Owning or operating buildings constructed or improved to be more energy efficient could increase your cash flow by reducing your current year federal income tax liability. This tax-deferral strategy is also frequently applicable to the designers of government-owned buildings.
Below are the answers to frequently asked questions to provide further insight into the Section 179D deduction.
What Is the Section 179D Tax Deduction?
Also known as the Energy Efficient Commercial Building Property Deduction, Section 179D is an incentive to install energy-efficient features in commercial buildings.
Section 179D allows eligible building owners and designers a tax deduction of up to $1.80 per square foot for work performed on one or more of the following three building systems:
- Interior lighting
- Building envelope
- Heating, ventilation, air conditioning (HVAC), and hot water
Why Was the Section 179D Deduction Created?
The US government created Section 179D as part of the 2005 Energy Policy Act to help reduce energy consumption by incentivizing commercial building owners to build with more energy-efficient property.
This deduction was extended in 2008 to allow government building owners to allocate this potential tax deduction to the designer of the energy-efficient property.
Is the Section 179D Deduction Permanent?
Yes, the Section 179D deduction was made a permanent part of Consolidated Appropriations Act of 2021, which also established inflation adjustments to its value and updated energy efficiency standards, based on when projects are completed.
How Do You Conduct a Section 179D Study?
All Section 179D studies on government-owned buildings require the same basic steps:
- Assess designer qualifications for the project.
- Allocate the deduction to the designer.
- Create an energy model using DOE-approved software.
- Perform a site visit with a qualified individual to verify that the energy model matches the features placed in service.
- The study must be certified by a licensed engineer or contractor in the state where the building is located.
For Section 179D studies conducted on a building that you own, you would omit the first two steps because, as the owner, you do not need to be the designer or have a deduction allocated to you.
How Do You Qualify for Section 179D?
There are two main avenues to qualify for the Section 179D deduction:
- Owners of commercial buildings through new buildings, renovations, and additions
- Designers of work performed on government-owned buildings
Both involve work performed on one or more of the three building systems on a commercial building.
The work must be performed on a building within the scope of Standard 90.1 published by the American Society of Heating, Refrigeration, and Air Conditioning Engineers (ASHRAE), which includes most commercial buildings and residential buildings four stories or higher.
What Is a Section 179D Allocation?
An eligible designer would need to obtain an allocation letter to receive the Section 179D deduction, because as a non-taxpaying entity, the government entity doesn’t qualify for it.
Being able to receive this deduction gives designers the incentive to create more energy efficient government commercial building properties.
Who Qualifies as a Designer Under Section 179D?
For the Section 179D deduction, a designer is defined as a person who creates technical specifications for the installation of energy efficient commercial building property for a new construction, retrofit, or building addition project, according to IRS notice 2008-40.
Within this definition, qualifying taxpayers include:
- Environmental consultants
- Energy service providers
This broader definition differs from the conventional definition of designer used in the architecture, engineering, and construction fields, which typically only refers to architects and engineers.
The determining factor is that the designer must create technical specifications for the installation of energy-efficient commercial building property. Architects and engineers are almost always primary designers, but other types of firms could also qualify as designers.
Energy service companies leverage their expertise to improve building energy efficiency, often through building automation and HVAC upgrades.
Specialty contractors for building envelopes are often involved in the design if the architect or engineer calls for specialized features.
How Does a Designer Get Selected for the Section 179D Allocation?
The government entity that owns the building determines the allocation, provided that the designer creates the required technical specifications to be eligible.
If there’s only one designer, the process is simple. However, in the case of most construction projects, there are multiple parties who qualify as designers, making the allocation decision less straightforward. For these types of projects, the government entity may allocate among several designers or choose to allocate the entire project to the primary designer.
Some government entities have created processes for selecting a designer for the Section 179D allocation and many involve finding the government representative who’s most familiar with the project to help determine who should get the allocated deduction.
Can You Claim the Section 179D Deduction for Every Upgrade?
As the tax code is currently written, the maximum amount of deduction available to be claimed for the lifetime of the building is $1.80 per square foot. Once the full $1.80 per square foot has been taken, future upgrades to the same building won’t be eligible for additional deductions.
With Section 179D now a permanent provision in the tax code, there has been discussion around increasing the deduction limit for properties that previously claimed $1.80 per square foot benefit where additional energy-efficient upgrades were made.
If you previously claimed the lifetime maximum Section 179D deduction for a building, monitor potential developments with your tax consultant to adapt accordingly should there be a policy change.
What Happens When You Take a Section 179D Deduction?
The Section 179D deduction will differ for designers and building owners, as detailed below.
The designer takes a tax deduction in the year the commercial building property was placed in service. If the building was placed in service during a previous tax year, amending tax returns for years already filed where a Section 179D opportunity is identified could be possible.
The deduction can’t exceed $1.80 per square foot or exceed the cost to place the energy efficient commercial building property in service.
In the case of a building owner, the deduction doesn’t need to be claimed in the tax year when the commercial building property was placed in service. The deduction can be claimed on a current return or it can be claimed for properties placed in service during prior periods with an amended return or automatic accounting method change. The basis of the commercial building is reduced by the amount of the Section 179D deduction.
When Does a Section 179D Study Need to Be Completed?
A Section 179D study is performed after all work is complete and the building is in use, typically during the tax year when the building is in service.
For designers, there may be an opportunity to complete a study up to three years after the work is completed via amended returns. Commercial building owners, however, aren’t bound by this three-year restriction and can apply a Section 179D deduction for eligible work installed previously via a 3115.
Can You Conduct Your Own Section 179D Study?
No. The tax code doesn’t allow taxpayers firms to perform their own Section 179D studies. Deductions must be certified by a qualified third-party.
Work closely with your Section 179D team to determine which of your projects are eligible for the deduction. Your tax consultants will work with you through to the final certification of the study.
To learn more about how to claim and report the Section 179D deduction on your tax returns, read Claim the 179D Tax Deduction: Insight for Architecture, Engineering, and Construction.
We’re Here to Help
If you’re interested in the Section 179D tax deduction, please contact your Moss Adams professional.
You can also visit our Tax Credit & Incentive Services for additional resources.