How Real Estate Developers Can Use the Section 179D Deduction

We work with a lot of real estate developers who know how to find opportunity in a spreadsheet, on a set of plans or during a hardhat walk-through. But one area where we still see money left on the table is in energy-efficient building deductions — specifically, the Section 179D deduction.

This is not a new tax break. What is new is the expanded scope and higher value made possible by recent legislation. If you’re building commercial property or multifamily buildings four stories or taller and installing qualified HVAC, lighting or envelope systems, there’s a strong chance you can deduct a significant portion of those costs (sometimes several dollars per square foot).

The key is planning. To fully benefit, you need to build the 179D deduction into your design, budget, documentation and accounting approach from day one. Here’s what real estate developers need to know.

 

 

What is Section 179D and why it matters for developers

Section 179D is a federal tax deduction that allows commercial building owners or designers to write off part of the cost of energy-efficient systems. It was originally introduced in 2005; updates from the Inflation Reduction Act in 2022 made the deduction more valuable, flexible and relevant for developers.

The current version of 179D provides a base deduction of $0.50 per square foot. That number scales up based on the energy savings achieved by your project. If your building meets certain wage and apprenticeship requirements, the deduction can increase up to $5.00 per square foot. That means a 150,000-square-foot commercial development could yield up to $750,000 in tax deductions.

Here are a few reasons developers are paying attention:

• Projects only need to show a 25% energy savings compared to a reference building. This lower threshold makes qualification more achievable.
• The deduction now applies annually for repeat upgrades. Developers working on phased projects can claim benefits in multiple years.
• Tax-exempt entities such as universities or local governments can transfer the deduction to the designer or contractor. This opens the door for design-build firms and private partners to benefit.

To qualify, a third-party engineer or approved modeler must certify the energy savings using Department of Energy software. You also need documentation that matches the building’s placed-in-service date and project timeline. That’s why it pays to involve your accounting and controllership team early.

If you want to see the IRS breakdown, here’s IRS Notice 2022-48, which outlines the technical requirements. For modeling standards, the Department of Energy’s 179D resources are a useful reference.

This deduction is not automatic. But with the right strategy and support, it can significantly improve your project’s financial return.

Who qualifies and what types of projects are eligible

Real estate developers are in a unique position when it comes to Section 179D. While the deduction was originally designed for building owners, recent changes have expanded eligibility to include designers and contractors in certain public and nonprofit projects. This opens valuable tax planning opportunities for both developers and their strategic partners.

Here’s how eligibility works:

• Privately owned projects: If you’re the developer and own the building when it is placed in service, you are eligible to claim the deduction directly. This applies whether you lease the space to tenants or operate it yourself.
• Government or nonprofit projects: If you’re designing or building a facility for a public or tax-exempt entity, you may be able to claim the deduction if it is allocated to you. This includes schools, airports, municipal buildings and universities. The building owner must formally allocate the benefit to you and you must be responsible for the energy-efficient design or construction.

Qualified projects must be commercial buildings or multifamily residential properties that are at least four stories above grade. The improvements must relate to:

• Interior lighting systems
• HVAC or hot water systems
• Building envelope components (including insulation, windows and roofing)

Your improvements must reduce the total annual energy and power cost of the building by at least 25% relative to a reference building that meets ASHRAE Standard 90.1. That energy savings must be modeled and certified by a qualified third party.

This deduction is based on square footage, not the cost of the upgrades. This means the larger the building, the larger the potential benefit. For developers working on big-box retail, office towers or multi-building campuses, that can add up quickly.

How to plan for the deduction in the development lifecycle

Section 179D works best when it is treated as a strategic lever from the beginning of a project. Here’s how to do that.

1. Feasibility and pro forma modeling

Early in the development cycle, include 179D in your ROI models. If your plans already involve energy-efficient systems, factor in the potential deduction to improve your project’s internal rate of return. You might find that a higher-efficiency HVAC system or envelope material pencils out better once the tax deduction is considered.

2. Design and specifications

Work with your architects and mechanical engineers to ensure systems meet or exceed ASHRAE 90.1 standards. Document these specs clearly and ensure your team knows which systems will be modeled for compliance.

3. Budget and cost segregation alignment

Your controllership team should integrate 179D modeling with your cost segregation approach. Since both strategies affect depreciation and timing, coordinating them can avoid basis reduction issues and unlock greater cash flow.

4. Certification and engineering reports

Before the building is placed in service, engage a qualified engineer or energy modeler who is approved to certify the deduction under IRS guidelines. This report must be completed before you file your return and should be retained in your permanent project file.

