Leveraging the 179D Tax Deduction for New Construction and Major Renovations  

The Inflation Reduction Act (IRA) of 2022 was signed into law nearly two years ago. The legislation contains multiple provisions relating to energy-efficient construction and various “green” technologies. It also expands the § 179D tax deduction for energy efficiency in commercial buildings, allowing more taxpayers to benefit. The IRA’s amendments to § 179D also enable the designers of tax-exempt entities to claim the energy-efficient deduction via allocation. The details of § 179D can be complicated, so having an experienced tax planning professional on your side can be invaluable. This article summarizes § 179D, describes how the IRA makes the energy-efficient tax deduction more widely available, and offers some tips for taxpayers contemplating energy-efficient construction.

What Is the § 179D Tax Deduction?

Congress created the § 179 Energy-Efficient Construction Tax Deduction as part of the Energy Policy Act (EPAct) of 2005. The deduction incentivizes commercial property owners to use energy-efficient materials and technology in new construction, expansions, renovations, and remodels. The deduction may be claimed on:

• All energy-efficient commercial buildings (EECBs); and
• Residential rental properties with at least four above-ground floors.

The amount of the deduction is based in part on the property’s square footage. Larger properties receive bigger tax deductions. The reduction of energy consumption – as compared to a reference building that meets minimum industry standards – is also a factor in calculating the deduction amount. 

How Did the IRA Change the § 179D Deduction? 

The IRA made numerous important changes to § 179D. 

Lower Efficiency Standards for EECBs (Energy-Efficient Commercial Buildings)

Before the IRA, taxpayers had to document a minimum of 50% reduction in energy consumption compared to a reference building. Now, they must only demonstrate a 25% reduction. 

Higher Maximum Deduction

Section 179D(b) establishes base and maximum amounts used to calculate the deduction, known as the “Applicable Dollar Value” (ADV). The IRS may adjust the ADV amounts each year for inflation.

The statute establishes two pairs of amounts, with the higher amounts available to taxpayers that meet the IRS’s prevailing wage and apprenticeship requirements.

The ADV increases for each percentage increase in energy efficiency over the 25% threshold. This increase is also larger for taxpayers who meet the Prevailing Wage and Apprenticeship Requirements.

Under the IRA’s amendments to § 179D, the base and maximum ADVs are as follows:

• Taxpayer does not meet Prevailing Wage and Apprenticeship Requirements: $0.50 per square foot, increasing by $0.02 for every percentage point over 25% to a maximum of $1.00/SF
• Taxpayer meets Prevailing Wage and Apprenticeship Requirements: $2.50/SF, increasing by $0.10 per percentage point to a maximum of $5.00/SF

Repeat Use of the Deduction

Previously, a property owner could only claim the § 179D deduction once. The IRA changes this to allow subsequent claims, subject to time limits:

• Taxpayers may claim the deduction once every three years for EECBs.
• Non-profit entities may claim the deduction every four years for buildings they own.

Revised Reference Building Standard

Section 179D uses standards established by the American Society of Heating, Refrigerating and Air-Conditioning Engineers (ASHRAE) for reference building comparisons. Under the IRA, a taxpayer must show that their building’s energy costs are at least 25% lower than a reference building that meets the applicable ASHRAE standard.

The reference standard to be used is the most recent ASHRAE standard published in the 4 years before the property was placed-in-service. 

Alternative Deduction for Energy Retrofits

The IRA adds a new subsection (f) to § 179D that establishes an alternate deduction for retrofits of existing properties. To qualify for the § 179D deduction, a taxpayer must have a “qualified retrofit plan” for a property that has been in service for at least five years. The taxpayer must show that the retrofit reduces “energy use intensity” by at least 25% compared to before the retrofit.

Claims by Tax-Exempt Entities

The IRA amends § 179D to allow tax-exempt entities to transfer the deduction to professionals involved in designing the energy-efficient project, including engineers, designers, and architects. Before the IRA, only government entities could allocate the deduction to a designer. Now this right extends to private nonprofit organizations, religious institutions, and various other entities and organizations.

How Is the § 179D Deduction Calculated?

Calculating the amount of the Energy-Efficient Deduction requires the following information:

• How much is energy-efficiency increased as compared to the reference building?
• What is the building’s square footage?
• Does the taxpayer meet the IRS’s Prevailing Wage and Apprenticeship Requirements?
• Has the taxpayer claimed the § 179D deduction in the past three years (or four years for tax-exempt entities)?

As discussed above, the ADV increases for every percentage point of energy cost savings over 25%, up to a maximum amount. Both the base and maximum ADVs are greater if the taxpayer meets the prevailing wage and apprenticeship requirements.

Suppose a business:

• Owns a 25,000 square foot EECB;
• Saves 30% on its energy costs over the applicable reference building;
• Meets the Prevailing Wage and Apprenticeship Requirements; and
• Has never claimed the § 179D Deduction.

Its base ADV would be $2.50 per square foot, but this amount would increase by $0.50 because of the 30% reduction in energy costs ($0.10 times 5 percentage points). Its final ADV, therefore, would be $3.00 per square foot, for a total deduction amount of $75,000. Since the business has never claimed the § 179D deduction before, it can claim the full amount.

Who May Benefit from the § 179D Deduction?

Taxpayers who own or lease an EECB may claim the deduction for expenditures on construction, renovation, refitting, or remodeling. Tax-exempt entities, such as nonprofits or government organizations, may transfer the deduction to designers, architects, or engineers who worked on the project.

How Can Taxpayers Benefit from the § 179D Deduction for New Construction and Major Renovations?

The IRA’s expansion of the § 179D deduction’s availability gives taxpayers many opportunities to take advantage of its benefits. Far more projects are now eligible for the deduction thanks to the decrease in minimum energy cost reduction required, the newer reference standards, deduction reset, and the transferability of the deduction for tax-exempt entities. Taxpayers and tax-exempt entities should consider whether any planned energy-efficient improvements will be eligible for this deduction.

Capstan Tax Strategies is here to help you navigate the 179D Deduction.  Feel free to contact us at your convenience.