In the past two years, several federal tax incentives have been extended and enhanced for designing and constructing energy-efficient buildings, both residential and commercial. Some of these measures should be equally attractive to your business and individual clients looking to remodel existing homes and workplaces to save on energy and, as a bonus, taxes.
Four federal laws enacted since early 2008 contain provisions targeting energy conservation: the Economic Stimulus Act of 2008, PL 110-185 (ESA); the Housing Assistance Tax Act of 2008, PL 110-289 (HATA); the Emergency Economic Stabilization Act of 2008, PL 110-343 (EESA); and the American Recovery and Reinvestment Act of 2009, PL 111-5 (ARRA).
In addition, many states and local governments have enacted provisions to encourage energy-efficient buildings.
Too often, a flurry of legislative activity can overwhelm taxpayers and their advisers with new provisions. Typically, the taxing authorities need time to develop summaries and guidelines for newly enacted laws. As a result, taxpayers who could benefit from the deductions and credits might not be aware of them, in some cases missing out on substantial savings. Here are five recent federal provisions expanded or extended by the EESA and the ARRA that should be of interest to builders, architects and anyone in the market for a new building or thinking about retrofitting one for energy savings. These are by no means all the tax incentives for energy-efficient building or remodeling even in these two acts. The EESA extended a number of provisions of the landmark Energy Policy Act of 2005. Among the ESA's provisions were those providing for 50% bonus depreciation on equipment and more funding for the low-income home energy assistance program. HATA requires states to consider energy efficiency in low-income housing when allocating available tax credits to those projects.
Energy-Efficient Commercial Building Deduction
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. The taxpayer must secure an analysis by a qualified person (defined as a professional engineer or contractor licensed in the jurisdiction where the real estate is located) who must use software prescribed by the IRS. 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), but was largely overlooked by tax advisors because of its original expiration date of Dec. 31, 2007, for buildings placed in service after Dec. 31, 2005. It was extended an additional year by the Tax Relief and Health Care Act of 2006 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 credit, 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.
An interesting application of this benefit occurs when the building is owned by a government, school or municipality. Since Congress' intent was to encourage energy-conscious construction, and 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.