The EPAct 179D Energy Tax Deduction
The 179D Federal Energy Tax Deduction was enacted by the Energy Policy Act of 2005 (EPAct). The benefits of this Act were later extended through December 31, 2013 by the Emergency Economic Stabilization Act of 2008. Section 179D of the Internal Revenue Code provides a deduction for qualifying U.S. taxpayers who install energy efficient property that reduces annual energy and power consumption by 50% compared to the American Society of Heating, Refrigerating, and Air Conditioning Engineers (ASHRAE) standard. If the taxpayer does not meet the 50% threshold, partial deductions are available contingent upon certain requirements.
The deduction itself is actually a variant of IRC Section 179. Instead of depreciating building improvements over a 39 or 27.5 year term, the taxpayer will be allowed to deduct the entire cost of the energy improvements in the year they are placed in service so long as the amount does not exceed $1.80 per-square-foot. If total improvement costs do exceed this amount, the residual amount would then be capitalized and depreciated over the term appropriate for its property class. It should be noted that the amount of the 179D deduction taken would be a reduction in the amount capitalized for tax purposes.
In order to qualify for the full deduction, the taxpayer must improve the energy efficiency of an existing building or new building. The required 50% reduction in energy consumption must be accomplished solely through energy and power cost reductions for the following systems: 1) heating, cooling, ventilation, hot water, 2) building envelope (exterior of building, building structure, etc), and/or 3) interior lighting. If the 50% reduction is accomplished, the taxpayer would be able to deduct the lesser of the cost of the improvements or $1.80 per-square-foot.
In order to qualify for a partial deduction, a 16 2/3% reduction must be achieved, resulting in a $0.60 per-square-foot deduction. If more than one system qualifies for the partial deduction, they can be combined in order to generate a $1.20 per-square-foot deduction. Lighting systems, however, must achieve an improvement of energy efficiency of light power density by at least 25 – 40% (50% in case of warehouse) in order to qualify for the partial deduction between $0.30 and $0.60 per-square-foot. The IRS also allows for threshold substitutions to be made for certain qualifying properties.
The deduction is applicable to commercial buildings of any size, apartment buildings (four or more stories, for lease), and public buildings only. All of which must be located in the U.S. As public buildings are concerned, the IRS allows the deduction to be allocated to the person primarily responsible for designing the property in lieu of the public entity. Eligible improvements are to have been completed between January 1, 2006 and December 31, 2013.
Before claiming the deduction, the taxpayer must obtain a certification with respect to the property. This can be done by having the building inspected by a qualified individual who has received a certification of energy savings. Usually, an engineer or contractor licensed in the applicable state should qualify. The qualified individual will use modeling software, which should be approved by the Department of Energy, to compare the actual building to a reference building. The taxpayer would then be issued a certification of energy savings by that individual. The certification need not be filed with the IRS, but should be retained by the taxpayer.
Aside from the tax deduction, the actual cost of building “green” is approximately 10% more costly for a building with a very high quality of energy efficiency as compared to a building without all of the energy efficiency installations. However, the typical green building that will qualify for the deduction will cost around 3% – 5% more than a building without such improvements. This extra cost will usually be recaptured within two to 10 years (depending upon the level of energy efficiency) through savings on actual energy costs, such as utilities.
For those considering a “green” commercial building, the 179D incentive should be a factor that is weighed in the decision.
Authored by Jason Deirmenjian, CPA
November 14th, 2010