Commercial Real Estate Accelerated 179D Tax Deduction Expanded

Real Estate

The Inflation Reduction Act of 2022 (“IRA”) is landmark legislation that aims to promote investment in clean energy and combat climate change. The act expands existing clean energy tax credits and enhances tax deductions to further incentivize the development and use of clean energy products and technologies. The IRA is expected to have a significant impact on the environment and the economy, and it is a crucial step towards a more sustainable future.

IRC Section 179D (“Sec. 179D”), now permanent, pertains to commercial building energy-efficient tax deductions that provide potential ongoing tax benefits for architecture, engineering, and construction companies. With the 100% bonus depreciation expense potentially phasing out, Sec. 179D allows an alternative method for immediate tax deductions.

The modified legislation also allows specified tax-exempt entities to allocate any Sec. 179D deduction to the taxpayer primarily responsible for designing the property (i.e., engineer, architect, etc.). This allows specified tax-exempt entities to monetize the Sec. 179D benefits for the first time in history.

To the extent a for-profit taxpayer takes a Sec. 179D tax deduction, they must reduce the basis of the energy efficient commercial building property (“EECBP”) that it capitalizes, places in service, and recovers through depreciation expense.

Increased Deduction Rate and Decreased Efficiency Rate

The IRA raised the Sec. 179D tax deduction from $1.88 to $5.00 per square foot in 2023 if specific requirements are met. In addition, the amount of increased energy efficiency required to receive an accelerated deduction significantly decreased under the IRA. The increase in the deduction amount per square footage and the decreased energy efficiency requirement were intentionally added to allow more commercial building improvements to be subject to the tax benefit.

Based on the previous law, to receive a Sec. 179D deduction, the energy efficiency percentage increase was required to be greater than 50%. Under the revised law, a deduction can still be accelerated even if the commercial building only has an energy efficiency percentage increase of at least 25%.

Provided the proper prevailing wage and apprenticeship (“PWA”) requirements are met, the accelerated 179D tax deduction is equal to $2.50 per square foot and increases by an additional $0.10 for each percentage point by which the total annual energy and power costs for the building are certified to be reduced by a percentage of at least 25%.

No PWA PWA Requirements Met
Base amount per square foot $0.50 $2.50
Increase for each percentage point over 25% per square foot $0.02 $0.10
Maximum $ deduction per square foot $1.00 $5.00

For example, assume a company has a 200,000 square foot building. Based on a proper certification of energy savings, the total annual energy costs were reduced by 40% by various energy-efficient building improvements. In addition, the company could certify that they met the prevailing wage and apprenticeship requirements. The maximum deduction for the improvement property that can be immediately deductible would be $800,000. The dollar amount applied to the 200,000 square foot building would be $4, or $2.50 plus $1.50 (40%-25% x .10 cents).

Energy-Efficient Commercial Building Property

The Sec. 179D tax deduction can be taken on improvements and new construction for EECBP. The following criteria must be met to claim the Sec. 179D tax deduction on EECBP:

  • It is depreciable property.
  • It is installed on or in a building located in the United States.
  • It is installed as part of the interior lighting system, heating, cooling, ventilation, and hot water systems, or the building envelope.
  • It is certified as being installed as part of a plan designed to reduce the total annual energy and power costs with respect to the interior lighting systems, heating, cooling, ventilation, and hot water systems of the building by 25% or more in comparison to a reference building which meets the minimum requirements of Reference Standard 90.1 published by the American Society of Heating, Refrigeration, and Air Conditioning Engineers and the Illuminating Energy Society of North America.

Prevailing Wage and Apprenticeship Requirements

To receive the increased amount of the Sec. 179D tax deduction, prevailing wages must be paid, and apprenticeship standards must be satisfied. Prevailing wages are considered to be paid when any laborers and mechanics employed by the taxpayer or any contractor or subcontractor in the installation of any property are paid wages at rates not less than the prevailing rates for construction, alteration, or repair of a similar character in the locality in which such property is located as most recently determined by the Secretary of Labor.

For a taxpayer to meet the apprenticeship requirement, they need to ensure that they:

  1. Satisfy apprenticeship labor hour requirements,
  2. Satisfy apprenticeship participation requirements, and
  3. Comply with general recordkeeping requirements, including maintaining books of account or records for the taxpayer’s contractors or subcontractors, as applicable.

There are good faith exceptions to meeting the apprenticeship requirements.

Qualified Final Certification Needed

The certification must be performed by a qualified person that meets these three requirements:

  1. Is not related to the person or entity claiming the deduction,
  2. Is an engineer or contractor who is professionally licensed in the building’s jurisdiction, and
  3. Has represented in writing that they possess the requisite qualifications to provide the certification required under Internal Revenue Bulletin 206-26, Notice 2006-52, Section 4, or to perform the inspection and testing described in Notice 2006-52, Section 4.05.

Certification must be completed by a qualified individual for both building owners or the primary designer to whom the credit is transferred to claim the deduction under Sec. 179D.

The Internal Revenue Service has released new Federal Form 7205 to be used by qualified business entities and primary designers to calculate and claim the Sec. 179D deduction for qualifying EECBP placed in service on their federal tax return.

What Is the Solution?

The IRA energy tax deductions provide for additional tax minimization strategies and planning opportunities. As your trusted advisor, we at Withum can help you navigate these new provisions to allow for maximum tax benefits. Our team of experts can assist you in identifying the most suitable tax-saving strategies and help you make informed decisions. Let’s continue the conversation and work together towards a more sustainable future.

Authors: Wyatt Chinn, CPA | [email protected]; Michael Hurwitz, CPA, Partner | [email protected]; and Lynn Mucenski-Keck, CPA, MST, Principal and National Lead, Federal Tax Policy | [email protected]

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For more information on this topic, please contact a member of Withum’s Real Estate Services Team.