Energy Efficiency Tax Incentives in the Real Estate Industry
Originally published on October 17, 2022
The environmental impact of doing business varies by industry. In real estate, that impact ebbs and flows based on new buildings and the upkeep costs of current structures. Now with changes to Sections 179D and 45L brought by the Inflation Reduction Act (IRA), energy efficiency tax incentives provide more savings opportunities — and a chance to help the environment.
Sections 179D and 45L of the tax code provide energy-efficient incentives for both commercial and residential construction projects. When performed properly and verified by a third party, improvements could provide major tax incentives when building or remodeling. It’s good news for a wide range of real estate industry stakeholders, from owners to developers to designers.
Section 179D: The Energy-Efficient Commercial Building Tax Deduction
Section 179D was a temporary deduction designed to encourage energy efficiency. Made permanent by Congress at the end of 2020, it allows a per-square-foot tax deduction for energy-efficient commercial buildings.
To qualify for the deduction, buildings must be at least four stories high and have energy-efficient improvements in the lighting system, heating, ventilation, and air conditioning (HVAC), hot water system or building envelope. A third-party contractor must verify that the building meets energy-efficient standards set by the American Society of Heating, Refrigerating, and Air-Conditioning Engineers (ASHRAE).
IRA Changes to Section 179D
The IRA’s changes to Section 179D apply to buildings placed into service starting Jan. 1, 2023. These adjustments include increases in the maximum deduction and a decrease in calculated energy savings required. An alternative deduction for qualified retrofitted property has also been established for buildings placed into service before 2006. Additionally, more properties now qualify for these benefits.
Here’s a rundown of Section 179D’s benefits for buildings placed in service before on/after Jan. 1, 2023.
|Provision||Placed in Service 2006-2022||Placed in Service Starting
Jan. 1, 2023
|Maximum deduction amount||$1.88/square foot (subject to adjustment for inflation).||Up to $5.00/square foot (sliding scale, with exact amount dependant on the projected % of energy savings). Minimum deduction is $2.50/square foot. *|
|Minimum for estimated energy savings||50%||25% (earns the minimum deduction – higher percentages result in higher deduction amount).|
|Alternative deduction for qualified retrofitted property||None||Amount still in discussion; will require a written retrofit plan (from a qualified professional) that projects a minimum 25% energy use reduction.|
|Lifetime limit||The 179D deduction can only be taken once in a building’s lifetime.||Removed. The 179D deduction can be taken every three or four tax years, depending on the situation.|
|Eligible entities||Federal, state and local government properties (e.g., K-12 public schools, airports, public hospital systems, government buildings, public higher education buildings, etc.)||Previously eligible properties along with those owned by tribal governments, Alaskan Native Corporations and nonprofit organizations.|
* To qualify for the new range of deduction amounts, your company must meet prevailing wage and apprenticeship program requirements. Otherwise, the maximum deduction is $1.00/square foot, with a minimum deduction of $0.50/square foot.
While these changes open much wider possibilities for tax savings, however, the IRA has removed two provisions previously in effect:
- The partial allowance of $0.60/square foot for replacement of a system allowed under 179D(c)(1)(c).
- A deduction for reducing lighting power density from 25%-50% (deduction amount ranged from $0.60/square foot and up)
Property owners can claim this deduction on prior year returns if they request a change in accounting methods. Architects, contractors and engineers who design energy-efficient buildings owned by eligible entities can claim a deduction through an allocation process with the government entity as part of their overall contract. Prior year deductions are also available.
Section 45L: Energy Efficiency Residential Tax Credit
Section 45L gives those who build residential properties an energy-efficient credit per dwelling unit. Established in 2005, it had actually expired at the end of 2021 but was renewed by the IRA.
Section 45L can still be used by amending prior returns if it was not used previously. Qualifying properties range widely, from single-family homes to student housing and senior housing facilities. Even manufactured mobile home parks may qualify.
Changes to Section 45L
Originally, 45L provided a $2,000 tax credit per energy efficient home or apartment under four stories. Units had to be 50% more efficient than a comparable standard dwelling (per 2006 International Energy Conservation code standards). This energy efficiency had to be certified by a third party. Section 45L’s original amounts and standards still apply to units acquired before 2023.
For dwellings acquired Jan. 1, 2023 onward, however, there are several changes with the new law. For starters, the single-family home credit has increased to $2,500. The law also incorporates a base rate and bonus rate for multifamily homes. The base rate would be $500 and a bonus credit of up to $2,500.
Energy efficiency must now be measured using the Energy Star Residential New Construction program or the Energy Star Manufactured New Homes program. The standards for both are more strict than International Energy Code.
However, you can get more money if you exceed these standards. Zero Energy Ready single-family homes could include a credit of up to $5,000. Multifamily Zero Energy Homes include a base credit of $1,000 and a bonus credit of $5,000. A Zero Energy Ready home is defined by the U.S. Department of Energy as “a high-performance home which is so energy efficient, that a renewable energy system can offset all or most of its annual energy consumption.”
Finally, the building height limitation has been removed for multifamily properties (again, if acquired after Dec. 31, 2022).
Get Help with Real Estate Tax Credits and Incentives
Between increased credit amounts, lowered restrictions and expanded eligibility, you could be in line for a windfall of tax benefits. Check with your real estate CPA to see whether and Sections 179D and 45L can help you!
All content provided in this article is for informational purposes only. Matters discussed in this article are subject to change. For up-to-date information on this subject please contact a James Moore professional. James Moore will not be held responsible for any claim, loss, damage or inconvenience caused as a result of any information within these pages or any information accessed through this site.
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