The Energy-Efficient Commercial Buildings Deduction — more commonly known as the section 179D deduction — was a temporary incentive provision added to the Internal Revenue Code in 2005. Over the years, the provision has repeatedly expired and been retroactively extended.
Fortunately, the Consolidated Appropriations Act, 2021 has now made section 179D permanent. The Act also provides that the maximum tax deduction of $1.80/sq. ft. under section 179D will be adjusted for inflation in future years.
The cost of this new permanency, however, is that the hurdle for qualifying for the deduction has been raised for property that is placed in service after 2020.
Key elements of section 179D
The section 179D tax deduction was originally passed in direct response to energy usage and independence concerns. According to data released by the U.S. Department of Energy, buildings are responsible for 73% of all electricity consumption in the U.S., with about half of that attributed to commercial buildings.
To encourage greater energy efficiency, section 179D allows qualifying building owners and commercial tenants to receive an up to $1.80 per square foot tax deduction for the construction or renovation of energy-efficient buildings. Qualifying buildings include residential properties that are at least four stories above grade and all commercial properties regardless of height.
This deduction allows taxpayers to immediately expense the cost of improvements to lighting, HVAC and hot water, and the building envelope. Without section 179D, the cost of those energy-efficient improvements would be depreciated over 39 years (commercial property), 27.5 years (residential property) or 15 years (qualified improvement property).
How ASHRAE standards have made it more difficult to qualify
To qualify for section 179D, the property must improve a building’s energy efficiency by 50% as compared to a baseline building constructed according to specified ASHRAE 90.1 standards.
- For property placed in service in 2006-2015, the 2001 ASHRAE standards applied.
- For property placed in service in 2016-2020, the 2007 ASHRAE standards applied.
- For property placed in service after 2020, the ASHRAE standards in effect as of two years before the start of construction will apply.
Since the ASHRAE standards generally become increasingly more stringent over the years, this creates a higher hurdle for section 179D qualification after 2020.
A partial deduction can still be claimed
If the entire building does not meet the 50% test, a partial expense can still be claimed, limited to the lesser of cost or $0.60/sq. ft. for each of the building subsystems (lighting, HVAC and hot water, or building envelope) that meets an applicable energy-efficient test. A simplified method is also available for lighting only, which allows a prorated deduction ranging from $0.30 to $0.60 per square foot as the lighting power density decreases from 25% to 40% of standard.
Who qualifies for the deduction?
In addition to building owners or tenants, eligible designers and builders (such as architects, engineers, contractors, environmental consultants and energy service providers) can also claim a section 179D tax deduction under a special rule for public property. In this case, designers and builders that have enhanced the energy efficiency of a new government-owned building or made energy-saving renovations and retrofits to existing government-owned buildings can be allocated the deduction by the government owner.
If a taxpayer did not claim a section 179D deduction for qualifying property that was placed in service in a prior tax year, it is not too late to do so. Owners and tenants can choose to either amend their prior-year income tax return (if the tax year the property was placed in service is still open) or claim a catch-up deduction on their current-year tax return by requesting a change in method of accounting. If the taxpayer is a BBA partnership, only the change in accounting method option is available. Designers of government-owned buildings only have of the ability to amend their prior-year income tax return.
How can Wipfli help?
Wipfli offers a complimentary preliminary analysis to determine whether your building qualifies for the section 179D deduction. If it does, we can also provide the necessary certification study. If you have questions or want further details, contact us to get started.
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