EPAct 179D and 45L have been part of the tax code since 2006. The Inflation Reduction Act of 2022 (IRA) was signed into law August 16, 2022. The Act includes several major updates to federal energy-efficiency tax incentives that may be of interest to Capstan clients. The following provisions take effect 1/1/2023, unless otherwise indicated.
EPAct 179D Tax Deduction
Created as part of the Energy Policy Act of 2005, the EPAct 179D tax deduction was made permanent by the Consolidated Appropriations Act of 2021 (CAA). The federal deduction may be applied to ground-up energy-efficient construction projects as well as to energy-efficient retrofits. 179D applies to all types of energy-efficient commercial buildings (EECB) and to residential rental buildings that are a minimum of four stories high.
Clauses in the IRA will increase and expand the utility of 179D as follows:
- Lowers the minimum EECB efficiency standard required to qualify.
Under the IRA, taxpayers must demonstrate a 25% reduction in total annual energy and power costs relative to benchmark.
- Under the old law, taxpayers had to demonstrate a 50% reduction in costs relative to benchmark.
CAPSTAN’S TAKE: This is clearly a win for taxpayers. The Consolidated Appropriation Act stepped up the benchmark standards quite a bit, in essence mandating a 75% efficiency gain over the previous 2004 standard. These new standards will make it easier for taxpayers to achieve the 179D deduction moving forward.
- Increases the maximum potential deduction to $5.00/SF.
The deduction is determined using an “Applicable Dollar Value” (ADV) multiplication factor. The initial value and eventual cap of the ADV varies depending on whether prevailing wage and apprenticeship requirements* are satisfied.
As mentioned above, 25% is the new minimum energy reduction threshold that must be met to qualify for the deduction. The ADV will reward taxpayers who exceed this minimum threshold up to a certain cap.
The previous maximum deduction was $1.80/SF, increased to $1.88/SF in 2022 due to inflation. This was derived from a maximum of $.63/SF from each of three focus areas – HVAC, lighting, and building envelope. (If taxpayers could not fully demonstrate savings in all three categories, they could claim a partial deduction. Partial deductions are no longer permissible under the IRA. The legacy 179D interim lighting rule has also been eliminated.)
CAPSTAN’S TAKE: This new method of calculation may be extremely promising for taxpayers, particularly if prevailing wage and apprenticeship requirements* are met. Consider this illustrative example.
Example: A 100,000SF qualified property demonstrates a 50% reduction in total annual energy and power costs. This is a change of 25 percentage points beyond the minimum threshold.
If the prevailing wage and apprenticeship requirements* are met, the 179D deduction under the new law would more than double.
Note that the ADV cap has been met. Even if the building managed to achieve a 60% reduction in energy – a 35 percentage point change beyond the threshold – the total building deduction would not exceed $500,000.
It’s important to note that the total deduction is still dependent on building size. Whether you are working under the old or new laws, large buildings will consistently generate the greatest 179D benefit.
- Changes ASHRAE standard used for benchmarking
The reference standard to be used is the most recent ASHRAE standard published in the 4 years before the property was placed-in-service
- Previously, the most recent standard published 2 years before the building’s construction was used
- As of August 2022, the most recent published standard remains ASHRAE 90.1-2007
- On 12/23/2022, the IRS released Announcement 2023-01, clarifying the use of ASHRAE Reference Standards moving forward.
- Allows the EPAct 179D deduction to be taken by designers, architects, and engineers of building projects for tax-exempt entities, including religious and charitable organizations, private schools, Native American tribal governments, and various non-profits.
- Previously, the deduction could only be taken by designers of energy-efficient government-owned or leased building projects.
CAPSTAN’S TAKE: By expanding the scope of the deduction, engineers, architects, and designers of tax-exempt properties, including non-profits,) can now take advantage of 179D.
Establishes an Alternative Deduction Election for Energy Retrofit Projects
- Retrofits can now qualify by showing at least a 25% decrease in “Energy Use Intensity” as compared to the building pre-retrofit.
