How Will the Inflation Reduction Act Impact Commercial Real Estate?

commercial real estate

At the start of 2023, several changes introduced by the Inflation Reduction Act (IRA) of 2022 took effect. As part of the effort to reduce carbon emissions, the landmark $369 billion spending bill revamps and restructures the IRC 179D deduction and the IRC 45L tax credit. We will begin to see the effects of these changes as the year progresses, and our national tax experts expect that the commercial real estate industry in particular will be significantly impacted.

 

Let’s take a closer look at the changes enacted by the IRA and what they could mean for commercial real estate. 

Which Changes Will Have the Greatest Effect on Commercial Real Estate?

Two of the changes that could have the most significant impact on the commercial real estate industry are the alterations to tax benefits for energy-efficient buildings. The 179D Commercial Building Energy-Efficient Tax Deduction and the 45L Energy-Efficient Home Credit offer substantial tax savings that could lead to an increase in energy-efficient construction and renovation projects moving forward. 

The IRC 179D Deduction for Energy-Efficient Commercial Buildings

First, let’s clarify what exactly this tax provision is. The 179D Energy-Efficient Commercial Buildings Tax Deduction was originally passed under the 2005 Energy Policy to encourage commercial building owners and designers of government buildings to lower their carbon footprint. It compares the building’s energy efficiency to a reference building that meets only the minimum standards. Depending on how much lower the taxpayer’s building’s energy consumption is, its developer can earn a substantial tax deduction. 

 

The Inflation Reduction Act introduced several changes that make the deduction more widely applicable, easier to claim, and more valuable to the commercial real estate sector. Let’s take a look:

179D Permanent with Extended Guidelines

Since its introduction, the 179D has been a temporary provision continuously renewed and extended rather than expiring or being made permanent. The constant uncertainty about the deduction’s longevity and availability makes planning future construction projects challenging. Developers can’t make arrangements for a deduction that may not exist by the time they are ready to claim it, and the up-front costs can be prohibitive without the benefit.

 

Now, the commercial real estate industry no longer has to deal with this uncertainty. In 2021, the Consolidated Appropriations Act made the IRC 179D permanent, and the Inflation Reduction Act of 2022 established guidelines for the deduction that will last until the end of 2032. This gives contractors ten years of stability to design projects with the deduction in mind, making it a much more influential and beneficial tax provision. 

Increased 179D Deduction Amount

In addition to the added stability, the IRA also significantly boosts the deduction’s monetary value. The maximum deduction used to be $1.88 per square foot of property, and many developers of small buildings in particular didn’t find it valuable enough to justify the associated expenses. 

 

Now, developers can claim up to $5 per square foot — almost three times the previous value. Taxpayers can qualify for the full deduction by reducing their buildings’ energy consumption by 50% or more compared to a reference building, and they can also claim smaller deductions for smaller energy reductions on a sliding scale. Starting at 25% energy reduction, taxpayers can claim incrementally greater deductions until the scale caps out at 50%. 

 

The sliding scale system for deductions offers a valuable opportunity for savings, as every bit of progress earns a monetary reward. Before, if an energy efficiency upgrade reached just below the qualification standards of energy reduction, commercial real estate developers would be left without a tax benefit or with the flat-rate partial deduction of $0.63 per square foot. The new arrangement encourages continued efforts toward efficiency, which may spark an increase in green commercial renovations and constructions in the future.

Decreased Minimum Efficiency Requirement for IRC 179D

Under the IRA, the IRC Section 179D deduction is available to more taxpayers than ever before. In the past, the eligibility requirements have been a deterrent to many commercial real estate developers, especially for renovations of existing buildings. The required 50% energy savings were too high a bar to reach, and for some, the partial deduction value was too small to chase after. 

 

Under the current system, eligibility starts at a 25% reduction in energy consumption, and each additional percentage point earns additional savings. This threshold is vastly more attainable, and it opens the deduction up to commercial real estate developers who did not qualify in the past. In combination with the increased monetary value of the deduction, this could be enough incentive for contractors to take on energy efficiency projects they would not have attempted previously.

The IRC 45L Tax Credit for Energy-Efficient Homes

Where the IRC 179D deduction applies to energy-efficient commercial buildings, the 45L Energy-Efficient Home Tax Credit is for properties sold or leased as residential buildings. Common qualifying properties include single-family, multifamily, in addition to apartments, condominiums, student housing, and assisted living facilities. 

 

The credit offers builders and contractors a substantial tax credit for each dwelling unit that meets or exceeds the required energy efficiency standards. Qualifying homes must include independent living facilities that include provisions for living, sleeping, cooking, and sanitation. 

 

Builders and contractors who own the qualifying home during construction can claim the 45L credit if they document their installations before the construction crew breaks ground. The IRS defines eligible builders and contractors as:

  • Individuals
  • A trust
  • An estate
  • A partnership
  • An association
  • A company
  • A corporation

Increased IRC 45L Tax Credit Value

Previously, the 45L Tax Credit offered builders and contractors up to $2000 per dwelling unit that reduced its energy consumption by 50% or more compared to a reference building meeting the minimum standards. The Inflation Reduction Act restructured the credit and added different eligibility options, and the maximum credit value has increased to $5000 per unit.

 

Single-family and multifamily homes can now claim the credit for meeting either the EnergyStar Program certification requirements or the Department of Energy’s Zero Energy Ready Home (ZERH) criteria. EnergyStar certification earns contractors $2500 per unit, and ZERH certification earns $5000 per unit. 

 

Qualifying single-family or multifamily homes must meet the Zero Energy Ready Homes (ZERH) or EnergyStar certification requirements (Version 3.1 for constructions before Jan. 1, 2025, and Version 3.2 thereafter).

Expanded 45L Eligibility

Historically, the IRC 45L tax credit qualification criteria have specified that only residential buildings standing three stories high or less could claim the credit. The Inflation Reduction Act replaces the old qualification criteria with the EnergyStar and ZERH requirements, which do not have a height limit. This opens the credit up to mid-rise and high-rise buildings, which were previously considered commercial and qualified for the 179D deduction instead. Commercial real estate developers who invest in residential properties should be aware of this change and tailor their tax strategy to the appropriate benefit. 

Connect with a National Tax Expert

From changing the eligibility requirements of the 45L tax credit to making the 179D permanent, the various tax code adjustments of 2022 have added an extra layer of challenge to the 2023 tax season. The best strategy to ensure that you earn the maximum savings on your taxes is to consult with an experienced tax expert. At National Tax Group, we have over 20 years of combined experience helping businesses leverage underutilized tax benefits to save money, and the 179D and 45L are two of our specialties. Reach out to us today to see how we can help you this tax season.

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