Section 179D tax deduction
Also known as the Energy Efficient Commercial Buildings Deduction, Section 179D is an incentive to install energy-efficient features in commercial buildings.
For tax years 2022 and prior, Section 179D allows eligible building owners and designers of government buildings a tax deduction of up to $1.80 per square foot3nflation adjusted to $1.88 per square foot for 2022 — for work performed on one or more of the following three building systems:
- Interior lighting
- Building envelope
- HVAC and hot water
The Inflation Reduction Act of 2022 dramatically increased the Section 179D energy efficient commercial building deduction, making it especially impactful for the AEC industries.
These changes, which are outlined below, are significant and could add additional value — and complexity — to Section 179D. They apply to qualifying property placed in service after Dec. 31, 2022.
How AEC firms could qualify for section 179D
AEC companies that create technical specifications for the installation of energy-efficient commercial building property can be classified as designers per the tax code requirements.
To the extent these companies perform work on non-taxpaying entities, the Section 179D deduction associated with the construction project can be allocated to a designer. The eligible non-taxpaying entities available to allocate the Section 179D deduction depends on when the project was placed in service, detailed below.
How does a designer claim the section 179D deduction?
An eligible designer claims the Section 179D deduction by applying a Section 179D study in the same tax year as when the building is placed in service. If the building was placed in service during a previous tax year, amending tax returns for years already filed would be required to claim the deduction.
What is a section 179D study?
In a Section 179D study, a qualified third party uses Department of Energy-approved energy software to model the energy performance of the building and improvements.
The energy model then compares the building’s performance with a reference building that meets relevant energy efficiency requirements, according to standards set by the American Society of Heating, Refrigerating, and Air-Conditioning Engineers (ASHRAE).
After completing a physical site visit of the facility and reviewing results of the energy model, the qualified third party verifies that the improvements meet the applicable energy-savings thresholds using the ASHRAE standards. They then sign a certification document for the Section 179D deduction stating they’ve examined the energy model and support the allocation of the deduction to its respective designer.
Note that the third party must be a contractor or professional engineer (PE) licensed in the state where the building is located.
Changes to section 179D from the Inflation Reduction Act
There are four main opportunities that affect the AEC industries as a result of the Inflation Reduction Act. The act:
- Increases the qualification thresholds
- Adds a bonus deduction
- Expands the deduction allocation to tax-exempt entities
- Creates an alternate deduction path
Increases qualification thresholds
To qualify for any deduction, a project must meet a 25% energy cost reduction threshold. The base deduction is equal to 50 cents per square foot with a potential bonus deduction equal to $2.50 per square foot.
The deduction increases on a sliding scale for each percentage point of energy cost reduction above 25% . This increase is capped at a 50% reduction with the base deduction set at $1 per square foot and a potential bonus deduction equal to $5 per square foot. The updated nominal deduction values noted for the base and bonus deduction are all inflation adjusted for tax years 2023 and beyond.
Previously, for projects placed in service in 2022, the tax deduction range was 63 cents per square foot for each of the three eligible systems, including HVAC and hot water, interior lighting, and building envelope to a maximum value as adjusted for inflation of $1.88 per square foot.
Adds bonus deduction
The bonus deduction is available to companies that meet local prevailing wage and apprenticeship requirements for any laborers and mechanics employed by the taxpayer or contractors associated with the installation.
The bonus deduction is a new measure introduced by the act and took effect for buildings where construction started after Jan. 30, 2023. If the prevailing wage and apprenticeship requirements are satisfied or construction started prior to this date, taxpayers may be eligible for increased tax deduction amounts.
Expands deduction allocation to tax-exempt entities
The deduction can now be allocated to designers of buildings for tax-exempt entities including religious organizations, nonprofit organizations, private K–12 schools, private higher education institutions, and Tribal organizations. This is a significant and beneficial change for the AEC industries as it greatly expands the pool of potentially qualifying properties. Government entities that could previously allocate the deduction will continue to be eligible to allocate.
Creates alternate deduction path
The act creates an alternate deduction path for renovation projects based on reducing a building’s energy-use intensity by 25% or more. This alternate path allows for energy savings to be assessed based on actual energy savings related to the project rather than complying with the typical energy modeling approach.
