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Industries: Real Estate

Tax Deductions for Energy Efficient Commercial Buildings

Improving the energy efficiency of older buildings makes sense on many levels. But the expense of building new energy efficient structures (or retrofitting older ones) can be prohibitive.

To offset the added cost of constructing or retrofitting energy efficient buildings, Congress created the Section 179D Energy Efficient Building Tax Deduction as part of the Energy Policy Act 2005 (“EPAct 2005”). Since then, legislators routinely extended many of the EPAct 2005 incentives until finally making it permanent in December 2020, as part of a COVID-19 stimulus package.

Data from the U.S. Department of Energy (DOE) shows about 76% of all electricity consumed in the U.S. goes to buildings, with over a third attributable to commercial properties. The goal of the 2005 legislation was to help promote American energy independence by incentivizing the construction of green energy property, which includes the construction of energy efficient buildings. Here is how the Section 179D tax deduction can help real estate builders and operators today.

Spending money to save money

Section 179D provides a deduction of up to $1.80 per square foot for specific energy-efficient commercial building property placed into service after December 31, 2005. For a building to qualify for the deduction, it must improve energy performance in at least one of three areas:

  • interior lighting
  • heating, ventilation and air conditions (HVAC) and hot water systems
  • the building envelope

Interior lighting is essential for any building and is also one of the top users of energy. The list of upgrades for lighting systems includes:

  • changing physical equipment like lamps, fixtures and ballasts to high-efficiency models,
  • switching to LED lightbulbs, or
  • embracing automated lighting systems
  • or utilizing daylight, where practical.

Upgrades to HVAC systems and the building envelope are less common as a standalone improvement project so Section 179D deductions are most often taken for new construction, or lighting retrofit projects.

What qualifies for the deductions?

To claim the maximum deduction of $1.80 per square foot, the building owners need to show they made upgrades in all three areas – and prove the improvements reduced their power consumption. To qualify, the building's total energy and power cost must be cut by 50% (or more) than the minimum requirements set by the American Society of Heating, Refrigerating and Air-Conditioning Engineers (ASHRAE). For buildings built or upgraded before 2016, the standard is ASHRAE 90.1-2001, and 90.1-2007 for structures built or upgraded after 2016. A third party must verify the energy savings using qualified computer software.

If a building owner chose to make upgrades in only one area, they could claim up to a $0.60 per square foot deduction. However, they would still need to show a 16.6% reduction in the building's energy and power costs using the ASHRAE minimum requirements.

The commercial buildings that qualify for the 179D deductions include retail, office and industrial buildings, apartments of at least four stories and warehouses. The deductions can be carried back two tax years or carried forward for 20 years.

Section 179D has expanded over the years to cover construction and improvement costs for the non-taxpaying organization like schools, airports, municipalities, universities, post offices and libraries. However, in these situations, the deductions may be claimed by the primary designer of the building or building system.

Here are a couple of examples to see how it works.

Case Study 1: Newly constructed LEED Gold Class A office building

A developer in the San Francisco Bay area completed construction on a new building that receives a LEED Gold rating for its energy efficiency. The building is 132,000 square feet. A third party conducted a study showing the structure consumes 50% less energy than the ASHRAE standard. The builder can claim a 179D deduction of $237,600 ($1.80 x 132,000 square feet) and enjoy significant maintenance cost savings. Professional fees for testing and design totaled $16,000.

Case Study 2: Energy install for Public School District

A Top-10 U.S. public school district hired an external renewable energy company to do an extensive retrofit of its school buildings. The work entailed using high-efficiency fixtures and ballasts, as well as the use of LED bulbs. The total square footage for all structures worked out around just under 16 million square feet. Testing showed the buildings consumed 16.6% less energy than the ASHRAE minimum standard. The designer/builder can claim $9.5 million ($0.60 x 15.8 million square feet), with professional fees totaling around $100,000.

Improve your return on investment

Smart building owners recognize upgrading or building a new structure offers a better return on their investment than just the lucrative tax deduction. An energy-efficient building has lower energy and maintenance costs. Studies show certified environmentally-friendly structures can charge about 4% more for rent and have nearly a 10% higher vacancy rate than non-certified properties. The improvements typically directly improve the profitability of a building. Finally, the upgrades can increase the sales price of a structure by as much as 25%. To find out more about the benefits of the Section 179D Energy Efficient Building Tax Deduction, contact BPM Managing Director James Su.

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