Commercial building owners and tenants have been entitled to deductions under Section 179D since 2006. While the deduction has served as an incentive to make commercial buildings energy efficient, it may not have been impactful enough to sway decisions on improvements that move the needle.
Under the Inflation Reduction Act of 2022 (IRA), however, the deduction now attached to energy-efficient improvements for tax years beginning after December 31, 2022, has the potential to generate significant tax savings. These enhanced savings may be the incentive owners and tenants need to help commercial buildings take the leap into higher levels of energy efficiency.
Section 179D is a deduction available to commercial building owners, as well as tenants, architects or engineers, under certain situations, who make energy-efficient investments into new or existing commercial buildings. To qualify, an improvement must reduce annual energy and power costs by at least 25% relative to certain industry standards — previously this rate was 50%. This reduction must be certified by a contractor or engineer, and often can be part of a cost segregation study.
The amount of the deduction is based on the square footage of the building being improved multiplied by an “applicable rate.” The IRS annually publishes the applicable rate, which is tied to the number of building systems being improved. There are three potential building systems available for 179D treatment:
It is important to note that this incentive is an accelerated deduction of otherwise depreciable property and not a credit against tax owed. As a result, the deduction allows for building owners to expedite cost recovery of improvements into the year placed in service, rather than over longer depreciable lives of typically 39 or 40 years.
The most important change to Section 179D under the IRA is the applicable rate for tax years beginning after December 31, 2022. Previously, the maximum applicable rate for Section 179D deductions was $1.80 per square foot, indexed for inflation ($1.88 in 2022). Each building system improved entitles a taxpayer to one-third of the applicable rate.
For example, if only HVAC was improved in 2022, this would provide a deduction of $0.63 per square foot. However, if all three applicable building systems were improved, the full $1.88 per square foot would be deducted. Under the IRA, the partial deduction rules for each building system above have been removed and the applicable rate has been increased to a maximum of $5 per square foot, but there are also new requirements:
Read “What Prevailing Wage and Apprenticeship Requirements Mean for Energy Tax Credits”
The IRA also expanded eligibility for the deduction to tax-exempt and governmental organizations. As these entities by nature would not benefit from a tax deduction, the IRA allows them to pass the deduction onto the property designer, including architects and engineers. This makes 179D important even to a tax-exempt organization. Passing on the deduction should reduce the organization’s overall cost of energy efficient improvements on a project since the contractor will receive a special tax deduction from being involved on the project.
When deciding if certain energy-efficient improvements are worth their cost, there are several factors to consider:
It is best to model out all expected costs and savings expected from a project to understand the investment’s ROI both initially and over time. On an ongoing basis, keeping an eye on any relevant tax law changes will be critical.
Keep in mind since this is not a new deduction, if you believe an improvement may have qualified for Section 179D treatment previously but you didn’t claim it, you may still have time. This deduction can be included as part of an amended return for a period of time after the original tax return was filed, so you will want to act quickly. Regardless of whether you are considering new improvements to capitalize on the increased applicable rates or want to look at benefiting from older projects, contact your tax adviser and start the conversation.
Contact Justin Gartner at jgartner@cohenco.com or a member of your service team to discuss this topic further.
Cohen & Co is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.