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Over the past few years, Congress has extended and expanded several important income tax incentives for building, retrofitting and remodeling energy-efficient buildings, both residential and commercial. For owners, developers and designers of commercial buildings, one of the most significant of these tax incentives is the §179D deduction for energy efficient commercial buildings. This valuable federal tax benefit allows taxpayers to take a current income tax deduction for the cost of energy efficient building components of commercial building property for the year placed in service. For government-owned buildings, this deduction can be allocated to the design professional for the property – a feature that both governmental building owners and designers should bear in mind for public building projects.
Who Can take the Deduction.
As a general rule, the § 179D tax deduction is allowed for owners of new or existing commercial buildings that meet certain energy efficient standards. Any type of entity (e.g. “C” Corporation, Partnership, LLC, etc.) that is the owner of energy efficient commercial building property will qualify, and the taxpayer may be either the owner or lessee of the building in which the qualifying property is installed. However, in the case of energy-efficient improvements to a building owned by a Federal, State or local government (including public schools), the Tax Code allows the building owner to allocate the 179D deduction to the person “primarily responsible for designing the property”. This unusual tax code provision was intended to provide incentive for “green” building design in government buildings, since the 179D deduction would otherwise be of no use. The designer is the person that creates the technical specifications for installation of the energy efficient property, and would typically be an architect, engineer, contractor, environmental consultant or energy services provider. For a design-build project or repair and alteration project for which there is no architect-engineer, the general contractor may be recognized as the designer, although a person who merely installs, repairs or maintains the property is not a “designer” for purposes of this rule. If more than one designer creates the technical specifications for installation of the qualifying property, the government building-owner may either allocate the entire deduction to the designer primarily responsible, or allocate the deduction among several designers. Since the governmental building owner cannot use the 179D deduction, the building owner and designers should always make sure to take advantage of this allocation provision which, in effect, would allow the designer to bid a lower fee than if it would not qualify for the tax deduction.
Amount of the Deduction.
The tax benefit provided by §179D is a deduction (which reduces taxable income), rather than a credit against the bottom-line taxes payable. For any tax year, the maximum possible deduction is $1.80 per square foot of the improved building, less any deductions taken for the same improvements in previous years. This $1.80 psf limit must be allocated to not more than $0.60 psf for each of the following components of a qualifying building: (i) interior lighting (including parking garage lighting) ; (ii) heating, ventilation and air conditioning systems (HVAC); and (iii) the building envelope (i.e. windows, doors, roof and insulation). The tax benefit can be significant, as the cost of these improvements would otherwise need to be depreciated over a period ranging from 3 to 39 years, depending on the nature of the improvement. Since §179D essentially accelerates the depreciation deduction otherwise available on qualifying improvements, the depreciable tax basis of qualifying improvements are reduced by the amount of the §179D deduction.
The §179D deduction is available for both new construction and retrofits that is placed into service after between January 1, 2006 and December 31, 2013, and includes buildings used for office, retail, industrial, manufacturing, warehouse, healthcare, and government functions. The deduction also applies to multifamily residential structures which are more than three stories. However, to qualify for the maximum $1.80 deduction the property must meet all of the following requirements:
- The improvements must qualify for depreciation or amortization (i.e. the building is held for use in a trade or business or for the production of income);
- The property must be installed on or in a building that is located in the United States and is within the scope of Standard 90.1-2001 of the American Society of Heating, Refrigerating, and Air Conditioning Engineers (ASHRAE) and the Illuminating Engineering Society of North America;
- The property must be part of the building's interior lighting systems, HVAC systems, or envelope; and
- The property must be “certified” as part of a “plan” to improve the building’s energy efficiency by at least 50% in comparison to a baseline standard for a “reference building” that meets the ASHRAE Standard. The certification must be made by an engineer or contractor (unrelated to the taxpayer) who is properly licensed in the jurisdiction where the building is located and otherwise satisfies IRS certification requirements.
Regarding the last requirement, if the certified plan for the property does not specify reduction of building energy and power costs reductions of at least 50 percent, the improvements for partial building systems (lighting, HVAC or building envelope) will still be allowed up to a maximum of $0.60 per square foot (rather than $1.80) as long as the improvements satisfy the energy-savings target for the system of which it is a part. For improvements which will not qualify for the maximum $1.80 psf deduction, perhaps the biggest target area for the §179D tax deduction (i.e the lowest hanging fruit) is energy-efficient lighting, such as new lighting fixtures and reduced lighting levels, since this is often the “easiest” to implement (with building envelope often the most difficult). In addition, there is a special rule which allows for lighting to qualify for a deduction of $.30 psf to $.60 psf for a reduction in lighting power density between 25% and 40% as compared to ASHRAE standards. This special rule does not apply to warehouses, for which the lighting system must reduce the power density by at least 50 percent to earn a reduction up to $.60 psf.
Timing and Sunset for the 179D Deduction.
Currently, the §179D tax deduction is set to expire on December 31, 2013 - that is, energy efficient improvements placed in service after that date will not qualify. However, there is legislation currently pending that may extend the expiration date to as late as 2019. The current deficit-reduction and political climate will likely factor into the final form of any such legislation. Whether or not extended beyond 2013, §179D currently provides a significant tax benefit for developers of energy efficient properties and high performance buildings, and also for design professionals involved with public projects.
The information contained in this article is general in nature, and may not apply to your specific situation. Legal advice should be sought before taking action based on the information discussed. Applicable State Bar or Attorney Regulations May Require This Be Labeled as "Advertising."
Matthew L. Kimball is the Chair of the Real Estate Department.see all Commercial Real Estate articles »
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