- A qualified retrofit plan is required, and the election must be taken in the year of of final qualifying certification.
- The property must have been placed-in-service at least five years before the establishment of the qualified retrofit plan.
CAPSTAN’S TAKE: The relative simplicity of this Alternative Deduction Election should encourage energy retrofits and result in great 179D benefit.
- Permits deduction reset
- The deduction may now be taken every 3 years on a commercial building, and every 4 years on a building owned by a tax-exempt entity.
- In the past, a property owner was permitted to take the 179D deduction once.
CAPSTAN’S TAKE: Additional good news from the Inflation Reduction Act. Deduction reset encourages developers to continue to improve property efficiency. This will be very beneficial on long-term multi-phase energy upgrade projects.
These updates apply to years beginning after December 31, 2022 and beyond.
Section 45L Tax Credit
The 45L Tax Credit is a one-time federal tax credit that promotes the construction of energy efficient residential dwellings. The credit is available to builders, developers and others who build homes for sale or lease, and credit is allocated per “dwelling unit.” The 45L Tax Credit was not extended by the Consolidated Appropriations Act.
FOR PROJECTS PLACED-IN-SERVICE IN 2022
The IRA retroactively extended the 45L Tax Credit for properties placed-in-service through 2022. For projects placed-in-service in 2022, the $2,000 credit per dwelling unit and the existing qualification criteria will remain unchanged. Residential rental property no more than 3 stories above grade are eligible for the Credit.
FOR PROJECTS PLACED-IN-SERVICE IN 2023-2032
The IRA also extends the 45L Tax Credit moving forward for projects placed-in-service from 1/1/2023-12/31/2032. For projects placed-in-service in 2023 and beyond, several major changes will go into effect:
- The energy efficiency requirements for the 45L tax credit will change from 50% better than the 2006 IECC energy code to Energy Star and Zero Energy Ready (ZER) Home standards.
- Energy Star and Zero Energy Ready Home programs don’t include a height requirement for qualification. Residential projects of any size may be eligible for the 45L Tax Credit under the IRA.
- The maximum tax credit will increase to up to $5,000/dwelling unit
- The maximum tax credit for single-family Energy Star homes will be $2,500
- The maximum tax credit for single-family ZER homes will be $5,000.
- For the Energy Star Multifamily program (5 units or more) the credit will be $2,500 per unit, subject to prevailing wage provisions*. If these provisions are not followed, the credit is reduced to $500 per unit.
- Section 42 Low Income Housing Tax Credit (LIHTC) projects will NOT need to take the 45L credit into account when determining adjusted basis of a property for LIHTC Credits.
SINGLE FAMILY DWELLING UNITS UNDER THE IRA
MULTIFAMILY DWELLING UNITS UNDER THE IRA
CAPSTAN’S TAKE: This is a solid win for LIHTC developers. In the past, claiming the 45L Credit resulted in a mandatory basis deduction and a corresponding decrease in the subsequent LIHTC Credit.
Under the legacy 45L program, 45L eligibility was limited to residential rental property with a maximum of three stories. Under the IRA, all residential properties may be eligible for 45L Credit. This change in qualification criteria means that that multifamily projects that are 4 or more stories high may now qualify for both 179D tax deductions and 45L tax credits.
This is promising news that may positively impact your business. Can you take advantage of the retroactive extension of 45L? Are you a tax-exempt entity now eligible for 179D? Want to plan ahead for 2023 and take advantage of these newly powered-up incentives? We’re here to help. Mark your calendar for an all-new webinar on the Inflation Reduction Act, November 9th at 12pm EST.
* Prevailing wage requirements. Under the prevailing wage requirements, for any qualified residence, the taxpayer must ensure that any laborers and mechanics employed by the taxpayer or any contractors and subcontractor or subcontractor in the construction of the residence 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 the residence is located as most recently determined by the Secretary of Labor.