November 13, 2023
While the Inflation Reduction Act was signed into law on August 16, 2022, its provisions only took effect for properties placed-in-service on/after 1/1/2023. It’s been almost a year, and while we’re still waiting for additional guidance to further flesh out the IRA versions of 179D and 45L, we certainly know more than we did 12 months ago.
Here’s a one-year update of What We’ve Learned, and What We Need to Learn.
179D Tax Deduction
- Must only demonstrate a minimum 25% reduction in energy consumption vs. benchmark standard, making it easier for properties to qualify.
- The reference standard to be used is the most recent ASHRAE standard published in the 4 years before the property was placed-in-service – currently, that’s 90.1-2007. (Announcement 2023-01).
Deduction Value and Supporting Documentation:
- Deduction value depends on energy efficiency increase over baseline (from 25%-50%) and on whether contractor meets Prevailing Wage and Apprenticeship Requirements (PWA).
- Notice 2022-61 provided additional detail on PWA Requirements.
- The IRS released proposed regulations on 8/29/2023, expanding on PWA Requirements. The proposed regulations state that taxpayers must “maintain and preserve sufficient records to establish compliance…” and that these records may include:
- Payroll records that reflect the hours worked in each classification
- The actual wages and fringe benefits paid to each laborer and mechanic performing construction, alteration, or repair work on the facility
- Records of any correction payments made to a laborer or mechanic
- Copies of any written requests for apprentices by taxpayer (or contractor/subcontractor)
- Copies of any agreement entered into by taxpayer (or contractor/subcontractor) with a registered apprenticeship program
- Documents reflecting any registered apprenticeship program sponsored by the taxpayer (or contractor/subcontractor)
- Documents verifying participation in a registered apprenticeship program by each apprentice
- Records reflecting the required ratio of apprentices to journeyworkers prescribed by each registered apprenticeship program from which qualified apprentices are employed
- Records reflecting the daily ratio of apprentices to journeyworkers, and the payroll records for any work performed by apprentices
- In February of 2023, the IRS released a new form for claiming the 179D deduction.
We do expect the IRS to roll out a NEW version of this form — Form 7205 – that may require demonstrated compliance with the PWA Requirement.
Need to Learn: It’s still unclear exactly how the documentation must be maintained, how long it must be preserved, and which pieces, if any, must be submitted when filing.
Allocating the Deduction to Designers
- Designers of government buildings have been able to benefit from the 179D Deduction since its inception. The deduction can’t be claimed directly, but can be transferred through an “Allocation Letter” to the architect/engineer.
- Under the IRA, designers of tax-exempt entity properties may do the same.
- Part IV of Form 7205 is exclusively for designers – the name of the building owner’s representative who executed the allocation letter must be included.
- Under the IRA, the 179D deduction may be taken once every 3 years on a commercial building and once every 4 years on a building owned by a tax-exempt entity. This will be very beneficial for multiphase long-term projects.
Alternative Deduction Election for Retrofits
- The IRA established an easier way for retrofits to qualify for the Deduction. Instead of comparing to an ASHRAE standard, the building’s energy usage post-retrofit is compared to its energy usage pre-retrofit.
- Will likely compare two years of utility bills – the year before the retrofit vs. the year after the retrofit. This will lead to a lag effect – taxpayers will need to wait a full year after the retrofit to get the data required to claim the Deduction.
- Requires a “qualified retrofit plan.”
Need to Learn: There are a lot of unanswered questions about this Election.
Will a full model be required or will utility bills be sufficient? What is the “qualified retrofit plan” referred to in the IRA? What kind of benefit is possible? Why should a taxpayer choose the Alternative Deduction Election in light of the expected lag effect?
We are expecting extensive guidance from the IRS on this program.
45 Tax Credit
- The legacy standard to meet was 50% better than the 2006 IECC energy code. Under the IRA, taxpayers must meet Energy Star and/or Zero Energy Ready (ZERH) Home Standards.
- The IRS has released an updated version of Form 8908 for claiming the Credit. This version of the form permits a taxpayer to claim both legacy projects and IRA-era projects simultaneously.
Need to Learn: Zero Energy Ready Home requirements vary by housing sector. The DOE is coordinating with the IRS and will provide further guidance regarding certification requirements by calendar year. Several program documents are still under development – a schedule of expected release years is available here.
Credit Value and Supporting Documentation:
- Credit may reach up to $5,000/dwelling unit for homes that meet the Department of Energy’s Zero Energy Ready Home Standards, or up to $2,500/dwelling unit for homes meeting Energy Star Standards. Prevailing wage requirements must be met. Apprenticeship requirements do not apply.
- On September 27, 2023, the IRS further expanded on Credit documentation with the release of Notice 2023-65. The Notice explains:
- A contractor doesn’t need to file the Energy Star/ZERH Home Certification with his tax return, but must retain it under the IRC Section 6001 recordkeeping requirement.
To substantiate the Credit, the contractor must retain the dated Certification, and records sufficient to establish:
- The home’s address
- Taxpayer’s status as an “eligible contractor”
- Name of person who acquired home and proof that acquisition occurred during tax year in which Credit is being claimed
- PW requirements when appropriate
- Builders must apply for Energy Star Certification while still in the planning stages. This is a significant difference in procedure. Under the legacy program, builders just had to verify energy-efficiency after construction was complete. Moving forward, planning ahead will be crucial in capturing the 45L Credit.
Need to Learn: How exactly will this process work?
From what we understand, an independent “Energy Consultant” will model a project before construction begins, to ensure that Energy Star requirements will be met. If the model indicates a project will not meet the target, upgrades/adjustments must be made. During construction a HERS Rater will make frequent field verifications and upload data to a Home Certifying Organization. Finally, the project will be determined to be Energy Star compliant by home, unit, or lot.
This is our current general understanding of the procedure, but further guidance on roles, timing, and documentation is expected.
- Multifamily structures that qualify for the Low Income Housing Tax Credit (LIHTC) may also qualify for the 45L Tax Credit.
- Under the IRA, claiming the 45L Tax Credit will not impact the property’s adjusted basis, and will not affect the value of the LIHTC.
Concurrent Use with 179D Deduction?
- The 45L Credit was initially restricted to properties no more than 3 stories above grade, but the IRA eliminated this restriction.
Need to Learn: It seems possible that, given the elimination of the height restriction, the 45L Credit could be claimed concurrently with the 179D Deduction. We await additional direction on this matter.
One year later, further clarity is still required. Fortunately, we anticipate the release of additional information, and we’ll keep you posted — feel free to follow our LinkedIn Page for real-time updates. Or just contact us with your questions any time. We’ll figure things out together.
Zero Energy Ready Home requirements vary by housing sector. The DOE is coordinating with the IRS and will provide further guidance regarding certification requirements by calendar year.
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