Inflation Reduction Act Tax Savings for Real Estate
On Tuesday, August 16, 2022, the Senate passed the Amendment of H.R. 5376, “The Inflation Reduction Act.” This bill contains many energy-related tax provisions. For many building owners, developers, and designers, the most important provisions are the significant changes to the New Energy Efficient Home Credit and the Energy Efficient Commercial Buildings Deduction.
The New Energy Efficient Home Credit
The Internal Revenue Code (IRC) §45L New Energy Efficient Home Credit is for developers of energyefficient dwelling units, including single-family homes, multifamily buildings, and even mobile homes. The credit was $2000 per unit but expired at the end of 2021.
The bill extends the current §45L credit for dwelling units acquired by sale or lease for use as a residence through December 31, 2022. For units acquired starting on January 1, 2023, there are substantial changes to the credit rate and qualifications.
- Single-family dwellings eligible for the Energy Star Residential New Construction Program or the Energy Star Manufactured New Homes program that meets the energy savings targets qualify for either a $2500 per unit credit or a $5000 per unit credit.
- For units acquired before January 1, 2025, the $2500 credit is for dwelling units that meet the Energy Star Single Family New Homes National Program Requirements 3.1.
- For units acquired after December 31, 2024, the $2500 credit is for homes that meet the Energy Star Single Family New Homes National Program Requirements 3.2
- In both cases, the dwelling unit must also meet the most recent Energy Star Single Family New Homes Program Requirements for its location that was in effect on the latter of January 1st, 2023, or January 1st of two calendar years before the date of acquisition.
- The $2500 credit also applies to a mobile home that meets the most recent Energy Star Manufactured Home National program requirements in effect on the latter of January 1st, 2023, or January 1st two years before the acquisition date.
- The $5000 credit is for a unit that meets the Zero Energy Ready Home Program of the Department of Energy in effect on January 1st, 2023 (or the successor program).
- Multifamily dwelling units that meet the requirements of the Energy Star Multifamily New Construction Program receive a credit of either $500 or $1000.
- The $500 credit is for dwelling units that meet the most recent Energy Star Multifamily New Construction National Program Requirements in effect on the latter of January 1st, 2023 or January 1st three years before the acquisition.
- The $1000 credit is for dwelling units that meet the most recent Energy Star Multifamily New Construction Regional Program Requirements that applies to the unit’s location and is in effect on the later of January 1, 2023 or January 1st three years prior to the acquisition.
- The multifamily credits increase to $2500 and $5000, respectively, if they meet prevailing wage requirements. If the prevailing wage requirement is not met, the affected workers can be paid the difference in wages plus interest and the developer can pay a $5,000 per worker penalty to meet the requirements.
Energy Efficient Commercial Buildings Deduction
Unlike the §45L credit, the §179D Energy Efficient Commercial Buildings deduction is a permanent part of the IRC that currently provides up to a $1.88 per square foot deduction for building owners or designers of government buildings that install energy efficient commercial property. The Inflation Reduction Act makes permanent, substantial changes to the deduction starting in 2023.
- The partial deduction, including the interim lighting rule, is eliminated.
- The energy savings target is reduced from 50% to 25% and the amount of the deduction is reduced to from $1.88 per square foot to $0.50 per square foot. For each percentage point increase in energy savings, the deduction goes up by $0.02 to a maximum of $1.00 per square foot for a reduction of 50%.
- If the building owner or designer meets the prevailing wage requirement and an apprenticeship requirement, the deduction increases to a $2.50 per square foot with 25% energy savings.
- The deduction increases by $0.10 per square foot for every percentage increase until it reaches $5.00 per square foot with 50% energy savings.
- The prevailing wage requirements generally require “Davis Bacon Act” wages.
- Unlike the prevailing wage requirement, the apprenticeship requirement cannot be fixed after construction. The Act does allow good-faith, failed efforts to meet the apprenticeship requirements.
- The energy standard is now the more recent of ASHRAE Standard 90.1-2007 or the Standard 90.1 affirmed by the government not later than four years before the property’s placed-in-service date. This change will require building owners and developers in areas with long construction lead times to increase the energy savings relative to the current standard.
- The allocation of the deduction by government agencies to designers has now been expanded to allow other taxexempt entities to allocate the deduction to a designer.
- Currently, the deduction must be reduced by all past §179D deductions. The Act reduces this to a three-year
lookback period for property owners, four years for building designers.
- The Act replaces the partial deduction with an Alternative Deduction for Energy Efficient Building Retrofit Property installed as part of a qualified retrofit plan.
- This alternative deduction is based on a reduction in energy use intensity certified a year after the property’s placed-in-service date.
- The deduction is limited to domestic buildings originally placed in service at least five years before the qualified retrofit plan’s establishment.
- A baseline energy use intensity must be established to show a reduction.
Observation: Some taxpayers may have difficulty meeting the prevailing wage requirement. Others may have to purchase off-the-shelf software to monitor compliance with the prevailing wage requirement.