For commercial buildings, IRC § 179D provides a deduction of up to $1.80 per square foot for energy-efficient features of the building’s construction or retrofit. A qualified person (defined as a professional engineer or contractor licensed in the jurisdiction where the real estate is located) must provide an analysis to the taxpayer. Special software prescribed by the IRS must be employed. This deduction is effectively an acceleration of depreciation deductions that would have otherwise been spread over a 39-year recovery life, and reduces tax basis accordingly.
This incentive was originally enacted as part of the Energy Tax Policy Act of 2005 (PL 109-58) and was originally set to expire on Dec. 31, 2007, for buildings placed in service after Dec. 31, 2005. However, as is the case with many deductions, this provision was extended an additional year by the Tax Relief and Health Care Act of 2006 (PL 109-432) and then until the end of 2013 by the EESA. Qualifying commercial buildings can include multifamily residential structures so long as they have more than three stories above grade.
Three primary building components are analyzed to determine the qualifying amount of the deduction, with each available for a deduction of 60 cents per square foot:
- Interior lighting systems
- HVAC (heating, ventilation and air conditioning) systems
- Building envelope (defined as the outer shell used to protect the indoor environment as well as to facilitate its climate control)
In each case, the analysis considers the extent to which the construction of the building provides energy consumption reductions from the American Society of Heating, Refrigerating and Air-Conditioning Engineers (ASHRAE) 90.1-2001 baseline (as in effect April 2, 2003), which is a widely used industry standard. Since the majority of states’ standard building codes are based on the subsequently developed ASHRAE 90.1-2004 or later iterations, virtually all buildings in these states will qualify for some or all of the deduction, even if built to only the minimum standards. Engineers use a modeling guideline promulgated by the U.S. Department of Energy. The study, which must include a signed certification, is not attached to the taxpayer’s return but is instead maintained in the taxpayer’s file for future documentation in case of an IRS inquiry or examination.
Congress’ intent was to encourage energy-conscious construction. This is a great deduction for those seeking to build a new facility or retrofitting an existing building. In addition, many energy-efficient buildings across the country are owned by government agencies (which of course do not pay taxes). There was concern that the impact of the incentive would be dramatically reduced since it was not useful for these properties. To address this concern, Congress made the unusual decision to allow the building designer (typically the architect) to take the deduction, even though the designer has no ownership interest in the property. In this case, the deduction is particularly valuable, since no basis reduction is required. The building owner must approve the choice of the designer in writing.
The IRS has released further guidance in notices 2006-52 and 2008-40. The ARRA increased the carryback of net operating losses to up to five years for certain small businesses, so this deduction could provide an immediate cash benefit even if the current economic downturn has reduced or eliminated profitability in the current tax year.
This provision will expire for all buildings not placed in service before December 31, 2013, however, it is still possible that the provision will be extended for years after 2013.