The 179D tax deduction and 45L tax credit, two energy efficiency tax incentives designed for commercial and residential buildings, underwent notable modifications under the Inflation Reduction Act of 2022. This landmark legislation, which includes a $369 billion investment in green energy projects, allows more parties than ever before to partake in these lucrative tax benefits.
Let’s take a look at the impact the Inflation Reduction Act will have on the 179D and 45L tax incentives, and how these changes will impact taxpayers.
What is the 179D Tax Deduction?
The 179D deduction is a tax incentive that allows newly constructed or renovated properties that have installed energy-saving upgrades to lower their tax burden by reducing the amount of income subject to income taxes. Originally passed under the 2005 Energy Policy, it incentivizes commercial building owners and designers of government buildings to reduce their building’s energy consumption.
Changes to the 179D Tax Deduction
The Inflation Reduction Act’s modifications to the 179D deduction, applying to property placed in service after December 31, 2022, will significantly increase the deduction’s complexity in addition to its value. It’s important to work with a knowledgeable tax expert to navigate this change in the coming years. National Tax Group has decades of collective experience in underutilized areas of the tax code, and the 179D deduction is one of our specialties. Reach out to our team to learn more.
Lower Qualification Thresholds
Originally, buildings had to reduce annual energy consumption by 50% or more to qualify for the full deduction. Properties could earn a partial deduction if individual lighting, building envelope, or heating and cooling systems met certain target levels.
Under the Inflation Reduction Act, the deduction qualification threshold is set at a 25% reduction in annual energy consumption. From there, the deduction amount increases on a sliding scale for each percentage point above 25%, capped at 50%.
Increased Deduction Dollar Amount
Previously, the maximum possible deduction was $1.88 per square foot, for 50% energy reduction by services placed in 2022. Partial deductions earned up to $0.63 per square foot.
The updated version of the 179D offers a base level deduction of $0.50 per square foot for a 25% energy reduction, increasing by $0.02 per square foot for each additional percentage of reduction, capped at $1.00 for a 50% reduction.
However, it also offers a bonus deduction for meeting prevailing wage and apprenticeship requirements. With these requirements met, a 25% reduction earns $2.50 per square foot, increasing by $0.10 per additional percentage of reduction. The maximum deduction with the bonus totals $5 per square foot for a 50% energy reduction.
Originally, the 179D deduction was available primarily to commercial building owners, as well as architectural and design firms that have worked on government projects. Since government entities do not pay taxes, the deduction for government buildings could be allocated to the eligible designer.
The Inflation Reduction Act extends eligibility to include designers of commercial buildings owned by any non-taxable entity, including nonprofits, religious organizations, tribal organizations, or any other organization falling under IRC 501(c). This means that buildings like private schools, churches, hospitals, museums, and charitable facilities can qualify for the deduction in addition to the privately-owned commercial buildings and government buildings already eligible.
Lifetime Limit Removed
Since 2006, there has been a lifetime limit on the 179D deduction, preventing taxpayers from taking further deductions for subsequent energy efficiency improvements.
The Inflation Reduction Act removes the lifetime limit and resets eligibility every four years (or three years for some situations). If a previous full deduction claim occurred over four years prior, additional energy upgrades on the same building can qualify for the 179D deduction.
What is the 45L Tax Credit?
The 45L credit rewards builders and contractors of energy-efficient homes and apartment buildings with a lucrative tax incentive. The credit applies to properties sold or leased as residential buildings, such as apartments, single-family homes, condominiums, student housing, and assisted living homes. To claim the credit, qualified contractors must own the property during construction or renovation.
Changes to the 45L Tax Credit
The original version of the 45L credit expired on Dec. 31, 2021. For now, the Inflation Reduction Act retroactively extends the credit to the end of 2022 with no additional changes to the qualifications or credit amount. However, starting Jan. 1, 2023, the subsequent amendments laid out in the Inflation Reduction Act will take effect. These amendments include…
Energy Efficiency Requirements
Currently, buildings must reduce their energy consumption by at least 50% compared to reference buildings that meet the standards of the 2006 IECC. Eligibility is confirmed by a licensed third-party HERS Rater who performs energy modeling and detailed efficiency analyses.
In the updated Inflation Relief Act 45L tax credit, contractors have the option to meet either the Energy Star Program certification qualifications, which receive a base level credit amount, or the DOE Zero Energy Ready Home requirements, which receive an even higher credit amount.
Increased Tax Credit Dollar Amount
The original version of the 45L tax credit allows builders and contractors to collect up to $2000 for each unit of property that meets the certified energy-efficiency standards.
In 2023, single-family and manufactured homes can collect up to $2500 for meeting the Energy Star Program requirements, and $5000 for meeting the DOE Zero Energy Ready Home criteria. Multifamily homes can collect $500 per Energy Star-compliant unit and $1000 per Zero Energy Ready Home-compliant unit, although they can increase their credits to $2500 and $5000 respectively if they also satisfy prevailing wage requirements.
The 45L tax credit has historically only applied to residential buildings three stories high or less. Under the Inflation Reduction Act, 45L credits apply to any size development — the new Energy Star and Zero Energy Ready Home criteria do not include a height limit.
This removal of the height restriction also allows residential buildings four stories and over to qualify for both the 179D deduction and the 45L. In the past, residential buildings taller than four stories were classified as commercial buildings rather than homes, relegating them to strictly the 179D deduction.
Consult with a Tax Expert
With the shifting eligibility criteria and brand-new certification process, it’s more important than ever before to consult with a knowledgeable tax professional to achieve the maximum savings on your tax return. National Tax Group specializes in the 179D tax deduction and the 45L tax credit, and we have the technical expertise and experience to guide you through these changes successfully. Reach out to us today for a free assessment of your tax benefits, and find out how we can help you save.