Called the largest climate bill in U.S. history, the Inflation Reduction Act (IRA) seeks to lower the federal deficit through investments in clean energy and healthcare. Under the plan, greenhouse gas emissions would be reduced by 40 percent in 2030. Considering building operations alone generate more than a quarter of global carbon emissions annually, it’s no surprise that the IRA contains several tax incentives to motivate building owners to go green. These are especially beneficial to Denver construction companies and contractors. To help clients, prospects, and others, Hanson & Co has provided a summary of the key details below.
Section 179D: Historically
Section 179d, energy efficient building deduction was first established in 2005. It targets the building envelope, HVAC, and lighting systems. In 2021, Sec. 179D was made permanent. Historically, the building owner would take the deduction in the first year the building was placed in service unless the project was for tax-exempt property. In those cases, the owner could transfer the deduction to the building or systems designer or contractor.
It’s been a successful, valuable tax incentive because it allows building owners to take advantage of accelerated cost recovery for qualified energy-efficient design. There are many ways to qualify for the Section 179D deduction. These are a few examples:
- Window glazing and daylighting
- Certain types of high-rated insulation
- Metal insulated panels on the building envelope
- New HVAC system
- Geothermal heat pump system
- Solar electricity or heating
- Occupancy sensors
Up until now, the deduction allowed for a maximum $1.80 per square foot for new construction of a commercial building and $0.60 per square foot for partial upgrades and renovations. Qualifying for the full credit meant increasing energy efficiency by at least a 50 percent. Only certain types of commercial buildings qualified, including retail, office, warehouse, industrial, parking garages, and multi-family properties four stories or higher.
Bids to expand Sec. 179D go back before the Tax Cuts and Jobs Act. At one time, the proposed ceiling for deductions per square foot was $9.25 for building retrofits. Permanent changes to the tax deductions were made recently in the IRA.
Sec. 179D has been a successful tax incentive for reducing energy consumption. For example, it’s estimated that government buildings will save about $1.2 billion in energy – annually – by 2026. And that’s without factoring in the IRA.
Section 179D: 2023 and After
Starting January 1, 2023, Sec. 179D has been expanded and upgraded, but only in certain circumstances. The base deduction is lowered to $0.50 per square foot for projects that meet 25 percent energy efficiency ratings. A top base deduction of $1.00 per square foot can be taken against the qualifying expenses of a building that achieved a 50 percent reduction in energy costs.
To get to the bonus deductions of $2.50 to $5.00 per square foot, the project has to both meet energy efficiency requirements and prevailing wage/apprenticeship requirements. The $2.50 deduction is for prevailing wage projects with at least a 25 percent reduction in energy usage. For every point above 25 the project is more energy efficient, it will get ten cents more per square foot for a maximum of $5.00.
Government buildings, which are among the country’s largest energy customers, will benefit under the new rules as well. Because the prior law prohibited tax-exempt building owners from taking the Sec. 179D deduction themselves, there wasn’t as much incentive to spend more money on a sustainable project.
There are other slightly more favorable changes, too.
- Buildings can now claim Sec. 179D every three years with qualifying upgrades.
- The determination period for energy-efficient upgrades will be four years before the building was placed into service, rather than three.
- There is an alternate Sec. 179D deduction just for retrofits, but the IRS hasn’t published specific guidance yet.
- Tax-exempt building owners have more control over assigning the deduction.
These new rules are in effect for tax years between 2023 and 2032.
Section 45L: Historically
Residential real estate developers and builders have been able to claim a tax credit per housing unit of up to $2,000 since 2006. Single- and multi-family properties, student housing, senior living facilities, and condos or townhomes can all qualify for the credit. Primary residences and rental properties qualify. Eligible projects must not have been more than three stories tall.
The taxpayer claiming the credit could be a partnership, trust, individual, or its own business entity as long as the taxpayer owned the property during construction.
Up through the end of 2022 (45L expired at the end of 2021 but was retroactively extended), the tax credit is worth either:
- $1,000 – 30 percent energy savings plus one-third of the energy savings must be in the building envelope; Energy Star manufactured homes also qualify for the $1,000 per unit credit
- $2,000 – 50 percent energy savings plus one-fifth of the energy savings must in the building envelope
To get the full credit, the property must meet at least a 50 percent energy savings when compared to a 2006 baseline. A partial credit was awarded to properties that met a 30 percent energy savings.
Section 45L: 2023 and After
These are the revised credit amounts for properties placed in service between 2023 and 2032:
- $2,500: Energy Star single-family home
- $5,000: Zero Energy Ready single-family home
- $2,500: Energy Star manufactured home
- $5,000: Zero Energy Ready manufactured home
- $500: Energy Star multi-family, per unit
- $1,000: Zero Energy Ready multi-family, per unit
- $2,500: Energy Star multi-family with prevailing wage, per unit
- $5,000: Zero Energy Ready multi-family with prevailing wage, per unit
Besides the changes in credit amounts, 45L has also been expanded to include all residential properties instead of just low-rise buildings.
Additionally, multi-family property owners who complete a building retrofit and achieve 20 to 35 percent energy savings can qualify for a per-unit rebate of $2,000 or $4,000, depending on energy efficiency. The rebates are doubled for properties in low- to moderate-income communities.
Energy-efficient buildings produce more benefits than energy savings, although that on its own may provide enough of an incentive. Tenants and customers increasingly want to be in buildings that use sustainable practices and have a lower carbon footprint. Innovative, environmentally friendly buildings can also command higher rents and usually have lower vacancy rates, too.
The tax-saving opportunities created by the Inflation Reduction Act are a boon for many Denver construction companies, contractors, and building owners. The IRS is expected to issue guidance in the coming months that will provide additional details. If you have questions about the information outlined above or need assistance with a tax or accounting issue, Hanson & Co can help. For additional information call 303-388-1010 or click here to contact us. We look forward to speaking with you soon.