The Inflation Reduction Act, signed into law by President Biden on Aug. 16, 2022, is a massive bill that touches on everything from prescription drug prices to energy security investments. One of the changes it introduces is a revamped version of the IRC Sec. 179D deduction. This new version has expanded eligibility, higher deduction opportunities, expanded qualification thresholds and updated yearly limits.
Our team’s national tax experts will walk you through the ins and outs of the new 179D. We specialize in this deduction, and with over 20 years of combined experience, we can guide you through the changes and what they mean for your business. First, let’s start with the basics:
What is the Internal Revenue Code Section 179D Deduction?
This deduction rewards commercial building owners who lower the energy consumption of their property. Originally passed under the 2005 Energy Policy, the IRC Sec. 179D deduction compares the building’s energy efficiency to a reference building that meets the minimum requirements. Depending on how much less energy the taxpayer’s property consumes, they can reduce the amount of income subject to taxes, lowering their overall tax burden.
Currently, the 179D deduction offers $1.88 per square foot of property for buildings that have reduced their energy consumption by 50% or more. It also offers partial deductions of $0.63 for buildings that reach other target levels.
This version of the 179D deduction is primarily intended for commercial building owners. However, in the case of renovation and construction projects for government entities, the deduction passes to the eligible designer responsible for designing the changes. Government entities do not pay taxes, so they cannot benefit from the deduction themselves.
Changes to the IRC Sec. 179D Deduction Under the Inflation Reduction Act (IRA)
The Inflation Reduction Act of 2022, signed into law on Aug. 16th, 2022, overhauled many key areas of the Internal Revenue Code Section 179D deduction. The new version has a lower barrier to entry, and higher potential savings, in addition to several other modifications and expansions. Our national tax experts will walk you through the new energy-efficient commercial buildings deduction, and how it can save you money this upcoming tax season.
Adjusted Qualification Thresholds
In the past, commercial building owners had to increase their energy efficiency by 50% or more compared to a reference building in order to earn the maximum deduction of $1.88 per square foot. Or, they could opt for the partial deduction of $0.63 per square foot if they reached a 10% energy reduction after renovating the building envelope, a 15% energy reduction after upgrading the HVAC system, or a 25% energy reduction after improving the lighting system.
The Inflation Reduction Act introduces a sliding scale system to the IRC Sec. 179D. Instead of either meeting the requirements for the partial deduction or the full deduction, the scale starts at 25% energy savings and caps out at 50% savings, with every percentage point in between increasing the deduction.
Before the changes made in the Inflation Reduction Act, Internal Revenue Code Section 179D was intended mainly for commercial building owners and, in some cases, architects or designers. Architects and designers could only claim the deduction if they designed energy-efficient upgrades on a government building, as government entities don’t pay taxes and cannot benefit from tax deductions themselves.
The new version of the deduction expands on that reasoning. Now, any entity that does not pay taxes can pass along their deduction to their designer. This includes groups like religious organizations, non-profits, tribal organizations, and other groups falling under IRC 501(c).
Increased Deduction Savings
The IRC Sec. 179D deduction used to offer a maximum value of $1.88 per square foot of property for commercial buildings that increased their energy savings by 50% or more. Buildings that did not make the full deduction amount but did reach other target levels — 10% higher energy savings for building envelope renovations, 15% for the HVAC system, or 25% for the lighting — earned a flat rate of $0.63 per square foot of property.
The Inflation Reduction Act introduces prevailing wage and apprenticeship requirements as a new variable while increasing the maximum deduction amount. The maximum deduction for a building that decreases energy consumption by 50% and meets the applicable state’s prevailing wage and apprenticeship requirements rises to $5 per square foot. Buildings that meet the prevailing wage and apprenticeship requirements and decrease energy consumption by 25% instead earn $2.50 per square foot. For each percentage increase in energy savings, the deduction increases by $0.10 until it reaches the maximum.
If the prevailing wage and apprenticeship requirements are not met, a 50% increase in energy savings earns a deduction of $1.00 per square foot. A 25% reduction in energy consumption earns $0.50 per square foot, and each percentage point in between increases the deduction by $0.02.
Lifetime Limit Removed
The original version of the Internal Revenue Code Section 179D introduced in 2006 included a lifetime limit for each building. Once a taxpayer has claimed the deduction, they cannot claim it on the same building a second time, even if they perform subsequent energy efficiency upgrades.
The Inflation Reduction Act removes this lifetime limit. Now, the eligibility is reset every three years (or four years in some situations). This means that if a building installs another energy efficiency upgrade, leading to further energy savings, the building owner or eligible designer can claim the credit again as long as three to four years have passed.
How to Apply for the IRC Sec. 179D Deduction
In order to confirm eligibility for the deduction, the taxpayer must provide extensive documentation and verification. An authorized, licensed third party must visit the property to check the upgrades, compare the building’s numbers against the digital readings, and sign off on the proper documents. Architects and designers seeking to claim the deduction must also have an allocation letter from the non-taxable entity, along with the relevant design contracts and technical specifications.
If you hope to claim the Internal Revenue Code Section 179D, or any other complex tax benefit, consulting with a national tax expert will give you the best chance of receiving the maximum savings you have earned. At National Tax Group, our team has over 20 years of combined experience, and the 179D deduction is one of our specialties. We can guide you through the documentation process and find all the deductions available to you. Reach out to us today for a free assessment of your benefits.