The Ultimate Guide to Federal Tax Credits for Heat Pumps and Geothermal Upgrades

What Are the Federal Tax Credits for Heat Pump and Geothermal Upgrades in 2026?

Federal tax credits for heat pump and geothermal upgrades are available to eligible homeowners and businesses right now — and they can put serious money back in your pocket when you file your taxes.

Here is a quick overview of the main credits available:

Both the Section 25D and Section 25C credits apply to qualifying property installed through December 31, 2025, meaning homeowners who completed an eligible upgrade last year can claim those credits when filing their 2025 tax return in 2026.

Upgrading your heating and cooling system is one of the biggest financial decisions a homeowner can make. For coastal North Carolina homeowners — where humidity, salt air, and year-round temperature swings put real stress on HVAC equipment — choosing the right system matters even more. Federal tax credits can significantly reduce the upfront investment in a high-efficiency heat pump or geothermal system, making the decision easier.

The rules around these credits have shifted recently. The One Big Beautiful Bill Act (P.L. 119-21), signed into law on July 4, 2025, revised several timelines and provisions in the tax code that affect energy credits. Understanding what changed, what still applies, and how to claim every dollar you are owed takes a bit of unpacking — which is exactly what this guide is here to do.

Whether you are a homeowner in New Bern, a small business owner in Morehead City, or a property owner anywhere along the Crystal Coast, this guide walks you through everything you need to know to take full advantage of available federal incentives.

Quick federal tax credits for heat pump and geothermal upgrades definitions:

• inflation reduction act benefits for nc homeowners
• north carolina energy rebates for hvac upgrades

Understanding Federal Tax Credits for Heat Pump and Geothermal Upgrades

Navigating tax laws can feel like trying to read a thermostat in the dark, but breaking down the two primary residential tax credits makes it much simpler. When we talk about federal tax credits for heat pump and geothermal upgrades, we are looking at two distinct sections of the Internal Revenue Code: Section 25C and Section 25D.

These credits were designed to help property owners transition to cleaner, more efficient energy systems. For those of us living along the coast, choosing high-efficiency systems isn't just about environmental responsibility; it is about keeping our homes comfortable against the heavy ocean air and humid summers. You can explore the unique advantages of these systems in our guide on Heat Pump Benefits for Coastal North Carolina Homeowners.

Let’s look at how these two credits compare side-by-side:

Residential Clean Energy Credit (Section 25D) for Geothermal

The Section 25D credit is a powerhouse for homeowners who choose to install geothermal heat pump systems. This credit covers a full 30% of the complete installation cost. Because geothermal systems require ground loops to be drilled or buried, the overall installation is more involved than a standard air-source system.

Fortunately, the federal government does not place an annual or lifetime dollar cap on Section 25D. If your geothermal system qualifies, you receive a tax credit equal to 30% of the entire project cost, period.

Furthermore, Section 25D is nonrefundable, meaning it cannot reduce your tax liability below zero to give you a cash refund. However, it features a highly beneficial carryforward provision. If your calculated credit is larger than the federal income tax you owe for the year of installation, you can carry the remaining unused credit forward to offset your taxes in future years. To determine if this advanced technology is the right fit for your property, read our detailed analysis: Is a Geothermal System Worth the Investment.

Energy Efficient Home Improvement Credit (Section 25C) for Air-Source Heat Pumps

If you are upgrading to a high-efficiency air-source heat pump or a heat pump water heater, Section 25C is the credit you will use. This credit also covers 30% of the costs, but it is subject to strict annual caps.

Under Section 25C, you can claim up to a maximum of $2,000 per year for qualified heat pumps and heat pump water heaters. This $2,000 limit is separate from the $1,200 annual cap reserved for other building envelope improvements (like insulation, windows, and doors), allowing homeowners to potentially claim up to $3,200 in total energy efficiency tax credits in a single tax year.

Unlike Section 25D, Section 25C is a "use-it-or-lose-it" annual credit. It cannot be carried forward to future tax years. This makes strategic planning essential if you plan to make multiple home improvements. To understand how high-efficiency heat pumps compare to standard models, check out our Standard Efficiency vs High Efficiency HVAC Comparison.

How the One Big Beautiful Bill Act (P.L. 119-21) Impacts Your Upgrades

The regulatory landscape for clean energy received a major update on July 4, 2025, with the enactment of the One Big Beautiful Bill Act (P.L. 119-21). This legislation revised several dates, percentages, and compliance rules in the Internal Revenue Code. For homeowners and businesses planning their taxes in 2026, understanding these legislative changes is key to maximizing your financial return.

The Act was designed to streamline clean energy incentives while maintaining long-term stability for key technologies, particularly geothermal. While it modified the broader framework established by previous legislation, it preserved the core benefits of the 30% residential tax credits for qualifying installations completed by the end of 2025. You can read more about the foundation of these incentives in our article on Inflation Reduction Act Benefits for NC Homeowners.

