Tax Deduction for Energy Efficient Commercial Buildings Made Permanent
179D Expected to Increase with “Build Back Better”
NOTE: This article was updated on Jan. 24, 2022, to reflect proposed upgrades in the Build Back Better bill.
The 2021 Consolidated Appropriations Act or “COVID Relief Bill” made permanent the section 179D Energy Efficient Commercial Building deduction. This means that owners of buildings that meet certain energy-efficient design criteria can realize an additional income tax deduction of up to $1.80 per square foot of the qualified building.
This benefit can be significant as evidenced by the following example:
- A single filer real estate investor constructs an energy-efficient commercial building containing 100,000 square feet. The building qualifies for a total $1.80 per square foot energy efficiency deduction or $180,000. At a 35-percent federal income tax rate, the investor’s tax bill is reduced by $63,000.
The new tax law also makes these important changes to the section 179D deduction:
- The deduction amount is indexed for inflation for years after 2020
- The comparable building standards are now within two years of construction start
The inflation index will increase the section 179D benefit, whereas the new two-year rule will make it more difficult for certain buildings to qualify (former comparable buildings were based on 2007 energy standards).
The benefits of section 179D will become even more valuable if President Biden’s “Build Back Better” agenda is passed. Proposed upgrades include:
- Sliding scale deductions with a base deduction of $3.00 per square foot, up to $5.00 per square foot with wage and apprenticeship requirements. The current maximum deduction is $1.80 per square foot.
- Energy efficiency design requirements include a 25% energy reduction over standards publicized by The American Society of Heating, Refrigerating and Air-Conditioning Engineers (“ASHRAE”). The current requirement is a 50% energy improvement.
- The current lifetime maximum deduction is replaced with a three-year cap
For building owners, section 179D is treated as a deprecation deduction subject to recapture upon disposition. Because most energy-efficient assets are 39-year property, or 27.5-year property in the case of residential buildings four stories or more, there is little if any negative impact when a section 179D energy study is combined with Cost Segregation.
For government-owned buildings, however, the section 179D deduction can be allocated to the primary design firm or firms and there is no depreciation recapture – because the beneficiaries have no basis in the property. Except for possible partnership interest or S-Corporation stock basis adjustments, the otherwise tax timing difference has the same effect as a permanent credit.
The COVID Relief Bill also extended the section 45L Energy Efficient Home Tax Credit through December 31, 2021. Section 45L benefits for certain prior years can only be realized through amended tax returns. Section 179D benefits can be realized for certain prior years through a change-in-accounting-method filing or amended tax returns for owners and amended tax returns only for designers.
As with section 179, section 45L benefits will become even more valuable if President Biden’s “Build Back Better” agenda is passed. Proposed upgrades include:
- Single-family and manufactured homes may qualify for a base credit increase to $2,500 per unit, with a tiered credit up to $5,000 per unit if certified as Energy Zero Ready DOE.
- Multifamily homes may qualify for a base credit of $500 per unit, then $2,500 or $5,000 per unit if prevailing wage and Energy Zero Ready DOE tests are met.
Under “Build Back Better”, proposed provisions for section 179D and section 45L would expire at the end of 2031.
If you have been or are involved in the construction of energy-efficient buildings, you will want to consider section 179D or section 45L, as applicable, to significantly reduce your next tax bill. Contact your Cherry Bekaert advisor or Ron Wainwright, of the Firm’s Tax Credits and Incentives Advisory practice for more information.