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179D Tax Deduction made Bigger and Better

The Federal tax deduction increases from $1.80 a sq ft to $5.00 a sq ft
179D

The Inflation Reduction Act of 2022 has been much talked about in the 14 days since it was signed by President Biden, but little has been said about the provisions that modified the 179D energy efficient commercial buildings federal tax deduction making it bigger and better.

Section 13303 of HR 5376 – The Inflation Reduction Act of 2022, beginning on page 137 of the bill, expands the maximum dollar amount of the federal tax deduction from $1.80 a square foot (actually adjusted for inflation for properties put into service in 2022, $1.88 a square foot) to $5.00 a square foot. It also adds who is eligible to utilize that deduction available today to commercial building owners and governments (that assign the tax benefit to others) adding tax exempt entities (including non-profits, houses of worship, schools, and more) and also REITs, each that do not pay federal income taxes and will now be able to assign the tax deduction to others (in the way governments currently assign this deduction).  

The 179D commercial buildings energy efficiency tax deduction has since 2006 enabled building owners to claim a $1.80 per square foot tax deduction (i.e., this tax incentive has been popular both because it is based on the area of the building not the dollar amount expended and that documentation is very easy) for installing qualifying systems and buildings. Tenants may be eligible if they make the construction expenditures. If the system or building was installed on federal, state, or local government property, the 179D tax deduction could be assigned to the businesses primarily responsible for the system’s design or installation; and now non-profits and REITs (that can now use this deduction directly in calculating profits) will be eligible, significantly benefitting the design and construction industries.

HR 5376 makes clear that the existing provisions remain in effect through December 31, 2022 and the new text will be effective, permanently, from January 1, 2023 forward.

While previous iterations of these IRS Code provisions were fairly straightforward, the new text adds new levels of complexity.

The amended Code provisions set a new minimum qualification, “.. the total annual energy and power costs for the building are certified to be reduced by a percentage greater than 25 percent.”

HR 5376 The Inflation Reduction Act of 2022

The dollar value of the deduction is a sliding scale, also found in the amendments, “the applicable dollar value shall be an amount equal to $0.50 [per square foot] increased (but not above $1.00) by $0.02 for each percentage point” by which the total annual energy and power costs for the building are reduced over 25 percent (i.e., the current $.60 partial deductions will be eliminated as will be the “interim lighting” rule).

Those deductions will see an “increased deduction amount” for projects that both meet local prevailing wage and apprenticeship requirements for any laborers and mechanics employed by the taxpayer or contractors associated with the installation, a politicized change in the program driven by the Democrat party [of course no Republican in Congress voted for this bill] benefitting unions, and note today only 32 states have prevailing wage requirements for government building. Again, on a sliding scale this increase is $2.50 a square foot for energy savings of 25 percent up to a resultant bonus deduction equal to $5.00 per square foot for energy savings of 50 percent or more (c.f., without the prevailing wage and apprenticeship requirements being satisfied, the maximum deduction will be $1.00 a square foot).

Significantly, since 2006 there has been a lifetime cap for this deduction of $1.80 a square foot (again, now $1.88 adjusted for inflation), but under these amendments, there is a 3 year cap that allows the new amount in full to be claimed if the previous 179D deduction was utilized by the taxpayer more than 3 years ago. This is a big deal for a program that had been interpreted as an accelerated depreciation program (i.e., from the usual building depreciation over 39 years to 1 year), but now the 179D deduction can be claimed again. 

In an interesting quirk, the reference standard for calculating the energy saving percentage will change prospectively. The amendment strikes ‘‘the most recent’’ and inserts ‘‘the more recent of –  “(A) Standard 90.1-2007 published by the American Society of Heating, Refrigerating, and Air Conditioning Engineers and the Illuminating Engineering Society of North America, or “(B) the most recent”.

And then altering time frames again by striking ‘‘2 years’’ and inserting ‘‘4 years’’, and by striking before ‘‘that construction of such property begins’’ and inserting ‘‘such property is placed in service’’.

There is new text relaxing the qualifications for retrofitting existing buildings, such that beginning in January, deductions will be available for buildings that improve their energy efficiency by 25 percent. The text describes this in terms of a decrease in “Energy Use Intensity” to 25 percent, which had been 50 percent, and the removal of the requirement for an energy model, but how those work will have to await regulations or other guidance. Retrofits may be the sweet spot of this Act funding, for example, Maryland’s mandatory 20 percent reduction in direct greenhouse gas emissions for commercial buildings by 2030.

There will be regulations issued to implement the amendments and it can be anticipated they will be extensive.

We have historically supported the “qualified individuals” including licensed contractors that have done the certifications under this program, including to assist in making the modeling and documentation frictionless, and we will continue to do so under the new Act.

Of note, given that other provisions of The Inflation Reduction Act of 2022 give the IRS another $45.6 Billion targeting taxpayer enforcement activities, which could mean as many as 87,00 new agents, taxpayers may be well served to seek advice and counsel before claiming these bigger and better deductions.

179D has, for more than a decade, been the most used government incentive driving energy efficient commercial buildings. It is not clear what impact these modifications will have, but many observers believe the politicization of the program will result in a precipitous drop in the number of buildings advantaged, but those fewer deductions will be in larger dollar amounts, which will not be good for the green building industrial complex and not good for repairing the planet.

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