New Timelines and Phase-Out Schedules under P.L. 119-21

Under P.L. 119-21, the timelines for residential clean energy incentives have been clarified. For the 2026 filing season (covering systems installed and placed in service during the 2025 tax year), the credit rate remains at a full 30% for both Section 25C and Section 25D.

As we look past 2026, the law outlines a gradual phase-out schedule to ensure long-term stability while transitioning the market. For geothermal systems under Section 25D, the 30% rate remains highly stable, but property owners should pay close attention to the designated phase-out steps in the coming years to ensure they lock in the highest possible credit percentage before statutory reductions take effect.

Commercial Investment Tax Credit (Section 48) Adjustments

For commercial building owners, institutional properties, and agricultural producers along the Crystal Coast, P.L. 119-21 brought significant updates to the Section 48 Investment Tax Credit (ITC).

Commercial geothermal heat pump (GHP) projects are eligible for a base tax credit of 6%. Under the revised guidelines, this base rate is scheduled to scale down to 5.2% in 2033 and 4.4% in 2034, phasing out completely for projects that begin construction in 2035.

However, businesses can unlock "bonus credits" that increase the total tax credit up to 30% if they meet specific federal requirements:

• Prevailing Wage and Apprenticeship (PWA): Projects under 1 megawatt (MW) automatically qualify for the enhanced 30% rate. Larger projects must meet strict prevailing wage and registered apprenticeship standards during construction.
• Domestic Content: An additional 10% credit is available if a specified percentage of the project's steel, iron, and manufactured products are produced in the United States.
• Energy Communities: Another 10% bonus can be claimed if the project is located in an area historically tied to fossil fuel industries or meeting specific economic distress criteria.

Eligibility and Requirements for Homeowners and Businesses

To successfully claim federal tax credits for heat pump and geothermal upgrades, your project must meet specific eligibility criteria defined by the IRS and the Department of Energy. These rules dictate which properties qualify and what technical standards the equipment must meet. For a deeper look at how these systems benefit local properties, see our guide on Geothermal Heating and Cooling Benefits for Homeowners.

Qualifying Equipment and Efficiency Ratings

Not just any heat pump off the shelf will qualify for federal tax credits. The equipment must meet strict performance metrics:

• Air-Source Heat Pumps (Section 25C): Must meet the ENERGY STAR Most Efficient criteria or the highest performance tier established by the Consortium for Energy Efficiency (CEE) in effect at the time of installation. To understand these metrics, read our guide on Efficiency Ratings Explained for Homeowners.
• Geothermal Heat Pumps (Section 25D): Must be ENERGY STAR certified at the time of purchase and must use the ground or groundwater as a thermal energy source or sink.
• Qualified Manufacturer Identification Number (QMID): Starting for systems placed in service in 2025 and claimed in 2026, the IRS requires taxpayers to report a valid QMID on their tax return. If your equipment does not have this certified manufacturer number, the credit will be disallowed.

Who Qualifies for Federal Tax Credits for Heat Pump and Geothermal Upgrades

Eligibility varies significantly depending on how the property is used and who owns it:

• Homeowners: You can claim the Section 25D credit for qualifying geothermal installations in your primary residence or an existing second home that you use as a residence. New construction homes also qualify.
• Renters: Renters are eligible to claim the Section 25C credit for air-source heat pumps they purchase and install in their rented residence, provided they meet all other criteria.
• Landlords: Landlords and property owners who do not live in the property cannot claim residential clean energy credits (Section 25C or 25D) for rental properties. However, commercial landlords may qualify for business energy credits under Section 48.
• Mixed-Use Properties: If you use your home for business (such as a home office), your credit eligibility depends on the percentage of business use. If business use is 20% or less, you can claim the full residential credit. If business use exceeds 20%, the credit must be allocated proportionally.

Qualifying Expenses and Stacking Local Incentives

Calculating your tax credit starts with understanding which project expenses are "qualified clean energy expenditures."

For geothermal systems under Section 25D, qualified expenses include:

• The cost of the geothermal heat pump equipment itself.
• All assembly and installation labor.
• Piping, ground loops, and wiring required to connect the system to the home.
• Ductwork or distribution components that are integral or functionally interdependent with the geothermal system.

For air-source heat pumps under Section 25C, qualified expenses include the equipment and professional installation labor. Unlike geothermal, standard building envelope improvements under Section 25C (such as insulation) do not allow you to include installation labor costs — only the material costs qualify.

How Rebates and Subsidies Affect Your Tax Credit

Before you calculate your 30% tax credit, you must adjust your total qualified expenses to account for any rebates, utility subsidies, or manufacturer incentives.

