05 Sep 2023 Tax Strategies for Energy-Efficient Buildings: Understanding 179D Deduction and 45L Credit
Professionals in the construction and building improvement industry constantly seek ways to enhance their final products while cutting expenses. One of the ways they achieve this is by ensuring their buildings are as energy-efficient as possible. This not only aids their clients in reducing operational costs but also allows them to pass on savings to their own customer base. In addition, the federal tax system offers various tax credits and deductions to incentivize developers to continue delivering top-notch products to their clients.
What is a 179D Tax Deduction?
By taking advantage of a tax deduction like the 179D deduction, you can effectively reduce the amount of income subject to federal taxation. This deduction is aimed at those who have made energy-efficient upgrades to important components of their buildings, such as the HVAC system, lighting, or insulation. Additionally, those who are involved in constructing new energy-efficient buildings that meet certain standards can also qualify for the 179D tax deduction.
What is a 45L Tax Credit?
Tax credits function distinctly compared to tax deductions, as they are focused on diminishing the actual amount of tax owed. The 45L credit is an example of a tax credit that developers and builders can claim on their federal taxes for constructing buildings that satisfy certain energy efficiency requirements.
Who Qualifies For A 179D Deduction Or 45L Credit?
Construction businesses and architectural or engineering companies that take part in developing specific structures can benefit from this tax deduction. To be eligible for the 179D tax deduction, the entity must be involved in the building or structure’s design. This means that merely installing, repairing, or maintaining components that contribute to a structure’s energy efficiency is insufficient to qualify for the deduction.
According to the IRS, businesses, corporations, and partnerships that provide funding and have ownership of a building project during its construction stage are classified as “eligible contractors” for this tax credit. Suppose you’re involved in the construction of residential dwellings that meet specific energy efficiency criteria and own the property being constructed or renovated. In that case, you may be eligible for the 45L tax credit.
The Inflation Reduction Act Of 2022
On August 16th, 2022, certain energy-efficient credits and deductions for taxpayers were modified and increased by a recently signed act. One of the affected deductions is the 179D deduction, which has been amended along with the 45L credit. The changes made to sections 179D and 45L by this act will apply to taxable years starting after December 31, 2022.
What Property Is Considered Eligible?
The 179D Deduction
Prior to the implementation of the Inflation Reduction Act, only government-owned structures were eligible for the 179D deduction. These structures could be either commercial or residential rental buildings with at least four stories, subject to specific thresholds.
Beginning in 2023, tax-exempt entities will now be able to receive deduction allocations for their design work. This is good news for many building types that were previously ineligible for the 179D deduction, as they will now be able to participate. The list of newly eligible tax-exempt entities includes:
- Charitable organizations
- Churches and religious organizations
- Private schools and universities
- Private foundations
- Political organizations
- Other non-profits
- Native American tribal governments
- Alaska Native corporations, and
- Other non-profits
The 45L Credit Properties that are eligible for the 45L tax credit include:
- Single-family dwellings
- Trailer homes
- Manufactured housing (eligible for $1,000 credit w/ a 30% reduction)
- Multi-family townhomes
- Apartment buildings
- Senior housing
- Student housing
If they meet certain criteria, properties within the United States can be eligible for the 45L tax credit. There are no restrictions on whether a property is a primary or vacation residence, and both newly constructed and renovated buildings are eligible. The good news is that dwellings built between August 8, 2005, and December 31, 2032, that meet all the requirements are also eligible.
How Much Is A Deduction/Credit Worth?
The 179D Deduction
If you’re filing taxes for any year prior to 2023, it’s important to know that the biggest possible deduction you can take advantage of with the 179D tax program is $1.80 per square foot. However, to qualify for this maximum deduction, your project must meet certain requirements, including a reduction of at least 50% in total annual power and energy costs across three different structural systems:
- Interior lighting
- HVAC system (including hot water systems)
- The building envelope
- Partial deductions are available if a project meets certain or lesser requirements
The maximum deduction for the 179D tax program can be increased up to $5.00 per square foot if you comply with the requirements of the Inflation Reduction Act. This act also lowers the efficiency standard from 50% to 25%, making qualifying for the deduction easier. Additionally, if you meet the prevailing wage and apprenticeship requirements, you can take advantage of the increased deduction amount.
The Inflation Reduction Act made other modifications to Section 179D, which include:
- Elimination of partial deductions – There is now a different deduction available for retrofitting buildings with energy-efficient properties. This deduction can be taken in the same year the final certification qualifies, so long as a qualified retrofit plan is in place.
- The 45L Credit – If you’re considering taking advantage of the 45L tax credit before 2023, keep in mind that it provides a $2,000 credit per dwelling unit that’s either constructed or substantially renovated. You may still be eligible for the credit for prior tax years by filing an amended tax return, but typically only for those going back less than three years.
The Inflation Reduction Act will modify the 45L tax credit and energy-saving requirements for homes to qualify. As of January 1, 2023, a home must be certified as a zero-energy ready home under the Department of Energy’s zero-energy ready home program to qualify for the credit. The program further categorizes dwelling units as single-family homes and multi-family homes. As of 2023, the credit amount can range from $500 to $5,000, depending on which energy efficiency requirements the home meets and whether the construction of the home satisfies prevailing wage requirements.
How Long Are They In Effect?
The permanent tax code now includes the 179D tax deduction, which applies to commercial building owners who made improvements after January 1, 2006. Building designers may also be eligible for any open tax years during the past three years.
Meanwhile, the Inflation Reduction Act extended the expiration of the 45L tax credit until December 31, 2032, with modified energy-saving requirements.
If you’re unsure whether you qualify for a tax credit in a previous tax year, we recommend consulting with a tax professional. Contact Haynie & Company for more information on the eligibility requirements for the 179D deduction, 45L credit, or both.
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