How to Claim the 179D Tax Deduction: Key Requirements and Procedure

The Inflation Reduction Act (IRA) of 2022 expanded many existing energy-efficient incentives, including the § 179D Energy-Efficient Congress created the 179D Tax Deduction as part of the Energy Policy Act of 2005. The IRA makes this energy-efficient deduction more widely available and permits tax-exempt entities to allocate the deduction to designers who implement energy-efficient systems in their buildings. Almost any taxpayer who owns commercial property – or certain residential retail property – and installs qualifying systems may claim the deduction. This article describes the requirements for the 179D Tax Deduction and outlines the claims process.

Requirements for the § 179D Tax Deduction

The § 179D Energy-Efficient Tax Deduction is available to property owners who install qualifying systems. The amount of the deduction may depend on whether they meet certain other requirements.

Eligible Properties

The §179D Tax Deduction is available for “energy-efficient commercial building properties.” The statute defines this term as a depreciable property that meets the following criteria:

Location

The property must be located within the United States.

Energy-Efficient Systems

The property must have energy-efficient systems that are part of any of the following:

• Interior lighting;
• Heating, cooling, ventilation, or water heating; or
• Building envelope.

The taxpayer must have placed these systems into service during the tax year for which they are claiming the deduction.

Cost Reduction

The energy-efficient systems must reduce the property’s total annual energy consumption – and associated costs — by 25% or more versus a reference building.

Energy Efficiency Certification

The system must meet the certification requirements found in the most recent version of Reference Standard 90.1 published by the American Society of Heating, Refrigerating, and Air Conditioning Engineers (ASHRAE). This standard governs energy-efficient systems in most commercial buildings and some residential buildings. It does not apply to “low-rise residential buildings,” such as single-family homes and multi-family buildings of no more than four stories.

Deduction Reset

Commercial buildings are eligible for the Energy-Efficient Tax Deduction once every three years, encouraging ongoing improvements. For buildings owned by government or tax-exempt entities, the Energy-Efficient Tax Deduction is available once every four years.

Eligible Taxpayers

Owners of eligible commercial properties may claim the tax deduction for energy efficiency. This includes property owners who operate a business on the property or rent the property to others, as well as real estate investment trusts (REITs) that own and operate commercial properties.

Owners of residential rental properties that are 4 or more stories above grade may also claim the tax deduction for energy-efficiency.

If the property owner is a tax-exempt entity, such as a nonprofit organization or a government entity, they may allocate the deduction to the energy-efficient system’s designer. This may be an engineer, architect, or other professional.

Prevailing Wage and Apprenticeship Requirements

Taxpayers are not required to meet the IRS’s Prevailing Wage and Apprenticeship (PWA) requirements, but are eligible for a larger deduction if they do. These requirements provide an incentive for taxpayers to pay a fair wage to employees or contractors who install energy-efficient systems.

IRS regulations require taxpayers to keep documentation that confirms compliance with PWA standards. This may include:

• Payroll records;
• Contractor and subcontractor agreements;
• Apprenticeship agreements; and
• Documents that establish appropriate ratios of apprentices to journeyworkers.

Claiming the Energy-Efficient Deduction

The IRS established procedures for inspecting properties and energy-efficient systems in Notice 2006-52. These procedures require a “qualified individual,” who is a licensed engineer or contractor, to inspect the property and certify in writing that it meets the standards found in §179D.

In addition to property inspection and certification, the statute also requires the use of “qualified computer software” to prepare the associated calculations. This is defined as software that has a certification from its designer stating that it meets the IRS’s requirements for calculating a building’s energy efficiency.

The software must produce a form that “documents the energy efficiency features of the building and its projected annual energy costs.” This document will provide the evidence required to substantiate a 179D claim.

Form 7205

Form 7205 is used to claim the 179D Tax Deduction. The Form is only one page long, but can accommodate information about four properties.

Part I

The form begins by asking for information about each property, including the address of each building and the date the energy-efficient system was placed into service. It then asks for the computed energy savings for the building. This is the calculation that must be obtained using the aforementioned certified computer software. The amount is expressed as a percentage, and, as mentioned earlier, must be at least 25% to qualify for the deduction.

Column G requests “Building square footage” as the potential 179D Deduction amount is directly dependent on building size.

Part II

In Part II, the actual deduction amount is computed. Column A requests the “total per square foot amount claimed in prior years.” This will determine if the property is indeed eligible for deduction according to the newly established deduction reset rules.  If the property has reached the maximum deduction amount in previous years, and the deduction has not yet reset, the taxpayer may not claim a deduction that year.

The result of the calculations in Part II is the total deduction amount that the taxpayer may claim. If the property owner is a tax-exempt entity, this figure represents the maximum amount that may be allocated to the designer.

Part III

This section collects information on the “qualified individuals” who inspected and certified the properties, requesting their names, addresses, employers, and the dates of the inspections.

Part IV

The final section of the form should only be completed if the Deduction is being allocated to a designer, and must be completed by the designer himself.  The designer must provide the name of the building’s owner, the date of allocation, and the name and address of the owner’s representative authorized to complete the allocation.

The Capstan Tax Strategies team is here to help you navigate the 179D Deduction, as well as other federal energy incentives and real estate tax strategies.  Please reach out at your convenience – we look forward to speaking with you.