The Inflation Reduction Act, passed in 2022, is the largest energy-efficient spending legislation in United States history. In addition to implementing several new green energy funds and sustainability initiatives, it also modifies the existing commercial property energy conservation deduction, the Internal Revenue Code Section 179D. This change expands the number of commercial property owners and eligible designers who can claim the deduction and increases the financial payout for most recipients.
Our national tax experts specialize in the IRC 179D deduction, and we’ve put our in-depth knowledge and expertise to work decoding the complexities of the update for you. Read on to learn more about the changes to the tax benefit.
What is the Internal Revenue Code Section 179D Deduction?
Originally passed under the 2005 Energy Policy, the IRC Sec. 179D deduction incentivizes commercial building owners and designers to install energy-saving upgrades and renovations. If the proper conditions are met, taxpayers can reduce the amount of income subject to income taxes based on the size of the building, the amount of energy usage reduced, and various other qualifying factors.
The IRC 179D primarily applies to commercial building owners. However, since government entities do not pay taxes, the deduction opportunity for improvements to government buildings is passed along to the designer responsible for the upgrades.
Renovation projects tend to be especially profitable with the IRC Sec. 179D, providing the opportunity to implement significant energy efficiency improvements. The three main areas of interest are the building envelope (insulation, roof, windows, and doors), HVAC systems (heating, cooling, ventilation, and hot water), and lighting systems (both interior and parking garages).
Changes to IRC 179D in 2023
The Inflation Reduction Act (IRA) of 2022, signed into law on Aug. 16, 2022, includes a $369 billion investment into energy efficiency projects. It expands and modifies the existing Internal Revenue Code Section 179D, broadening the scope so that more businesses than ever before can take advantage of the lucrative tax benefit. These changes apply to properties put into service after Dec. 31, 2022, so we will start to see the effects in 2023.
Let’s take a look at the differences our national tax experts have identified between the old and new versions of the deduction, and how they could affect your business this upcoming tax season.
Lower Qualification Thresholds for IRC Sec. 179D
Previously, to earn the full deduction of $1.88 per square foot, commercial properties had to reduce their annual energy consumption by 50% or more in comparison to reference buildings that met the minimum requirements. Buildings could earn a partial deduction of up to $0.63 per square foot if they reached other target levels: 10% energy reduction for the building envelope, 15% energy reduction for the HVAC system, and 25% reduction for the lighting.
The changes to the Internal Revenue Code Section 179D introduced by the IRA lower the qualification threshold to a 25% reduction in annual energy consumption. From there, every additional percentage of energy saved increases the deduction on a sliding scale, capped at a 50% reduction in energy usage.
This adjustment incentivizes even small shifts toward greater energy efficiency. In the past, property owners may have viewed the gap between a partial deduction and a full deduction as too insurmountable to reach; now, every bit of progress earns valuable savings come tax season.
Updated IRC Sec. 179D Building Eligibility
The primary beneficiaries of past versions of the Internal Revenue Code Section 179D were commercial building owners, but government entities could pass on the tax benefit to the designer responsible for their energy-saving upgrades. This exception was made because government entities do not pay taxes, so they couldn’t claim the deduction for themselves.
Starting in 2023, IRC 179D will expand on this principle and open up eligibility to the designers of other non-taxable entities’ energy-saving upgrades. This includes non-profits, religious organizations, tribal organizations, and other organizations falling under IRC 501(c).
In June of 2022, the Internal Revenue Service (IRS) released a training document for their staff about enforcing the 179D deduction. The document reveals that the IRS will place more scrutiny on eligible designers of non-taxable entities’ energy-saving upgrades. Auditors will examine design contracts, technical specifications, and allocation letters to make sure the taxpayer meets designer eligibility requirements.
The training document was not included as a part of the Inflation Reduction Act, but it will still most likely affect the IRC Sec. 179D in 2023. Take care to properly document your design work and provide all necessary information when you claim the deduction or connect with a national tax expert to guide you successfully through the process.
Adjusted IRC Sec. 179D Deduction Values
The Internal Revenue Code Section 179D used to offer tax deductions of $1.88 per square foot for a full, 50% reduction in energy consumption and $0.63 per square foot for a partial deduction.
The updated version of IRC 179D offers a maximum value of $5 per square foot of property. To earn the maximum deduction, property owners must reduce energy consumption by 50% and meet prevailing wage and apprenticeship requirements. With these requirements met, a 25% reduction in energy usage earns a $2.50 tax deduction per square foot. The deduction increases by $0.10 per additional percentage of energy savings until it caps at the $5 maximum deduction.
Energy-saving upgrades that do not meet the prevailing wage and apprenticeship requirements can still earn a slightly lower deduction. The base level deduction for a 25% reduction in energy usage earns $0.50 per square foot. It increases by $0.02 for each additional percentage of reduction, capped at $1 for 50% energy savings.
The adjusted deduction values offer a far greater reward than before for property owners that meet all qualifications. The partial values for projects that do not meet the prevailing wage and apprenticeship requirements begin at a lower value than the $0.63 partial deductions earned in the past, but with each percentage point earning a greater deduction, the updated version is beneficial in this area as well.
Connect with a National Tax Expert
Navigating tax season is tricky enough under normal circumstances, but the changes to 179D make 2023 an extra challenging year. When it comes to claiming all the savings your business has earned, and avoiding the pitfalls of documentation and regulation, our national tax experts can offer you the best results. With over 20 years of combined experience in complex tax incentive programs, our team will help you recover the most savings on your IRC 179D deduction. Contact National Tax Group today for a free benefit assessment and learn how we can maximize your savings.