A previous version of this article was published on April 20, 2022, by the Portland Business Journal.
Combating climate change is a challenge across many industries, but real estate organizations can pursue tax credits and other incentives in the federal tax code that could motivate them to create energy-efficient buildings.
Real estate developers and owners, as well as designers of government owned buildings, could stand to benefit from these energy-efficiency-based tax incentives on both past and current construction projects.
Reducing energy consumption in the real estate sector is one way to help mitigate the impacts of long-term climate change and tax benefits are available to the companies that construct and design qualifying energy efficient buildings.
Sections 179D and 45L of the US tax code make tax incentives available in relation to energy efficient commercial and residential construction projects that achieve the prescribed energy consumption reduction. The energy reduction must be certified by a third-party advisor as required by tax law.
The Biden administration placed climate change initiatives at the top of its priority list in its Build Back Better plan. While the House passed the Build Back Better Act (BBBA) in November 2021 with $555 billion dedicated to combat climate change—including enhancements to Section 179D and an extension of Section 45L—the Senate has yet to take up the legislation in its chamber.
Even though the BBBA, at least in its entirety, is unlikely to pass prior to the midterm elections later this year, the climate change portion of the bill could possibly end up separated into a smaller piece of legislation.
Considering the level of its priority for the administration, the Biden climate agenda is worth monitoring over the coming months, as changes to these tax incentives are quite possible.
Section 179D Energy Efficient Commercial Building Tax Deduction
The energy-efficient commercial building tax deduction—Section 179D—was made permanent at the end of 2020 and allows taxpayers to claim a deduction for as much as $1.80 per square foot for commercial-building energy-eﬃcient improvements with greater than 50% energy savings. The $1.80 per square foot deduction increases with inflation in future years.
Newly constructed or substantially renovated commercial buildings and residential rental buildings that are four-stories or higher are eligible for the deduction if qualifying improvements are made to at least one of the following three categories:
- Lighting system
- Heating ventilation and air conditioning (HVAC) and hot water system
- Building envelope
Who Benefits from Section 179D
Owners and tenants of commercial properties who built or installed improvements after January 1, 2006 are eligible for the deduction. The owners of these energy efficient improvements can claim the deduction related to a prior year on a current year tax return by requesting an accounting method change on a Form 3115.
Architects, engineers, or contractors who design government-owned, energy-eﬃcient buildings can claim the deduction through an allocation process with the government entity.
To claim the deduction from a prior tax year, a designer would have to amend open tax returns. These architecture, engineering, and contracting firms should do a deep dive into their recent and current design projects to identify buildings owned by government entities.
To realize the tax deductions, a third-party contractor or professional engineer licensed in the state where the building is located must certify the energy performance of the building and compare it with the standards set by the American Society of Heating, Refrigerating, and Air-Conditioning Engineers (ASHRAE).
Qualifying Buildings Owned by Government Entities
Buildings that could be allocated to designers include buildings owned by city, state, county, or federal entities, such as the following:
- K-12 public schools
- Public higher education buildings
- Public hospital systems
- City halls, courthouses, and legislative buildings
- Police stations, fire stations, and prisons
- Military buildings
- Public parking garages
Proposed Changes to 179D in the BBBA
The BBBA proposed major changes to Section 179D to be effective through December 31, 2031.
The most notable of these changes include:
- Tax-exempt entities would be able to allocate the deduction to the designers of the building or renovation project—opening an additional avenue for architects, engineers, and contractors to take advantage of 179D on these tax-exempt-owned projects
- The introduction of a base rate and a bonus rate, where the bonus rate would be tied to prevailing wage and apprenticeship requirements
- The base rate would be on a sliding scale of $0.50 per square foot for energy savings of 25%, up to $1.00 per square foot for energy savings of 50% or greater
- The bonus rate would also be on a sliding scale of $2.50 per square foot for energy savings of 25%, up to $5.00 per square foot for energy savings of 50% or greater
While these changes haven’t been enacted, the priority level of energy efficiency within the commercial building and government sector to Biden’s climate change initiative is particularly noteworthy.
Section 45L Energy Efficient Home Tax Credit
Residential property builders can take advantage of the energy efficient home tax credit (Section 45L), which can be up to $2,000 per dwelling unit for units placed in-service prior to December 31, 2021.
Although the credit is currently expired in the federal tax code, a proposed extension of Section 45L is in the BBBA.
A dwelling unit is considered eligible for the 45L tax credit if the unit is in a newly constructed residential building or substantially renovated building if they meet certain energy reduction standards and are certified by a qualified third-party. The Section 45L credit can still be claimed on a lookback basis by amending open prior tax returns.
Residential properties qualify if they are three stories or less, not including below-grade parking.
Qualifying properties include:
- Multifamily properties, such as apartments, townhomes, and duplexes
- Senior housing facilities
- Student housing
- Single-family homes
- Residential condominiums
- Manufactured and mobile home parks
Proposed Changes to 45L in the BBBA
The BBBA proposed an extension of Section 45L through December 31, 2031, with additional changes below.
- Single-family and manufactured homes credit would be $2,500, and $5,000 for Zero Energy Ready homes
- Base rate and bonus rate for multifamily homes, with the bonus rate tied to prevailing wage and apprenticeship requirements
- Multifamily homes base credit would be $500, with a bonus credit of $2,500
- Multifamily Zero Energy Ready Homes base credit would be $1,000, with a bonus credit of $5,000
Similar to 179D, an extension and enhancement of Section 45L is a high priority for the Biden administration’s climate goals. These changes are designed to incentivize residential builders to construct energy efficient properties.
We’re Here to Help
For more information on tax credits and incentives that can be used to combat climate change in the real estate industry, contact your Moss Adams professional.
You can also visit our Tax Credit & Incentive Services or Real Estate Practice for additional resources.