Guide to Energy-Efficient Commercial Building Tax Deductions

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These days, going green is a catchphrase in every aspect of life, from fashion to food. 

But for business owners like you, going green is more than just a trend. It’s good for business. Energy efficiency helps shave operating costs, which boosts your bottom line. But it also helps you save money in an area you didn’t expect: your taxes. There are a number of commercial building tax deductions available to business owners.

Uncle Sam knows that commercial buildings are a huge investment. That’s why there are federal tax incentives for energy conservation, particularly energy-efficient commercial buildings. Here’s what you need to know to make your taxes a little greener. 

Tax Law commercial building tax deductions

The Energy-Efficient Commercial Building Tax Deductions

The primary avenue for commercial buildings to maximize energy-efficient tax benefits is energy-efficient commercial building tax deductions. It’s also known as the 179D deduction (not to be confused with the 179 deduction, which allows businesses to deduct qualifying asset purchases from their taxes).

The Energy Policy Act of 2005

The 179D deduction was part of the Energy Policy Act of 2005. The Act broadly addresses energy production in the United States, including: 

  • Energy efficiency
  • Renewable energy
  • Oil and gas
  • Coal
  • Tribal energy
  • Nuclear energy and nuclear security
  • Vehicles and motor fuels
  • Hydrogen
  • Energy tax incentives
  • Hydropower and geothermal energy
  • Climate change and technology

The relevant section here is Subtitle C – Conservation and Energy Efficiency Provisions. 

Under Section 179D(a), the owner of a commercial building can take a deduction for commercial properties equal to the cost of energy-efficient commercial building property placed during the taxable year. 

History and Benefits

The Energy Policy Act was enacted in direct response to concerns about broader energy usage, particularly in commercial buildings. 

The building sector (both residential and commercial buildings) accounts for 40% of the nation’s energy expenditure, including more than 70% of nationwide electrical consumption. Buildings also emit more than one-third of the nation’s greenhouse gases, more than any other sector in the economy. Commercial buildings claim about half of that consumption cost, making them the worst offenders. 

However, lawmakers also recognize that business owners have to consider the profitability of making key investments. That’s is why section 179D deductions exist. With these deductions, building owners view going green as a profitable investment for their bottom line. 

The 179D deduction is intended to curb those energy costs by giving building owners a clear incentive. Owners of qualifying commercial buildings can receive a tax deduction of up to $1.80 per square foot for energy-efficient buildings placed into service during open tax years. Typically the “lookback period” is three years, and any accrued tax deductions can either be carried back two tax years or carried forward up to 20 tax years. 

How to Qualify

The 179D deduction is available to the owner OR lessee of a commercial building for qualified new constructions, renovations, or additions. Note that energy incentives for individuals and residential properties do exist but are in a different tax category from 179D. 

Common examples of qualifying commercial buildings include: 

  • Office buildings
  • Retail buildings
  • Industrial buildings
  • Warehouses
  • Apartment buildings at least four stories tall

In addition, designers, architects, engineers, contractors, environmental consultants, and others involved in the construction of a building can qualify for a 179D deduction under a special rule for public property. If designers or builders made enhancements to public property to improve energy efficiency, they can claim the deduction. This applies to government-owned buildings at the local, state, and federal level, including: 

  • Schools
  • Libraries
  • Universities
  • Town halls
  • Airports
  • Courthouses
  • Post offices
  • Transportation facilities
  • Military bases
  • Government offices

The deduction also applies retroactively to any structures built between 2006 and 2013 that meet the criteria for the 179D deduction, including new buildings, retrofitted buildings, and leadership in energy and environmental design (LEED) buildings. 

In order to qualify, your building must be checked by an independent third-party firm to review the building and confirm the energy savings provided by the construction or renovations. 

If you are a business seeking a 179D deduction for a government-owned building, you’ll also need to obtain a letter of allocation, in which the government entity agrees to transfer the benefit to the taxpayer. 

What Buildings Are Within the Scope of Standard 90.1-2001?

A clearer way of understanding what buildings qualify for the 179D deduction is to look at what buildings fall under the scope of standard 90.1-2001. This standard covers the building envelope, HVAC system, lighting, service water heating systems, electrical motors and belt drives, and electric power distribution and metering. 

Any of the following fall within the scope of standard 90.1-2001: 

  • Buildings used primarily for commercial purposes
  • Buildings that have been converted from other uses to primarily commercial uses
  • Buildings used primarily for industrial purposes
  • Multifamily residential buildings of more than four stories, including school dormitory buildings
  • Unconditional attached or detached garage spaces

Note that industrial process systems are excluded from the scope of standard 90.1-2001, which means they are excluded from the 179D deduction. Though dormitories house students and not families, they are considered multifamily buildings and fall within the scope of the standard so long as they are more than three stories tall. 

Once you know that your building is qualified, you will have to show that the building has certain percentages of energy expenditure for specific categories in order to qualify. The building upgrades must achieve the predicted savings levels in order to qualify under the deduction, so even improvements that should qualify you won’t count if they don’t deliver sufficient energy savings. 

How to Claim the 179D Deduction

If your building meets all of the above criteria, you’re ready to apply for your 179D deduction. This requires knowing the full cost of the improvements in order to calculate the maximum available deduction. 

