A Fund-Based Pathway to Monetize Geothermal Tax Attributes and Cash Flows
The One Big Beautiful Bill Act of 2025 (the “O3B”) provided significant changes to the renewable energy sector reshaping the policy and investment landscape. However, the changes in the O3B offer an opportunity for those in the geothermal sector to combine early-stage deductions (in line with those available to oil and gas drilling operations) with long-term income streams and tax credit eligibility.
Geothermal power has a combination of the attributes investors appreciate most in clean energy: dispatchable baseload generation, long asset lives, and monetizable tax benefits. By organizing a fund to invest in a geothermal project, sponsors can offer investors exposure to multiple sources of value, including (i) allocations of intangible drilling and development costs (“IDCs”), (ii) clean electricity tax credits under sections 48E (the “ITC”) or 45Y (“PTC”), (iii) ongoing operating income from sales of electricity, and (iv) cash proceeds from the sale (transfer) of credits to third parties.
IDCs: Immediate Deductions for Early-Stage Drilling Expenditures
Generally, capital expenditures, e.g., improvements, new buildings, etc., must be capitalized and are not currently deductible for taxpayers.[1] However, an exception in the Code[2] allows a taxpayer that holds a working or operating interest in a geothermal well to elect to expense IDCs (rather than capitalize them).[3] IDCs generally include non‑salvageable, pre‑production costs such as labor, fuel, repairs, hauling, supplies, and similar items that are “incident to and necessary for the drilling of wells and preparation of wells,” and the election is made by deducting them on the first return in which such costs are incurred.[4]
Choosing Between §48E (ITC) and §45Y (PTC)
The Inflation Reduction Act of 2022 (the “IRA”) introduced technology‑neutral credits that apply to geothermal electricity facilities placed in service after December 31, 2024:
- § 48E (ITC) provides a credit equal to an applicable percentage of qualified investment (basis) in a qualified facility. The base rate is 6%, but a 30% rate applies when prevailing wage and apprenticeship (“PWA”) requirements are satisfied or for certain small/early‑construction cases; adders for domestic content and energy community can increase the credit further.
- § 45Y (PTC) provides a per‑kWh credit for electricity produced and sold from a qualified facility. The base credit rate is 0.3¢/kWh, and a 1.5¢/kWh rate applies if PWA requirements are met; the credit is available for 10 years from the placed‑in‑service date.
Note, however, that taxpayers are disallowed from claiming both the investment credit and the production credit for the same facility.[5] Accordingly, sponsors must carefully consider the potential options in order to select the most valuable approach.
Monetizing Credits: Transferability and Direct Pay
For taxable investors, the IRA added a section to the Code that allows an eligible taxpayer (including partnerships) to transfer credits to an unrelated buyer for cash.[6] Consideration must be paid in cash, but the payment is neither (i) taxable income for the seller or (ii) a deductible payment for the purchaser.[7] For partnerships and S corporations, credit sale proceeds are treated as tax‑exempt income for basis purposes and are allocated according to partners’ (or shareholders’) pro rata portion of the underlying credit.[8]
Tax‑exempt and governmental entities may utilize “elective pay” (often referred to as “direct pay”) for credits allowed under sections 45Y and 48E.[9] This election permits the tax-exempt entity to receive a refund equal to the credit amount after a required pre‑filing registration.[10]
Operating Income: Revenue from Power Sales
Unlike intermittent renewables, geothermal plants can deliver a steady baseload output, enabling long‑term power purchase agreements (“PPAs”) and predictable revenues. When paired with tax credit monetization and IDC expensing, these cash flows support competitive, or superior, return profiles in an investment fund.
Example Financial Illustration: ITC vs. PTC for a Geothermal Project
Important: The numbers below are illustrative to compare mechanics and use synthetic assumptions which omit depreciation/basis adjustments (including any ITC basis reduction), financing costs, inflation adjustments to the PTC, and tax‑rate effects from IDC deductions. Actual outcomes depend on specific facts and current guidance.
Assume the Following:
- Nameplate capacity: 20 MW (AC); capacity factor: 90% → 157.68 million kWh/year.
- Capital expenditure (capex): $120 million; IDCs assumed at 35% of capex (IDC expensing election available to working‑interest holders.)
- PPA price: $60/MWh (illustrative).
- PWA requirements are met and credits may be transferred at 92¢ per $1 of credit.
Results
- Annual electricity: 157,680,000 kWh.
- Annual operating revenue (at $60/MWh): $9,460,800.
- IDC amount (35%): $42,000,000 (potential year‑one deduction to working‑interest investors via fund allocation).
Scenario A – Claim §48E ITC and Transfer the Credit
- ITC face value (30% of $120M): $36,000,000.
- Cash from credit sale at 92%: $3,120,000
Scenario B – Claim §45Y PTC and Transfer Annual Credits
- PTC face value per year (1.5¢ × 157.68M kWh): $2,365,200.
- PTC face value over 10 years: $23,652,000.
- Cash from credit sale at 92%: $2,175,984/year ($21,759,840 over 10 years).
Nelson Mullins Observation: In this example, a 30% ITC (transferred) delivers more near‑term cash than the 10‑year stream of PTCs. Projects with lower capex per MWh or higher output may tilt toward the PTC, while capital‑intensive developments often favor the ITC. Adders (domestic content, energy community) can improve either option’s economics.
[1] See generally, § 263.
[2] References herein to the “Code” refer to the U.S. Internal Revenue Code of 1986, as amended, and references to the “Treasury Regulations” or “Treas. Reg.” refer to the Treasury Regulations promulgated under the Code.
[3] § 263(c); Treas. Reg. § 1.263(c)-1.
[4] Treas. Reg. § 1.263(c)-1 (referencing Treas. Reg.§ 1.612-4).
[5] § 45Y(b)(1)(E).
[6] § 6418.
[7] § 6418(b)(1)-(2).
[8] See generally, § 6417.
[9] § 6417(b)(8) and (12).
[10] § 6417(d)(5).
