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.
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.
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.