Building owners and tenants who make expenditures to cause new or renovated commercial buildings to be more energy efficient continue to be eligible for a significant Federal tax deduction, an immediate one time depreciation deduction of up to $1.80 per square foot.

A new tool to see if a building will qualify

The U.S. Department of Energy has announced an online tool for making quick and easy estimates of the energy cost savings from improving the efficiency of a new or renovated commercial building. The soon to be released tool is expressly intended to assist in determining whether a building will qualify for the Internal Revenue Code, Section 179D deduction.

Of course, the free tool does not replace the need for the required certification of the anticipated performance from a qualified individual (a licensed contractor or engineer in the jurisdiction of the building location) in advance of a taxpayer actually taking the deduction.

Specifically, the tool is designed to help determine if a property qualifies for partial deductions for envelope; lighting; and heating, ventilating, and air conditioning (as described below). The savings estimates for the envelope and HVAC improvements are based on pre run energy simulations for several building types across all climate zones in the United States. Qualification for the interim lighting rule are based on reductions in the installed lighting power and all buildings or space types included in ASHRAE Standard 90.1-2001 are included in the tool.

The tool DOE 179D Calculator will go live in March, 2012.

This new tool will undoubtedly cause the 179D deduction to be to be more widely considered because it will now be quick and easy and free to see if a building will qualify.

Partial deductions are changing for the better

An expenditure is eligible for the deduction when certified as being installed as part of a plan designed to reduce the total annual energy and power costs of interior lighting systems, heating, cooling, ventilation, and hot water systems of the building by 50 percent or more when compared to a reference building, which meets the minimum requirements of Standard 90.1-2001 (effective April 2, 2003).

In the instance of a building that does not meet the whole building requirement of a 50 percent energy savings, a partial deduction may be allowed with respect to each separate eligible building system: Heating, cooling and water heating systems; building envelope; and lighting system.

Each of the three energy using systems can be evaluated separately, and is eligible for a share of the tax deduction if it meets its share of the overall savings goal for the building, a 50 percent reduction in energy costs. Earlier IRS guidance changed the rules now allowing a limited deduction for “partially qualifying property” that meet lower energy savings targets than the prior required 16 2/3 percent reduction for a tax deduction of 60 cents per square foot. A later guidance changed those percentages such that today an income tax deduction is available for a 10 percent reduction in energy costs for interior lighting systems; a 20 percent reduction for heating, cooling, ventilation, and hot water systems; and, a 20 percent reduction for the building envelope.

New IRS guidance will be dated March 12, 2012

And going forward, the applicable energy savings percentages permitted under the new Notice 2012-22 are 25 percent for the interior lighting system, 15 percent for the heating, cooling, ventilation, and hot water systems, and 10 percent for the building envelope.

The additional set of energy savings percentages that taxpayers may use to qualify for a partial 179D deduction under the permanent rule, as described in the new Notice are available for property placed in service on or after the effective date of the Notice, expected to be Match 12, 2012.

Spotlight on lighting

The specific tax regulations for lighting efficiency are not changing. Because lighting systems are easy to upgrade and the precise energy savings gained by upgrades are already known, building owners and tenants are encouraged to focus on lighting improvements.

An interim lighting rule provides lighting systems that reduce lighting power density by 40 percent (50 percent in a warehouse) and employ dual switching (i.e., the ability to switch roughly half the lights off and still have fairly uniform light distribution) qualify owners for a full tax deduction of 60 cents per square foot. The IRS outlines a prorated incentive schedule in which systems that reduce lighting power density by 25 to 40 percent may earn a partial deduction of 30 to 60 cents per square foot. The IRS guidance requires that lighting level and lighting control standards be met in order for owners to qualify for this tax deduction.

Tenants are eligible

The determination of whether a tenant is eligible for the deduction is a function of who owns the property for tax purposes. It is a question of fact and the determination may depend on the agreement of the parties. If the tenant pays for the investment, constructs it according to its owns specs, and there are no concessions in the lease or from the landlord, it is likely that the tenant will be the owner of the improvements for tax purposes and eligible to claim the deduction; and such a structure may be ideal when the landlord is a REIT or other tax advantaged entity that cannot benefit from the deduction.

Government allocation to designers

In the case of federal, state and local public buildings, significantly, the IRS issued guidance that the law allows for the tax savings to be allocated to the person primarily responsible for designing the buildings, in lieu of the public entity (that doesn’t have a tax burden).

Sophisticated bidders on public construction projects (from schools and universities to military bases and transportation facilities) have made their bids more competitive factoring in the allocation for a designer that may include, “an architect, engineer, contractor, environmental consultant or energy services provider who creates the technical specifications” for a new public building or an addition to an existing public building that incorporates energy efficient upgrades. This may be the only green building incentive targeted toward designers and at $1.80 a square foot it can be huge.

LEED projects are ideal candidates

While this issue of modeling energy performance carries a dollar cost, LEED® certified projects require similar (although not identical) energy modeling, such that once an energy consultant is engaged on a LEED project, the certification necessary for the 179D deduction certification is easily accomplished. Moreover, with the LEED 2009 prerequisite of a 10 percent improvement in the proposed building performance rating for a new building compared with the baseline in Appendix G of ANSI Standard 90.1-2007, many if not most LEED 2009 certified buildings will be eligible for this tax deduction!

We can assist you

A more comprehensive treatment of the 179D tax deduction can be found in the article, Tax Deduction of $1.80 per Square Foot for Building Owners, Tenants and Designers

There are opportunities for business to advantage government incentives in green building, including the significant Federal tax deduction described above. Many of the opportunities are best leveraged by including a knowledgeable owner’s representative early in the process. We regularly serve in that role.

We have the knowledge and experience in green building and sustainable business to advantage your company. Do not hesitate to contact Stuart Kaplow.