Inflation Reduction Act – Section 179D

On August 16, 2022, the Inflation Reduction Act was signed into law by President Biden. The Inflation Reduction Act provides for substantial enhancements and improvements to two existing tax incentives, Section 179D and Section 45L. The changes are expected to yield significant benefits. We covered the Inflation Reduction Act’s modifications to Section 45L last week and will cover Section 179D below.

Section 179D, which was made a permanent feature of the Internal Revenue Code with the passage of the Consolidated Appropriations Act, 2021, provides commercial building owners and eligible designers / builders with the opportunity to claim a tax deduction for installing qualifying energy efficient systems and buildings. The reference standard used to model energy-efficient buildings for the Section 179D deduction is published by the American Society of Heating, Refrigerating and Air Conditioning Engineers and the Illuminating Engineering Society of North America (ASHRAE). These standards and guidelines establish uniform testing, safe practices, and proper definitions for industry and the public, and are updated periodically.

Prior to the passage of the Inflation Reduction Act, the Section 179D deduction was limited to a factor based on the square footage of an energy-efficient commercial building. Each building had the potential to deduct up to $1.80 per square foot of qualifying space if it was 50% more efficient than the reference standard. Even if the building was not able to reach the 50% efficiency threshold, the statute permitted a partial deduction of $0.60 per square foot of qualifying space for each of three separate energy-efficient components: interior lighting systems; heating, cooling, ventilation, and hot water systems; and the building envelope construction.

The following are key changes to the Section 179D deduction under the the Inflation Reduction Act:

• The Section 179D deduction is $0.50 per square foot and can be increased by $0.02 for each percentage point by which the certified efficiency improvements reduce energy and power costs. There is a maximum deduction of $1.00 per square foot.
• If the project meets certain prevailing wage and apprenticeship requirements, the base amount is $2.50 per square foot, which could increase by $0.10 for each percentage point increase in energy efficiency, with a maximum amount of $5.00 per square foot.
• A qualifying building must now increase its efficiency relative to the reference standard by 25%.
• There is an alternative deduction for energy-efficient building retrofit property.
• The partial qualification for different building systems was eliminated.
• The Section 179D deduction can now be allocated to designers of energy-efficient buildings for tax-exempt entities, rather than only for governmental entities as was the case under the previous law. Real estate investment trusts (REITs) are also now eligible to utilize the Section 179D deduction.

As a reminder (and possibly a buzzkill), the Section 179D deduction requires a reduction in basis of the building property equal to the amount of the deduction.

Much appreciation to Stan Babicz and Caleb Solley for their contributions to this post.