Claim the 179D Tax Deduction: Insight for Architecture, Engineering, and Construction

The Section 179D Commercial Building Energy-Efficient Tax Deduction (Section 179D) is now permanent, providing potential ongoing tax benefits for architecture, engineering, and construction companies.

These entities can claim the deduction after construction is complete on designed projects for government-owned buildings. Before claiming the deduction, however, there are certain rules and regulations companies should be aware of based on timing and contract terms.

Below, learn how the Section 179D tax deduction could provide your company with significant tax savings as well as industry-related guidelines and restrictions.

What’s the Section 179D Tax Deduction?

Through claiming a Section 179D deduction, taxpayers can receive as much as $1.80 per square foot when making efficiency improvements above certain energy thresholds to commercial buildings. The $1.80 per square foot deduction also now increases slightly each year to account for inflation.

On December 28, 2020, Section 179D was made a permanent part of the US tax code in the Consolidated Appropriations Act, 2021. This change means architecture, engineering, and construction companies can claim the deduction beyond 2021—letting them plan for and generate significant tax savings from construction projects for government entities.

Can Engineering, Architecture, and Construction Entities Claim a Section 179D Deduction?

Yes. The Section 179D deduction can be allocated to engineering, architecture, and construction entities that are responsible for the design components of government-owned, energy-efficient buildings.

Because the owners of these public buildings are nontaxable entities, the deduction is then passed on to the primary designers of the buildings—in this case, engineering, architecture, and construction entities that qualify as designers. The purpose of the deduction is to incentivize designers of government-owned buildings to utilize energy efficient systems and components within the construction projects.

An entity is considered responsible for the building’s design components if it creates the technical specifications for a building. Any entity that installs, repairs, or maintains a property doesn’t meet the definition of a designer for the purposes of this deduction.

Learn more about Section 179D eligibility in our Alert.

Architects and Engineers

Architecture and engineering entities are typically responsible for designing a property’s technical specifications. As a result, they’re likely to qualify for the Section 179D deduction for improvements made to any of the following categories:

  • Building envelope
  • Heating, ventilation, and air conditioning (HVAC) system
  • Lighting system

That said, a company can only claim the deduction for building design elements for which they’re directly responsible. For example, a mechanical engineering firm that’s only involved in the design of a HVAC system in a government-owned building would only be able to take the deduction for the portion derived by the HVAC system.

Construction Contractors

A construction contractor may qualify for the Section 179D deduction if they have input in the design or are obligated to participate in the design based on their contract terms. For instance, contractors that are engaged on a design-build contract with a government entity are more likely to qualify for the Section 179D deduction than if they’re only operating as a project manager. 

Will Claiming the Section 179D Deduction Trigger an IRS Audit?

No. Claiming the deduction as a designer of government-owned buildings won’t automatically trigger an audit from the IRS, but it’s important to follow the right steps to determine qualification for the deduction.

The IRS Large Business and International division (LB&I) has included Section 179D in its list of so-called practice units, which provides a framework for designers that might be eligible to take the deduction. The Section 179D IRS practice unit released a knowledge-base document that outlines the steps the IRS would take when auditing Section 179D studies.

If you think your company could qualify for the Section 179D deduction, it’s important to act quickly because only a finite amount is available for each project.

How Does a Company Claim the Section 179D Deduction?

A company claims the Section 179 deduction by receiving a Section 179D study in the same tax year as when the building is placed in service. If the entity meets the requirements of the study, it can report the deduction on its current-year tax return.

The deduction can be up to $1.80 per square foot, adjusted for inflation. A company that’s claiming the credit for only one system, for example, the HVAC system, would claim the credit at $.60 per square foot. This can also be done retroactively if a company files an amended return.

Section 179D Study

In a Section 179D study, a qualified third-party—separate from the designer taking the Section 179D deduction—uses IRS-approved energy software to model the energy performance of the building and improvements.

The energy model then compares the building’s performance with a reference building that meets relevant energy and power cost requirements, according to standards set by the American Society of Heating, Refrigerating, and Air-Conditioning Engineers (ASHRAE). The third-party also completes a physical site visit of the facility.

The qualified third party must be contractor or professional engineer (PE) who’s licensed in the state where the building is located. The third party must review the results of the energy model and verify the improvements meet the applicable energy-savings thresholds using the ASHRAE standards. They must also sign a certification document for the Section 179D deduction stating they’ve examined the energy model and support the allocation of the deduction to its respective designer.

Allocation Letters

These documents state that a building meets Section 179D’s energy and power cost requirements. They’re signed by both the designer and someone within the government entity that has the authority to do so. The government entity can elect to allocate the entirety of the deduction to one designer or designate proportional allocations to multiple designers.

When Does the Section 179 Deduction Appear on an Entity’s Tax Return?

A company should claim the deduction in the same tax year as when the building is placed in service, but building owners can retroactively claim the deduction as far back as the 2006 tax year by filing an accounting method change.

Unlike building owners, however, if an architecture, engineering, or construction entity misses the deduction on a current-year tax return, they’ll need to file an amended return to receive the deduction. This can create a significant administrative burden, especially if an entity needs to retroactively claim the deduction for multiple years.

If you think your company could qualify for the Section 179D deduction, it’s important to act quickly because only a finite amount is available for each project. The designer should receive a signed allocation letter from the government entity, which must be signed by someone within the government entity that has the authority to do so.

How Does an Entity Report the Section 179D Deduction?

Building owners report the Section 179D deduction as a line item under other expenses for the applicable tax year. Building owners should also reduce the tax basis of the property by the amount of the deduction.

Designers, such as architects, engineers, or contractors, who are allocated the deduction for government-owned property also report the deduction as a line item under other expenses for the applicable tax year. Designers don’t need to recognize gross income or reduce future deductions by the amount the Section 179D deduction allocates.

We’re Here to Help

The Section 179D deduction can provide a significant cash-flow opportunity for certain architecture, engineering, and construction entities. For more information about Section 179D or assistance claiming the deduction, contact your Moss Adams professional.

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