Section §179D can helping your commercial real estate clients reduce taxable income and increase cash flow significantly. Just make sure you know the current rules, rates, regs and reach of this provision.
As part of the hotly debated tax and spending legislation moving through Congress—referred to as the “Build Back Better Act” (BBBA) —the House proposed a laundry list of investments and incentives for upgrading homes and buildings. It also includes dozens of proposals promoting electric vehicles, energy storage, renewable power and a more dynamic electric grid.
Even at this late calendar date, many believe the $1.7 trillion BBBA could still be passed before year-end. With the debt ceiling issue extended through February 2022, disagreements within the Democratic caucus over the contents of the bill are the main hold-ups—but not insurmountable.
As we discussed at the recent Kentucky Society of CPAs annual Commercial Real Estate Conference, The Ways and Means Committee’s proposed bill would modernize the outdated incentives for energy efficiency improvements for homes and buildings, including more than doubling the incentive levels. For instance, the Sec. §179D incentive for energy efficient buildings would jump substantially starting in 2022 from $1.80 per square foot for efficiency improvements to a sliding scale of between $2.50 and $5.00 per square foot. The bill would change the maximum to a three-year cap rather than a lifetime maximum. The changes to the provision would expire after Dec. 31, 2031.
The bill would also implement a new framework for making the deduction more accessible for retrofits to existing buildings. In addition to an inflation adjustment for 2022, the so-called “designer allocation” would be open to all tax-exempt entities including Indian tribal governments.
This fact pattern presents significant tax-saving opportunities for your clients with commercial building interests – if you know where to look. For clients that are primary designers of energy-efficient buildings, the proposed legislation could create new opportunities for work with not-for-profits.
START WITH A TEAM APPROACH
Whether you have a large roster of commercial real estate clients or are just dipping your toes in the water, it’s easy to get overwhelmed by all the existing and potential changes to energy incentives. That’s why it’s so important for the energy design needed to qualify for tax incentives is correct in the original design. The design for claiming lucrative tax incentives is as critical as building the financial stack.
That’s why we recommend taking a team approach to helping your commercial real estate clients maximize savings and increase cash flow as they move toward energy efficient buildings. It can be too much for any single professional to handle. Make sure your team includes an independent party that can assist with the design review and can certify the property’s performance for energy efficiency.
KEY DISCUSSION POINTS TO HAVE WITH YOUR CLIENTS
Map out a list of points to discuss with your CRE clients. Here are some we’ve found helpful for getting the ball rolling:
- Build a business case that supports the investment.
- Start planning at the beginning of the project – when you first conceptualize it — to maximize the benefits.
- Be aware of different enactment periods and different criteria to qualify.
- Be mindful of each client’s tax structure and their ability to absorb deductions.
- Explain the convergence of opportunities and the integration of approaches.
- Simplify confusion with a turnkey solution.
- Take advantage of respective industry experts, product, and performance.
- Stress the strength of audit defense and warranty.
- Emphasize that you have a team that advocates for the owner – customized to your client’s needs.
At its core, the §179D tax deduction encourages building owners and design firms to reduce their carbon footprint by implementing energy efficient systems. As energy costs rise, reducing those costs is a priority for most public and private organizations.
COMMERCIAL BUILDING OWNERS
If your clients build, own or lease commercial buildings, and if they have built, installed or retrofitted their properties to be more energy efficient, they may be eligible to deduct all or part of the costs associated with the construction, installation or retrofit.
DESIGN FIRMS – GOVERNMENT BUILDINGS
In the case of energy-efficient commercial building property that is installed on (or in) property owned by a federal, state or local government — or a political subdivision thereof — the government owning entity of the property may allocate the §179D deduction to the primary designer of the building.
Identifying Your Building
| COMMERCIAL | DESIGN FIRM |
| Apartment (4 Stories or Higher) | Courthouses |
| Auto Dealerships | Government Offices |
| Hotels | Libraries |
| Manufacturing Facilities | Post Offices |
| Offices and Parking Garages | Schools |
| Shopping Centers | State Universities |
| Warehouses | Recreational Buildings |
EPAct §179D Eligibility
Buildings that qualify fully include those that reduce their total energy and power costs by 50 percent or more when compared to a reference building. If you can prove that is the case, your client will earn a generous tax deduction amounting to $1.80 per square foot.
Buildings that qualify for a partial §179D credit include those with individual systems that are eligible for partial deductions. If so, your client will earn a tax deduction amounting to $0.60 per square foot for each system that qualifies. The partial qualifying systems include lighting, HVAC and building envelope.
Lighting ≥ 25% $0.60 / SF
HVAC ≥ 15% $0.60 / SF
Envelope ≥ 10% $0.60 / SF
INTERIM LIGHTING
Our clients often ask us if they can qualify for §179D credits if the scope of work includes a lighting retrofit, or if they are unable to qualify for a partial deduction through energy modeling. They answer is Yes: Interim lighting can often serve as an alternative. Here’s how:
Based on the lighting power density (LPD) calculation (watts per square foot) as compared to an ASHRAE reference building, there is a 25% to 40% LPD reduction (equal to a $0.30 to 0.60 tax deduction). However, you must incorporate bi-level switching and automatic controls.
Putting the EPAct §179D deduction into practice
Here are three proven ways to implement the §179D deduction:
- Subject to federal income tax, you can take an ordinary deduction.
- Firms structured as pass-through entities can take advantage of the EPAct §179D tax deduction up to the amount of shareholder basis.
- Deductions taken in excess of basis are exercised at a reduced amount.
NOTE: If you have clients that are design firms, their returns from the past three tax years can be amended to claim the EPAct §179D deduction, potentially generating a refund.
