Permanent 179D Tax Deduction for Energy Efficiency

Published: Jul 24, 2024
By: King Cheng
Topics: Tax
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The energy efficient commercial buildings deduction under IRC Sec. 179D (“179D deduction”) was created in 2006 as a temporary measure to incentivize building owners, designers, and builders to install energy efficient systems. The 179D deduction was made permanent as part of the Consolidated Appropriations Acts of 2021 and was further expanded as part of the Inflation Reduction Act of 2022 (“IRA”). As a result of these changes, an already popular deduction has become even more attractive for building owners, designers, and builders.

What Is IRC Sec. 179D?

IRC Sec. 179D is a popular tax incentive that provides building owners and eligible designers or builders the opportunity to claim a tax deduction for installing qualifying energy efficient systems and buildings. Tenants may be also eligible if they make the construction expenditures. The tax deduction applies to both new construction and retrofits.

Qualified buildings include:

Commercial buildings, including warehouses and parking garages;
Multifamily properties with four stories or more; and
Buildings owned by government and tax-exempt entities, such as universities and hospitals.

Under the IRA, the 179D deduction is no longer a one-time deduction. The deduction is available every three years for commercial buildings (four years for buildings owned by tax-exempt entities), provided the new construction work meets all the requirements. This will be very beneficial for multiphase long-term projects.

How to Qualify for the Deduction

To qualify, the energy efficient property must reduce the energy and power costs of newly constructed or improved buildings located in the United States minimum requirements of Standard 90.1 as published by the American Society of Heating, Refrigerating, and Air Conditioning Engineers (“ASHRAE”) for the following areas:

Interior lighting systems;
Heating, cooling, ventilation, and hot water systems; and
Building envelopes.

Certification Requirements

In order to qualify for the deduction, the energy efficient property must also receive proper certification by licensed engineers or contractors as meeting various energy efficiency standards. The qualified individuals will perform field inspections in accordance with guidelines from the National Renewable Energy Laboratory (“NREL”) and calculate the energy and power cost savings with software approved by the Department of Energy.

Calculating the Deduction

The deduction is based on the square footage of the construction or improvements. Prior to 2023, the maximum deduction allowed was $1.80 per square foot, adjusted annually for inflation. Taxpayers who qualified for a partial deduction could deduct up to $.60 per square foot, adjusted annually for inflation. For 2022, the maximum deduction allowed was $1.88 per square foot, with a partial deduction of $.63.

Beginning in 2023, the full amount of deduction allowed is based on a sliding scale dependent on the percentage of energy cost savings generated, all adjusted annually for inflation. As part of the IRA, the base deduction amount was decreased to $.50 per square foot, increased for every percentage point above 25% energy cost savings, capped at 50% of the energy savings costs, for a potential total deduction of $1.00 per square foot.

However, if the construction or improvement meets the Prevailing Wage and Apprenticeship (“PWA”) requirements outlined in the IRA, the base deduction amount increases five-fold for a deduction of up to $2.50 per square foot. The same increase applies when the PWA requirements are met; meaning taxpayers who meet those requirements are eligible for a deduction of up to $5.00.

Efficiency Increase Over Baseline	Deduction Amount (Without PWA)	Deduction Amount (With PWA)
25% (minimum needed to qualify)	$0.50/SF	$2.50/SF
30%	$0.60/SF	$3.00/SF
35%	$0.70/SF	$3.50/SF
40%	$.80/SF	$4.00/SF
50% (Maxes out)	$1.00/SF	$5.00/SF*

**Max will adjust for inflation (2024 max is $5.65/SF)

For 2023, the allowed deduction ranges from a base of $.54 to $1.07 per square foot if PWA requirements are not met, and from $2.68 to $5.36 per square foot if PWA requirements are met. For 2024, the deduction if PWA requirements are not met ranges from $.57 to $1.13 per square foot. If PWA requirements are met, the 2024 deduction ranges from $2.83 to $5.65 per square foot.

If a deduction is allowed under IRC Sec. 179D with respect to the energy efficient property, the basis of such property will be reduced by the amount of allowed deductions. Additionally, the deduction allowed may not exceed the cost of qualifying property.

One of the considerations for the 179D deduction is that taxpayers must recapture the deduction as ordinary income when the property is subsequently sold at a gain. Accordingly, an analysis on the benefits should be performed to determine if the 179D deduction is the best approach.

179D Tax Savings Illustrated

Assume an energy project costing $19,500,000 is completed for a commercial building with 600,000 square feet. Typically, the improvement would be depreciated over 39 years, providing annual depreciation of $500,000. With the 179D deduction, additional depreciation can be taken in the year that the energy efficient property is placed in service, resulting in significant benefit to the taxpayers:

600,000 sq ft x $5.00 benefit rate = $3,000,000
The basis of the energy efficient property will be reduced by $3,000,000 and
the remaining basis of $16,500,000 will be depreciated over 39 years, providing annual depreciation for approximately $423,000.

In this example, the total allowable deduction is $3,423,000 in the year that the taxpayer claims the 179D deduction, compared to $500,000 without.

How to Claim Deductions Under IRC Sec. 179D

Taxpayers can take the 179D deduction in the current tax year if they receive the proper certification and/or allocation letter at the time of tax filing.

There are different filing requirements to take the deduction for the energy efficient property placed in service in prior years.

Building owners may use Form 3115, Change in Accounting Method, to retroactively take the deduction in a current year tax filing without amending their returns. On the other hand, eligible designers or builders of government-owned buildings must amend their tax returns in order to take the deduction. They can only file for open tax years, generally three years from the date of filing.

The deduction offered under IRC Sec. 179D is one of many energy incentives that have become available over the past few years. Taxpayers who wish to take advantage of these credits and incentives should reach out to a trusted tax advisor for guidance.