If your business plans to invest in energy-efficient property, it pays to investigate whether you qualify for the federal tax deduction for energy-efficient commercial buildings. Under Internal Revenue Code Section 179D, owners (and certain tenants) of new or existing commercial buildings may deduct the cost of certain energy efficiency improvements. The deduction is also available to designers (such as architects, engineers or contractors) of buildings owned by certain tax-exempt entities.
Although the deduction was introduced more than 15 years ago, until recently it was a temporary incentive — up to $1.80 per square foot — that expired and was renewed several times. In late 2020, however, Congress made the incentive permanent and provided for the maximum deduction amount to be adjusted for inflation. In 2022, for example, the maximum deduction was $1.88 per square foot.
The deduction was given a generous boost by the Inflation Reduction Act (IRA), for improvements placed in 2023 or later. The IRA increased the maximum deduction to $5.00 per square foot under certain circumstances and made it easier for improvements to qualify for the deduction. It also expanded eligibility for the deduction to include real estate investment trusts (REITs) and designers of government buildings as well as buildings owned by nonprofit organizations, religious organizations, tribal organizations, and nonprofit schools or universities (previously, only designers of government buildings were eligible).
How it Works
Before 2023, the 179D deduction allowed eligible commercial building owners/tenants (as well as owners/tenants of multi-family residential rental buildings that are at least four stores above grade) to immediately deduct, rather than depreciate, up to $1.88 per square foot for qualifying investments in energy-efficient interior lighting, HVAC or hot water systems, or building “envelope” improvements (e.g., insulation, roofing, windows, doors).
To qualify, building improvements had to be certified by a licensed engineer or contractor to be part of a plan designed to reduce annual energy and power costs by at least 50 percent in comparison to a reference building constructed according to specified American Society of Heating, Refrigerating and Air-Conditioning Engineers (ASHRAE) standards. In addition, partial deductions (up to 63 cents per square foot) were available for improvements to one of the above building systems (interior lighting, HVAC/hot water, building envelope) that achieved specified energy savings.
Starting this year, it is easier to qualify for the deduction. The IRA reduces the minimum required energy savings from 50 percent to 25 percent. It also replaces partial deductions with a sliding scale under which the base deduction ranges from 50 cents per square foot (for 25 percent energy savings) to $1.00 per square foot (for 50 percent energy savings). Higher deductions — ranging from $2.50 per square foot to $5.00 per square foot — are available for improvement projects that meet certain prevailing wage and apprenticeship requirements.
The IRA also allows taxpayers to claim 179D deductions for the same building as often as every three or four years. Previously, the $1.88 per square foot maximum was a lifetime cap.
Improve Your Tax Bill
If you plan to invest in energy efficiency improvements of new or existing buildings, be sure to work with your tax advisors to determine your eligibility for the 179D deduction. It may also be possible to claim missed deductions for improvements made in previous years, either by filing amended returns or claiming “catch-up” deductions in the current tax year.
