Building owners and qualified professionals (architects, designers and engineers) can claim up to $5.00 per square foot for energy-efficient buildings through Section 179D. The deduction applies to both newly constructed or renovated energy-efficient commercial buildings and residential buildings that are at least four stories high.
The Sec. 179D Energy-Efficient Commercial Building Deduction was first introduced in 2005 as part of the Energy Policy Act (EPAct). It was created to provide a deduction for the cost of energy-efficient commercial building properties and was made permanent by the Consolidated Appropriations Act of 2021 (CAA). The Inflation Reduction Act of 2022 (The Act) significantly changed the Sec. 179D existing rules with major changes that started to take place in 2023.
What Did the Inflation Reduction Act Change for Section 179D?
The Act lowered the minimum required savings in total annual energy and power cost to a 25% reduction. The energy and power costs are now compared to the American Society of Heating, Refrigerating and Air Conditioning Engineers’ (ASHRAE) Reference Standard 90.1, that was in effect for four years prior to the in-service date of the building. The Act also removed the existing rules for partial certifications which was $0.60 per square foot for each lighting system, heating, cooling, ventilation and hot water (HVAC) systems and building envelope (e.g., windows and roofing).
In addition, the Act established an alternative deduction election for retrofit projects. To qualify, retrofits need to show at least a 25% decrease in “energy use intensity” compared with the building pre-retrofit. A qualified retrofit plan is required, and the election must be taken in the qualifying final certification year. The deduction cannot exceed the aggregate adjusted basis of retrofit property placed in service following the plan.
Prevailing Wage Requirements for 179D Deduction
For 2023, the maximum Sec. 179D deduction increases to $5.00 per square foot. If the building achieves a 25% reduction in energy and power costs, then the deduction starts at $2.50 per square foot. The deduction will increase by $0.10 for each additional percentage of reduction up to $5.00 per square foot. To determine the deduction, an applicable dollar value (ADV) multiplication factor is used. Total deduction is dependent on building size, so larger buildings will generate a greater Sec. 179D benefit. Once the ADV cap has been met, while meeting prevailing wage and apprenticeship requirements, the total building deduction cannot exceed $500,000. Even if a building achieved a 60% reduction in energy costs, which is a 35% change beyond the threshold, the deduction still cannot exceed the $500,000 limit.
Prevailing Wage Rate and Apprenticeship Requirements
Sec.179D increased benefit levels for energy-efficient incentives. These incentives can only be collected when prevailing wage and apprenticeship requirements are met.
Prevailing Wage Rate Requirements
Laborers and mechanics employed by the taxpayer, contractor or subcontractor, must be paid no less than the prevailing wages required to be paid for federal construction work. The wage will vary based on location and job description. The prevailing wage rate is made by the U.S. Secretary of Labor and is published on the official website of the U.S. Government called the System for Award Management (SAM). Wages for most labor classifications and geographical areas can be found on the SAM website.
Any construction or installation that started on or after January 30, 2023, must meet the prevailing wage rate to qualify for the $2.50 to $5.00 tier of deductions. Projects started prior to that date, do not need to meet the prevailing wage to qualify. If prevailing wage requirements are not met, then the deduction is $0.50 per square foot for a 25% reduction. Further reductions will increase by $0.02 per square foot, up to $1.00 per square foot.
To meet the apprenticeship requirement, two sets of criteria need to be fulfilled. The initial criterion entails that the construction of any eligible facility must involve a minimum percentage of qualified apprentices performing the total labor hours for the construction, alteration, or repair work of the facility. The percentage for a qualified facility depends on the date construction begins:
- Before January 1, 2023, 10% of total labor must be performed
- After December 31, 2022, but before January 1, 2024, 12.5% of total labor must be performed
- After December 31, 2023, 15% of total labor must be performed
The second set of criteria is fulfilling the requirement for apprenticeship participation. When a taxpayer has a construction project employing four or more individuals, it is mandatory for the taxpayer to also employ one or more qualified apprentices. Maintaining these requirements along with documenting and analyzing is essential to compliance and increased tax benefits.
Design Work Benefits and Eligible Tax-Exempt Entities
Previously, only public agencies were allowed to allocate Sec. 179D deductions. Now buildings placed in service in 2023 or after can obtain Sec. 179D deductions from tax-exempt entities. Architects, designers and engineers are eligible to receive allocations on projects for tax-exempt entities. Formerly, only designers of energy-efficient government-owned or leased building projects could take the deduction. Eligible tax-exempt entities include:
- Airport Terminals
- Charitable organizations
- K-12 schools, higher education and libraries
- Municipal buildings
- Parking garages
- Private school and universities
- Private foundations
- Political organizations
- Non-profit hospitals
- Native American Tribal Governments
- Alaska Native Corporations
- Any other organization falling under Section 501(c)
How Often Can This Deduction Be Claimed?
The Sec. 179D deduction can be taken every three tax years when the building is placed in service in 2023 and thereafter, or four years in some situations. Formerly, a property owner was only permitted to take the deduction once. This change is beneficial for multiphase energy upgrade projects. Here is an example of how the deduction can be claimed:
If a taxpayer constructed a building in 2008 and took a deduction of $1.80 per square foot, prior rules prevented the taxpayer taking additional Sec. 179D deductions for subsequent energy efficiency improvements. Beginning in 2023, the Inflation Reduction Act allows for additional Sec. 179D deductions for subsequent energy improvements.
Overall, the Sec. 179D tax deduction provides a powerful incentive for building owners to prioritize energy efficiency in building design and construction. Not only does it provide significant tax savings, but it also encourages the use of sustainable building practices. To understand how to fully maximize the updated provisions, contact a BSSF advisor.
About the Author
Carrie Small, CPA, MST, is a Tax Principal at Brown Schultz Sheridan & Fritz (BSSF). She is a leader within the BSSF Insurance Practice, which provides a full range of audit, tax and advisory services to insurance companies across the country. Within the practice, Carrie specializes in providing tax compliance, tax provision and tax consulting services to insurance entities.