5. Placed-in-service date coordination

Your deduction must align with the tax year in which the property is placed in service. Coordinate with your accounting team to match the certification date, occupancy certificate and project closeout timeline so your deduction is claimed in the right year.

6. Labor standards for higher deduction

If you plan to pursue the full $2.50 to $5.00 per square foot deduction, you’ll need to meet prevailing wage and apprenticeship requirements. These must be documented through certified payroll and training program records. We recommend building this into your subcontractor agreements and job cost tracking.

 

 

Key requirements under the new rules: Energy savings, prevailing wage and apprenticeship

The Inflation Reduction Act also introduced new rules developers must meet to claim the full benefit of Section 179D. Here are the three core requirements under the updated 179D framework:

1. Minimum energy savings of 25%

As mentioned earlier, your building must reduce total annual energy and power costs by at least 25% compared to a baseline building that meets ASHRAE Standard 90.1. This baseline is determined based on the ASHRAE version that was in effect four years before the building’s placed-in-service date.

The higher the energy savings, the larger the deduction. Once you meet the 25% threshold, the deduction increases by 2 cents per square foot for each additional percentage point saved, up to a maximum of $1.00 per square foot under the base rate. If your project meets the labor standards described below, those same figures multiply by five, with a new cap of $5.00 per square foot.

2. Prevailing wage requirement

To qualify for the higher deduction, all contractors and subcontractors working on the project must be paid at rates that meet or exceed local prevailing wages. These rates are determined by the U.S. Department of Labor and are typically based on union or market standards in the construction area.

This requirement applies to direct employees and workers brought in by subcontractors. Accurate documentation is essential. The IRS expects certified payroll records and may require evidence that prevailing wage rates were included in bid documents and contracts.

3. Apprenticeship requirement

In addition to prevailing wage, your project must meet registered apprenticeship thresholds. This means a certain percentage of total labor hours must be performed by qualified apprentices from a certified training program. (That rate is currently 15% for projects started in 2024 or later.)

You must also demonstrate a good-faith effort to hire apprentices. If no apprentices were available or a program did not exist in your market, the IRS may waive this requirement if you can document your efforts to comply.

Real estate developers need to address these rules during preconstruction. That means including wage and apprenticeship language in bid packets, verifying certified payroll systems and working with trade partners who understand federal compliance. It also means keeping your accounting and tax team in the loop so deduction eligibility isn’t compromised down the line.

Practical examples, common pitfalls and retroactive opportunities

Let’s walk through an example of capturing the full value of Section 179D, the issues that could result from planning gaps, and how to remedy them.

Example:

A developer builds a 100,000-square-foot professional office building in Florida, with modern HVAC, LED lighting and energy-efficient windows. The energy modeling shows a 34% energy cost reduction compared to the ASHRAE baseline.

• Meets prevailing wage and apprenticeship requirements
• Qualifies for the full $3.40 per square foot deduction (base rate of $0.50, plus 9 cents per point over the 25% threshold, multiplied by five)
• Total deduction: $340,000

With proper documentation, this deduction can reduce the developer’s taxable income significantly or create a benefit that passes through to investors.

Avoidable pitfalls:

• Late certification: If you wait until after the tax return is filed to obtain the engineering report, you may lose eligibility. Certification must be completed before filing.
• Insufficient labor records: Projects claiming the higher deduction without clear payroll records showing prevailing wages and apprenticeship participation may be denied upon IRS review.
• Failure to reduce basis: If you claim the deduction and forget to reduce the building’s basis by the same amount, it can lead to future depreciation errors and possible IRS penalties.
• Missed cost segregation coordination: If your team performs cost segregation but does not coordinate it with 179D modeling, deductions may overlap or conflict.

Retroactive opportunities:

If you built or renovated qualifying property in prior years and missed the deduction, you may still have options. In many cases, developers can file IRS Form 3115 to make a change in accounting method and claim the deduction retroactively.

This strategy allows you to avoid amending prior-year returns and instead apply a “catch-up” adjustment in the current year. It requires documentation and a technical review, but it can be a powerful recovery tool for past missed opportunities.

How Real Estate Developers Can Use Section 179D to Unlock Major Tax Savings

For real estate developers, Section 179D is a strategic advantage that can increase project profitability, improve investor returns and reward energy-efficient design. But to claim the full benefit, you need to plan early, document carefully and work with advisors who understand both the accounting and construction sides of the equation.

At James Moore, our Real Estate team works with developers to align tax strategy with construction schedules, cost allocations and long-term business goals. If you’re considering a new project or wondering whether a past one qualifies, we can help you evaluate the potential and take action.

Contact a James Moore professional to learn how our controllership and advisory services can support your real estate development goals and improve your tax efficiency.

 

 

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