Section 179D allows a deduction of $1.80 per square foot for buildings that:

  • Save at least 50% of the heating and cooling of a system
  • Qualify under standard 90.1-2001 (for buildings in service prior to January 1, 2016)
  • Qualify under standard 90.1-2007 (for buildings in service prior to January 1, 2017)

You can also take a partial deduction of $0.60 per square foot for energy-efficient measures affecting: 

  • The building envelope
  • The lighting system
  • The heating or cooling system

If that doesn’t sound like much, don’t underestimate how much you could write off. Let’s say you constructed a commercial building of about 19,000 square feet. At $1.80 per square foot, that’s a maximum deduction of $34,200 off your business taxes. 

In order to claim the deduction, collect your receipts for the construction, including any certifications (hint: the building has to be certified by a third-party firm before you can claim the deduction). You’ll enter the amount for the deduction under “Other Deductions”. If you have a corporation, you’ll need the Form 1120. S-corporations will need the Form 1120-S and partnerships will need the Form 1065

IRS Guidance

For additional guidance on navigating your 179D deduction, it’s time to turn to the IRS. 

The first port of call is notice 2006-52, which set forth interim guidance allowing building owners and lessees to navigate the process of claiming their 179D deduction. This will clarify: 

  • What buildings qualify
  • The maximum amount of your deduction
  • Navigating partially qualifying property (lighting)
  • Navigating partially qualifying property (heating, cooling, ventilation, and water heating)
  • Property subject to the permanent rule
  • How to handle deductions if they are applicable to multiple taxpayers

From there, refer to notice 2008-40, which spells out regulations surrounding government-owned buildings. This will clarify: 

  • Who qualifies for the deduction
  • Special allocation
  • The form of the allocation
  • The obligations of the designer
  • The tax implications for the designer
  • The tax implications for the building owner

Finally, if you think your building may partially qualify but aren’t sure how to navigate that situation, you can refer to notice 2012-26. This notice is particularly useful for clarifying qualifying buildings under the permanent rule, as well as permitted energy savings percentages for qualifying buildings. It will also help clarify the limitations on partially qualifying buildings so that you understand how partial qualification differs from regular qualification and how to calculate your deduction. 

Additional Resources

Think you can make sense of the qualifying standards? If you still need a bit of guidance, there are two key resources outside IRS jargon that can help you. 

The first is the Energy Savings Modeling and Inspection Guidelines for Commercial Building Federal Tax Deductions, created by the National Renewable Energy Laboratory (NREL). This offers guidelines for modeling and inspecting buildings for certification under Section 179D, which is helpful if you’re working on new construction. This applies to all buildings constructed prior to 2016. 

The second is the Energy Savings Modeling and Inspection Guidelines for Commercial Building Federal Tax Deductions for Buildings in 2016 and Later, which, as the name implies, is for commercial buildings constructed from 2016 onwards. 

 

179D and the Tax Cuts and Jobs Act of 2017

As with most other elements of the tax code, the 2017 Tax Cuts and Jobs Act threw a few questions into play for the 179D deduction. 

You see, the 179D tax credit isn’t a permanent fixture of the tax code. It’s what’s known as a tax extender, a set of temporary tax breaks which Congress typically renews for a period of one to two years at a time.

Over 50 tax breaks expired at the end of 2013, all of which have expired at least once and have been renewed several times. Some tax extenders have been renewed for so long that they’re practically part of the permanent tax code, like a research and experimentation tax credit that’s been renewed 15 times since 1981. 

The problem is that these tax breaks are extremely expensive for the federal government. That said, they’re even more expensive to enact permanently, even tax breaks that have been renewed for decades. That’s because the year-by-year renewal cycle encourages businesses to take advantage of the break now instead of in a few years. If these extenders were made permanent, the cost of enacting them would skyrocket (a leap from $85 billion to over $700 billion). 

Where 179D Stands

Section 179D was originally enacted to last for two years in 2005 and has been extended several times since then. This is in part because Section 179D is the only federal tax incentive for commercial buildings to become energy efficient.

It allows taxpayers to take deductions for later years, which ironically reduces the law’s effectiveness if the goal is to encourage future building. If anything, the deduction is most attractive for large commercial buildings that have already been constructed. 

After all, it’s a bit nonsensical to design new buildings for a tax law that may or may not exist in future years, even if its renewal is highly likely. That leaves the issue in the hands of business owners and builders. 

However, in the right circumstances, the 179D deduction can be quite attractive to businesses and builders when combined with other relevant energy efficiency and eco-friendly tax credits, such as the production tax credit or solar energy tax credits

The best route for an enterprising business owner like yourself is to work with a tax attorney to figure out what tax credits and deductions are applicable to you and what would be most lucrative for your project and bottom line. 

Tax Law commercial building tax deductions

Navigating Energy Efficiency and Taxes

There’s a reason why death and taxes are often equated in jokes–for the average person, they’re practically the same. However, with the right tax guidance, you can learn how to leverage your commercial buildings and make the most of your tax dollars. Your bottom line can go a little further. And in the meantime, you’re making smart investments in future eco-friendly construction in the meantime). 

If you need help from a professional tax consultant, we’re here to make the tax code understandable. Click here to find out more about our professional IRS tax consulting services. 

Managing Partner of Silver Tax Group, author of the book “Stop the IRS”. Practicing a variety of tax issues, regulations, laws and rights. Specializing exclusively on tax matters involving IRS audits, negotiation, settlements & compromises.

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