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How the Inflation Reduction Act expands the tax deduction for energy-efficient buildings

Aug 11, 2022

On August 7, 2002, the Senate passed the Inflation Reduction Act of 2022 (IRA) as part of the FY22 budget reconciliation bill. The House was expected to vote on the bill Friday, August 12. If passed by Congress, the legislation goes to President Biden for his signature.

The income tax implications for the IRA are far less significant than they were for other recent tax law changes, including the Tax Cuts and Jobs Act of 2017 and the CARES Act of 2020.

However, one important change it does contain relates to the deduction under Sec. 179D for energy-efficient commercial building property. Sec. 179D allows property owners (or designers, in the case of buildings owned by government entities) to claim an immediate deduction for the cost of qualifying energy-efficient property related to both new construction and renovation of existing buildings. Absent Sec. 179D, such costs would need to be depreciated over 27.5 or 39 years (for residential and commercial property, respectively).

The proposed changes expand the qualification for the deduction as well as significantly increase the potential maximum deduction. The following is a summary of the key proposed revisions.

Reduce the energy efficiency threshold

Under current law, the property must be certified as having reduced the energy and power costs of the building by 50% or more in comparison to a reference building. The current proposal would decrease the reduction requirement from 50% to 25%.

Increase the maximum deduction

The proposal would raise the maximum deduction value from the current maximum of $1.80 per square foot to $5.00 per square foot (subject to an annual cost-of-living adjustment). However, to claim this increased maximum deduction, the taxpayer would need to meet certain specified prevailing wage and apprenticeship requirements. If those requirements were not met, the taxpayer could only claim a $1.00 per square foot maximum deduction. A taxpayer that failed to meet the requirements but still claimed the increased deduction would be subject to penalties.

Under the prevailing wage requirements, the bill would require all laborers, mechanics and workers to be paid the prevailing wage during project. To meet the apprenticeship requirements, qualified apprentices would have to perform an applicable percentage of total labor hours for project construction. The bill would establish certain exceptions to these requirements as well as options to cure the failure to meet either the prevailing wage or apprenticeship requirements.

Revise calculation of deduction

As a result of the above two changes, the actual calculation of the deduction would be revised as follows:

If prevailing wage and apprenticeship requirements are not satisfied:

  • Square footage x applicable dollar value
  • Applicable dollar value = $0.50, increased by $0.02 for each percentage point by which the total annual energy and power costs for the building are reduced by a percentage greater than 25%

If prevailing wage and apprenticeship requirements are satisfied:

  • Square footage x applicable dollar value
  • Applicable dollar value = $2.50, increased by $0.10 for each percentage point by which the total annual energy and power costs for the building are reduced by a percentage greater than 25%

Remove the "partial allowance"

Prior law allowed a $0.60 per square foot deduction for improving energy efficiency in one of three distinct areas: HVAC, lighting, and building envelope. The current proposal would eliminate this partial allowance provision.

Remove the “interim lighting” rules

The current provision allowing a phased-in deduction for the reduction in lighting power density of 25% (50% in the case of a warehouse) of the minimum requirements would be eliminated.

Expand provision allowing assignment of deduction

The current law allows the deduction related to buildings owned by federal, state or local governments to be assigned to the designers of such buildings. This provision allows contractors, architects, engineers, etc. to claim the Sec. 179D deduction without having to make a corresponding capital investment.

The current proposal would expand this assignment “windfall” from only government-owned buildings to buildings owned by the following entities:

  • Charitable organizations
  • Churches and other religious organizations
  • Private schools and universities
  • Private foundations
  • Political organizations
  • Native American tribal governments
  • Alaska Native corporations
  • Other tax-exempt entities

Revise determination of applicable ASHRAE standards

Under current law, the determination of energy costs for a reference building are based upon the ASHRAE standard 90.1 affirmed by the Treasury Secretary not later than the date two years before construction of the property begins.

Under the current proposal, the applicable ASHRAE standard 90.1 would be the one affirmed by the Treasury Secretary not later than the date four years before the property is placed in service.

How Wipfli can help

Contact Wipfli to learn more about the Section 179D deduction and how our team can help property owners secure the maximum benefit (or architects or designers if the property is owned by a government or tax-exempt entity) for their energy-efficient commercial projects. Our experienced team is staying on top of all the legislative changes and how they can reduce tax liability.

Read more information about Sec. 179D:

Author(s)

Crystal Christenson, CPA, MST
Partner
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