or segment of the industry,” said Dougherty, who added, most community style thermal energy networks are “built around or contemplated upon a shared ownership model.”

Members of the Senate are not the only lawmakers concerned about the proposed regulation, for House member Rep. Sean Casten, D-Ill., is circulating a similar letter among his colleagues requesting they add their names to the missive.