- Though the energy-efficient commercial buildings deduction (Section 179D) is still in limbo, building owners and the designers of government buildings may find advantages in pursuing it.
- The new energy-efficient home credit (Section 45L) has been extended through 2032 and provides opportunities for increased tax credits to eligible contractors
- Review key changes to learn more about prevailing wage requirements, increased credits and deductions, and more stringent energy-efficiency models.
Do you qualify for energy-efficiency deductions or credits?
The Inflation Reduction Act of 2022 (IRA 2022), signed into law on August 16, 2022, includes numerous individual and business energy efficiency incentives. Two existing tax incentives received significant enhancements and improvements in IRA 2022. Review key changes to uncover potential tax savings and tax planning strategies.
Energy-efficient commercial buildings deduction (Section 179D)
Section 179D was made a permanent feature of the Internal Revenue Code with the passage of the Consolidated Appropriations Act, 2021. With this permanence, however, came the requirement that the “reference standard” used for calculating energy efficiency must be affirmed by the Secretary of the Treasury in consultation with the Secretary of Energy. To date, that consultation has not occurred, which has left Section 179D in limbo.
What is the energy-efficient commercial buildings deduction?
Prior to the passage of IRA 2022, Section 179D provided for a deduction of the costs of energy-efficient commercial building property. This deduction was limited to a factor based on the square footage of an energy-efficient commercial building. Each building had the potential to deduct up to $1.80 per square foot of qualifying space if it is 50% more efficient than a reference standard.
Even if the building was not able to reach the 50% efficiency threshold, the statute permitted a partial deduction for each of three separate energy-efficient components:
- Interior lighting systems
- Heating, cooling, ventilation, and hot water systems
- Building envelope construction
Each system could provide a $0.60 deduction per square foot of qualifying space.
There are two ideal targets for the Section 179D deduction — building owners and the designers of government buildings. Because governmental entities cannot take advantage of this deduction, the governmental entity is allowed to allocate the deduction to the designer of the energy-efficient systems. In the case of building owners, the Section 179D deduction requires a reduction in basis of the building property equal to the amount of the deduction.
What is the reference standard?
The reference standard used to model energy-efficient buildings for the Section 179D deduction is published by the American Society of Heating, Refrigerating and Air Conditioning Engineers and the Illuminating Engineering Society of North America (ASHRAE). These standards and guidelines establish uniform testing, safe practices, and proper definitions for industry and the public, and are updated periodically. To qualify for the Section 179D Deduction, ASHRAE 90.1-2001 was used from 2006 through 2015. Subsequently, ASHRAE 90.1-2007 was used for buildings placed in service from 2016 through 2020.
What changed in IRA 2022?
IRA 2022 states that taxpayers may use the “most recent” standard (ASHRAE 90.1-2007) until the Department of Energy has issued a final determination — affirmed by the Secretary of the Treasury after consultation with the Secretary of Energy — that is not later than four years before the date such property is placed in service. These changes are effective for taxable years beginning after December 31, 2022.
Other key changes to Section 179D include:
- Updated efficiency requirements — a qualifying building must increase its efficiency relative to a reference standard by 25%.
- Partial qualification for different building systems is no longer permitted.
- The deduction would be set at $0.50/sq. ft. and increased by $0.02 for each percentage point by which the certified efficiency improvements reduce energy and power costs, with a maximum of $1.00/sq. ft.
- If the project also meets certain prevailing wage and apprenticeship requirements, the base amount is $2.50/sq. ft., which would increase by $0.10 for each percentage point increase in energy efficiency, with a maximum amount of $5.00/sq. ft.
- The deduction can now be allocated to designers of energy-efficient buildings for tax-exempt entities rather than only for governmental entities.
New energy-efficient home credit (Section 45L)
The Section 45L credit for new energy-efficient homes expired on December 31, 2021. However, IRA 2022 extends this credit through 2032 and provides some substantial changes to the energy-efficient home credit scheme.
What is the new energy-efficient home credit?
Prior to the passage of IRA 2022, the Section 45L new energy-efficient home credit provided for a $2,000 tax credit per energy-efficient dwelling unit for an “eligible contractor,” defined as the person who constructed, reconstructed, or rehabilitated the qualified new energy-efficient home — or the producer of an energy-efficient manufactured home. The home must be acquired by a person from such eligible contractor for use as a residence during the taxable year.
To qualify, the energy-efficient dwelling unit was required to be 50% more efficient than a standard dwelling unit designed using the 2006 International Energy Conservation Code standards. The modeling for the energy-efficient dwelling unit must be completed by a third-party eligible certifier as defined in IRS Notice 2008-35. There is no partial credit if the 50% threshold is not met.
What changed in IRA 2022?
IRA 2022 extends the tax credit through December 31, 2032. In its current form, the tax credit stays as-is for new residential property sold or leased in 2022. Beginning in 2023, the credit will be increased to $2,500 per unit, but decreased to $500 per unit for multifamily homes. These homes will need to be modeled against the more stringent Energy Star Residential New Construction program or the Energy Star Manufactured New Homes program.
Other key changes to Section 45L include:
- An increased credit of $5,000 per unit for dwelling units that meet the more stringent Zero Energy Ready Home program according to the Department of Energy as in effect on January 1, 2023 (or any successor program determined by the Secretary).
- An increased credit of $1,000 per unit if multifamily homes meet the requirements of the Zero Energy Ready Home program.
- If the taxpayer confirms that employees of contractors and subcontractors are paid prevailing wages, the credit for multifamily units is increased to $2,500 (or $5,000 in the case of a Zero Energy Ready multifamily unit).
How CLA can help
CLA’s federal tax strategies professionals help clients capture tax incentives related to energy-efficient commercial and residential buildings. Our team members include engineers who are certified to provide the required authentication of the energy savings from these properties. Contact CLA to learn how your organization can increase cash flow and earnings by implementing tax planning strategies specific to your business.