Climate control and reduced energy consumption are well-established priorities in many new Denver area development projects. Construction companies regularly seek opportunities to implement energy-efficient systems to earn certification from the U.S. Green Building Council (LEED) and other environmentally focused accrediting bodies. The reality is that an energy-efficient building costs less to operate, has a reduced carbon footprint, and is often more attractive to residents and tenants. At the same time, installing these systems permits contractors to claim a compelling tax deduction, known as the Section 179d Tax Deduction. The value of the deduction is determined by the amount of energy savings and square footage of the impacted area. To help clients, prospects, and others, Hanson & Co has provided a summary of the key details below.
What is Section 179D?
First established in 2005, Section 179D incentivizes buildings to use energy-efficient lighting, HVAC, and building envelope components. The popular tax deduction was usually extended on a year-by-year basis or retroactively extended, and the tax benefits were known to change. It was hard for contractors and building owners to plan for large, multi-year projects (or projects in future years).
Now, Section 179D is permanent thanks to the Consolidated Appropriations Act of 2021. The amount of the deduction will be indexed for inflation.
The tax deduction is worth up to $1.80 per square foot for new commercial construction that can prove a 50 percent energy savings against a baseline average. Generally, buildings like retail, multi-family (four stories or higher), office, warehouse, and industrial buildings will qualify. Parking garages also qualify; government buildings do too but must follow different allocation rules.
Reduced deductions of $0.60 per square foot are available for partial energy-efficient improvements and building retrofits. Projects placed in service starting in 2018 qualify and a retroactive deduction may be available. Section 179D must be taken in the year the building is placed in service.
Qualifying for Section 179D involves several steps, calculations, and the use of IRS-approved software. It can get quite complicated depending on the project, but the benefits can be substantial. The deduction is calculated based on total square footage, which means the larger the project, the larger the tax break. The deduction allows building owners to receive an immediate, up-front cash infusion rather than writing off the property on a standard 39-year depreciation schedule.
Though Section 179D is usually taken by the building owner, that’s not always the case. Tax-exempt properties – government buildings, public schools, state universities, airports, and military installations are just a few examples – don’t qualify for Section 179D. In those scenarios, the deduction can be transferred to the business primarily responsible for designing energy-efficient systems. That would include the:
- Environmental consultant
- Energy services provider
Section 179D Systems
Energy-efficient improvements to the building envelope, HVAC, hot water, and lighting systems must meet certain energy use standards. For projects placed in service prior to December 31, 2020, the energy use is compared to theoretical models in ASHRAE Standard 90.1-2007.
The Department of Energy published the below table to show the Section 179D tax deductions and corresponding requirements for each system. Taxpayers can see that while the total deduction is worth up to $1.80 per square foot, that’s based on a maximum of $0.60 per square foot for each system. Retrofit projects, for example, that only make lighting upgrades would therefore qualify for a maximum deduction of $0.60 per square foot only.
Projects placed in service on or after January 1, 2022, must use the updated ASHRAE 90.1 standard that’s published within two years of when construction begins or when the construction permit is issued. More IRS guidance is expected.
Within each system, some examples of qualifying upgrades or repairs can include (but isn’t limited to):
- High R-value insulation
- Window shading or glazing with low-E coatings
- Green roof systems
- Metal insulated roof or wall panels
HVAC and Hot Water
- New or retrofitted HVAC system
- Digital thermostat
- Heat pump system
- Solar heating
- Daylighting systems
- Soft-start electronic ballasts
- Occupancy sensors
How to File for the Section 179D Deduction
Filing for the Section 179D deduction is a process. It starts with identifying the building(s) to determine whether the energy-efficient upgrades meet or exceed required ASHRAE standards. Taxpayers must work with an independent consultant and use IRS-approved software. In most cases, a state-licensed third party will conduct a site visit.
Using data gathered during the site visit and through energy modeling, calculations will decide whether and to what extent the project qualifies for the tax deduction, and for which system(s). The building will receive a certification and final report, which should be kept with other tax documents but not filed with the return itself.
On the owner’s (or designer’s) annual tax return, for the year in which Section 179D is claimed, taxpayers should report the amount of the deduction as a line item under Other Expenses. The tax basis of the property will also need to be reduced by the amount of the deduction.
Tips for a Seamless 179D Certification Process
The IRS watches Section 179D standards closely as it’s a tax benefit that can easily be abused, either intentionally or accidentally. Building owners or designers that plan to file for the deduction should ensure their record-keeping is impeccable and the entire process meets the IRS’s standards. That means keeping original receipts and adhering to IRS document retention rules. It also means substantiating the definition of designer in instances where the deduction is transferred.
Section 179D deduction calculations should always be done with a qualified CPA. In some cases, a cost segregation study may be used to maximize the value of the Section 179D deduction.
Hanson & Co works with middle-market companies and high-net-worth individuals in Denver, Colorado, and across the country. Regardless of the complexity of your need, our team is ready to help you. Please complete the form below, and we will follow up with you shortly.