Under IRS rules, any financial incentive that acts as a "purchase price adjustment" must be subtracted from your total project cost before you apply the 30% credit calculation. For example, if a local utility along the Crystal Coast provides a rebate for installing an efficient heat pump, that rebate amount must be deducted from your eligible expenses first. To see what state and utility programs are available in our area, review the North Carolina Energy Rebates for HVAC Upgrades.

Maximizing Savings with Federal Tax Credits for Heat Pump and Geothermal Upgrades

By understanding how these credits interact, smart property owners can stack incentives to achieve substantial savings. Because Section 25C operates on an annual cap, you can combine a $2,000 heat pump credit with other efficiency upgrades in the same year, up to a combined annual limit of $3,200.

Meanwhile, because Section 25D for geothermal has no annual limit and permits a carryforward of unused credits, you can install a geothermal system and a standard heat pump in the same tax year without one credit limiting the other.

How to Claim Your Clean Energy Tax Credits

Claiming your tax credits doesn't have to be a headache, but it does require careful recordkeeping and the correct tax forms.

Step-by-Step Filing with IRS Form 5695

To claim either the Section 25C or Section 25D credits, you must file IRS Form 5695 (Residential Energy Credits) with your federal income tax return.

1. Gather Receipts: Collect all invoices, itemized receipts, and proof of payment for the equipment and labor.
2. Obtain Manufacturer Certifications: Keep the manufacturer’s certification statement and the QMID for your records.
3. Fill Out Part I (Section 25D): Use this section to calculate your credit for geothermal heat pump installations. Multiply your adjusted qualified expenses by 30%.
4. Fill Out Part II (Section 25C): Use this section to calculate your credits for air-source heat pumps and other energy-efficiency upgrades, keeping in mind the individual and combined caps ($2,000 for heat pumps; $1,200 general limit).
5. Transfer to Form 1040: Carry the total credit amount from Form 5695 over to your main tax return to reduce your overall tax liability.

Note: Always consult with a qualified tax professional to ensure proper filing based on your unique financial situation.

Required Documentation and Professional Certifications

To protect yourself in the event of an IRS audit, maintain a dedicated file containing:

• The signed contract with your HVAC installer.
• Itemized invoices showing equipment model numbers and labor costs separated.
• The ENERGY STAR certification details for your specific geothermal or heat pump model.
• For commercial projects, documentation proving compliance with Prevailing Wage and Apprenticeship (PWA) rules if claiming the enhanced 30% ITC.
• When hiring professional designers or engineers, verify their credentials through recognized industry databases, such as the International Ground Source Heat Pump Association (IGSHPA) or the Geothermal Exchange Organization.

Frequently Asked Questions about Energy Upgrades

Can I claim the geothermal tax credit for a rental property?

No, as a landlord, you cannot claim the residential Section 25D tax credit for a property you do not live in. The Residential Clean Energy Credit is strictly reserved for properties used as a residence by the taxpayer. However, commercial landlords and business owners may qualify to claim the Section 48 Investment Tax Credit (ITC) for installing geothermal heat pump systems on commercial or income-producing properties.

What is the maximum tax credit I can receive in 2026?

For air-source heat pumps under Section 25C, the maximum annual tax credit is $2,000. For geothermal upgrades under Section 25D, there is no maximum dollar limit — you can receive a full 30% credit of the entire qualified installation cost, and any unused portion can be carried forward to future tax years.

Do DIY installations qualify for these federal tax credits?

While you can technically claim the credit for qualifying equipment you purchase and install yourself, you cannot include the value of your own labor in the qualified expenses. Furthermore, because geothermal and high-efficiency heat pump systems require specialized design, electrical wiring, and refrigerant handling, professional installation is highly recommended to ensure the system operates safely, meets local building codes, and performs at the efficiency levels required to qualify for the tax credits.

Conclusion

Investing in high-efficiency heating and cooling is one of the smartest upgrades you can make for your home or business. By taking advantage of federal tax credits for heat pump and geothermal upgrades, you can significantly offset the initial cost of installation while locking in lower utility bills for years to come.

At Airtech Mechanical Services, Inc., we bring over 20 years of local experience to homeowners and businesses throughout New Bern, Morehead City, Hampstead, and the Crystal Coast. Our certified technicians understand the unique demands of coastal climates, and we are committed to providing honest, reliable service with absolute integrity.

Whether you want to install a high-efficiency air-source heat pump, design a custom geothermal system, or join the Airtech Advantage Club to keep your current system running perfectly, we are here to help.

Ready to lower your energy bills and take advantage of these valuable federal tax credits? Schedule your heat pump or geothermal upgrade with Airtech Mechanical Services, Inc. to speak with our comfort specialists today!