The IRC Section 179D deduction was established with the intention to encourage commercial property owners to reduce their buildings’ energy consumption. However, it has faced criticism in the past for failing to actually incentivize change, with too unattainable eligibility requirements for too little reward.
The Inflation Reduction Act, signed into law in August 2022, introduces a massive overhaul of the deduction, changing the reward structure, the dollar value, the requirements, and more. Our national tax consultants specialize in the IRC 179D deduction, and we’ve broken down everything commercial property owners need to know — and why they should claim this deduction now more than ever before.
Improvements with the 179D Extension
The 179D deduction was first introduced in the 2005 Energy Policy Act. Commercial property owners could claim the deduction on a new construction, upgrade, or renovation project based on the building’s energy efficiency in comparison to a reference building meeting the minimum ASHRAE requirements.
The deduction is primarily focused on commercial property owners, but in some cases, non-taxable entities can pass along the deduction to the designer responsible for the energy savings.
IRC Section 179D Extension
The IRC Sec. 179D has historically been a tax extender, or a temporary tax provision scheduled to expire. It was first introduced with an expiration date set for two years later, and it has since been pushed forward (and at times retroactively extended backward) to make it a relatively constant presence in the tax code ever since.
However, the temporary and retroactive extensions make it challenging, and at times impossible, for commercial building owners to plan major upgrades with the deduction in mind. Property owners can’t budget around a deduction that may not even exist when their building becomes eligible, and many energy-efficiency upgrades have significant up-front costs that need to be strategized in advance.
In 2023, this uncertainty will come to an end. The Consolidated Appropriations Act of 2021 made the extension permanent, and the Inflation Reduction Act of 2022 made guidelines that will last from the beginning of 2023 through the end of 2032. This long, ten-year span gives builders and contractors plenty of time to schedule their renovation projects into the budget, making it more accessible to property owners and more successful at reducing energy consumption.
Increased Value of IRC 179D Deduction
Before the changes enacted with the IRC Section 179D extension, some property owners didn’t find the dollar value of the deduction significant enough to justify the associated expenses. Since the deduction value is linked to the building’s square footage, smaller buildings in particular have declined to claim the deduction for this reason. The cost of the energy-efficient upgrades themselves can be prohibitive; while in most cases they eventually pay for themselves through energy bill savings, the upfront costs are still a sizable expense.
For example, if the owner of a 10,000-square-foot building replaces their HVAC to increase energy savings by 35%, they could potentially earn only $0.63 per square foot, or $6,300 total in tax savings. Commercial real estate HVAC replacement prices can range from $15 to $18 per square foot, or $150,000 to $180,000 for a 10,000-square-foot building.
With the changes introduced in the IRC Sec. 179D extension, the reward is far greater. The previous maximum deduction was $1.88 per square foot for an energy reduction of 50% or more, and partial deductions for savings of less than 50% earned a maximum of $0.63 per square foot. The new 179D offers a maximum deduction of $5 per square foot for an energy reduction of 50% or more, and partial deductions are awarded on a sliding scale. Starting at 25% energy savings, taxpayers earn greater savings for each percentage point reduction until it caps out at 50%.
Under the new IRC 179D, that same 10,000-square-foot building’s 35% energy savings would earn $3.50 per square foot, or $35,000 provided the upgrade meets the state’s prevailing wage and apprenticeship requirements. Compared to the previous $6,300 deduction, and combined with the savings on the building’s energy bill, the new IRC Section 179D deduction is a much more appealing incentive. While the dollar amount is still linked to square footage, the greater reward makes it a much more valuable benefit to large and small buildings alike.
Lowered Eligibility Requirements of IRC 179D
In the past, the 179D eligibility requirements have been too challenging for some properties to achieve. Renovated existing buildings in particular tend to find the required energy savings too unattainable to attempt. Renovated buildings make up 52% of architecture firm billings in the U.S., however, and reducing their energy consumption would go a long way towards reducing the U.S.’s carbon footprint.
The new eligibility system under the 179D extension makes the deduction more attainable for renovated existing buildings. The sliding scale starts rewarding property owners for 25% energy savings, a reasonable goal for existing buildings. Since each percentage point of energy savings earns more money on the deduction, there is always an incentive to improve and make progress towards further energy efficiency for new constructions and existing buildings alike.
Tips for Claiming the IRC Section 179D
If the upfront cost of energy-saving projects has held you back from renovating your commercial building in the past, the C-PACE program offers a solution. The Commercial Property Assessed Clean Energy (C-PACE) program provides full, upfront financing with low, fixed interest rates for upgrades that improve a building’s energy efficiency, implement renewable energy usage, or increase resilience against natural disasters. It can be a valuable savings strategy in combination with the 179D, resulting in lower utility costs, increased property value, and maximum tax savings.
If you are interested in claiming the IRC 179D on your commercial property, or if you’d like to discuss your eligibility, reach out to our national tax consultants. We have over 20 years of collective experience navigating the 179D deduction and other underutilized tax benefits, and we look forward to saving your business money. Contact us today for a free assessment of your benefits.