TWO KEY CRITERIA FOR SELECTING PROJECTS:
- Includes new construction, renovations, and additions.
- Projects in which your clients’ firms are primarily responsible for the design.
Here is a typical §179D worksheet you can use to gather information to start the analysis:
REAL WORLD CASE STUDY
A Sec. §179D analysis of a high-rise residential building resulted in a total deduction of $1.20/sq. ft. The project included LED lighting, low-E glazing, and high efficiency heating and cooling systems. Although, the project fell short of the 50% savings required to qualify for the full $1.80/sq. ft. credit, the interior lighting and HVAC systems qualified for the partial deduction of $0.60/sq. ft. per system.
§179D CASE STUDY
| Property Description | |
| Client | Commercial |
| Property Type | High Rise Residential |
| Number of Floors | 42 |
| Aria (SF) | 800,865 |
| Benifit – HVAC Qualification | |
| Difference in Annual Energy ($) | $145,291 |
| Achieved Savings Over Refrence | 15.9% |
| §179D Tax Deduction ($/SF) | $0.60 |
| §179D Tax Deduction Total ($) | $480,519 |
| Benifit – Interium Lighting | |
| Reference Lighting Power Density | 0.7 watts/sq. ft, |
| Actual Lightning Power Density | 0.4 watts/sq. ft, |
| Achieved Savings Over Reference | 42.8% |
| §179D Tax Deduction ($/SF) | $0.60 |
| §179D Tax Deduction Total ($) | $480,519 |
A question that building owners and CPAs often ask us is: “Where do I start?” Owners can get confused when they have so many vendors offering various products to reduce their energy costs. If your clients are considering a major energy upgrade, the best place to start is with an energy audit. The audit will measure and validate the impact of energy efficient equipment as it relates to the investment costs.
WHAT IS AN ENERGY AUDIT?
An energy audit is a component-by-component, system-by-system evaluation of building’s HVAC systems, lighting or process equipment. Whereas most maintenance activities focus on making things work, an energy audit focuses on making things work properly and efficiently.
Make sure you use a qualified auditor who has the credentials not only to perform the analysis, but to understand the equipment specifications and the impact on overall energy reduction. A professional engineer with experience in various building components is a good person to start with.
5 REASONS TO HELP YOUR REAL ESTATE CLIENTS TO CONDUCT AN ENERGY AUDIT
- To maximize and protect the health and productivity of the building’s occupants by maintaining thermal comfort.
- To maximize energy efficiency and minimize losses.
- To determine the building’s overall value
- To keep up with rapidly changing government guidelines
- To use the energy audit results in determining the energy conservation measures.
If nothing else, remember that without an energy audit, your clients may end up wasting lots of money on projects that are not really improving their building’s energy efficiency. The American Society of Heating, Refrigerating, and Air-Conditioning Engineers (ASHRAE) outlines three different levels of energy audits, based on how intensive they are, and on the type of outcome expected.
3 TYPES OF ENERGY AUDITS YOU SHOULD KNOW
ASHRAE Level 1 – Preliminary Audit/Walk-Through Analysis.
This is the most basic audit involving site inspection and interviews. Here you’ll want to review your client’s utility bills and operating data. This is also where you’ll want to priority their energy efficiency projects. A Level 1 audit can give your clients and other stakeholders a picture of where the building currently stands, how it compares to similar buildings, and which areas need further investigation or improvement.
ASHRAE Level 2 – Energy Survey and Analysis.
Here is where you’ll want to do detailed energy calculations of energy efficiency measures life as well as life cycle cost analysis. This is also where you’ll want to do financial analysis based on the investment costs and savings from the energy efficiency measures. A Level 2 audit provides enough data to justify the implementation of a project without the need for additional data collection and analysis.
ASHRAE Level 3 – Detailed Analysis of Capital-Intensive Modifications.
A Level 3 audit expands on Level 2, with a particular focus on capital-intensive projects with a high-level of accuracy toward cost and savings calculations. This is also where you’ll do detailed field analysis and engineering calculations. Level 3 audits are for clients whose businesses have completed a Level 2 audit and have identified capital cost projects that they want to undertake but need more data before committing to a large investment.
HOUSING AUTHORITY UTILITY ALLOWANCES
If you have clients with low-income housing properties, here are some important considerations:
- Utility allowances are payments from housing authorities that pay the utility bills for low-income residents.
- They are generally excluded from gross rents under Reg. § 1.42-10.
- They are usually based on assistance from Rural Housing or HUD.
- For other tenants, they can use an Energy Consumption Model from a licensed engineer to determine the utility estimates.
- Reducing utility estimates can avoid overcharging tenants and may allow rent increases.
- They are generally required once per year.
CONCLUSION
Everyone from energy efficient equipment manufacturers and design engineers, to CPAs, contractors and commercial real estate professionals is familiar with EPAct. However, very few professionals design for it or can certify it. For you and your clients to utilize EPAct correctly, we urge you to add an independent provider to your team. Remember, every dollar in operating costs you help your clients save will have a positive impact on the capital worth of their building. A well-qualified team can design the process to include tax incentives to fund the upgrade. The benefit of lower operating costs starts on Day One when the install is complete. Further, it assures owners that they are paying the lowest energy costs. Be the leader who drives down operating costs for your clients!
About the authors
Karen J. Koch, CPA, MT, is a Senior Director in the Louisville, Kentucky office of Source Advisors. Imran Syed, P.E., LEED AP, CEM, HERS Rater, is a Senior Director, Energy Services in the Fort Worth, Texas office of Source Advisors
