No matter how New Yorkers may feel about the legislation coming out of Congress, a federal tax break incentivizing higher energy efficient standards for lighting makes it likely that new commercial building construction and major renovations in New York can qualify for a generous federal tax deduction—up to $1.80 per square foot.
This federal tax incentive can benefit building owners, federal, state and local governments and, most importantly, an architect or engineer who designs government buildings.
Buried in the Energy Policy Act of 2005 is Section 1331, the energy-efficient commercial buildings deduction that forms the basis for Section 179D of the Internal Revenue Code (IRC).
Section 179D was born when Congress, casting a broad net in order to encourage energy efficiency—including geothermal options such as sun or wind energy—recognized that there should also be incentives for energy efficiency in commercial buildings, which are major consumers of energy.
Congress does not require the buildings to demonstrate a great leap in energy efficiency to, at least partially, qualify for the tax benefit. CPAs should be aware that simply meeting New York standards will most likely garner significant deductions for their clients.
Who Can Benefit?
The three groups that can benefit from Section 179D are:
1) the private owner, and sometimes the tenant, of the commercial building;
2) the government-owner of the commercial building; and
3) the architect or engineer of a government-owned commercial building.
If the owner paid for the energy efficient components of the building or the improvements, then the deduction goes to the owner, which it takes in the current tax year, reducing its basis in the building or energy efficient components. For the owners of a building, the benefit of 179D is really the benefit of good timing.
It is important to note, however, that in those cases where the tenant or lessee paid for the building—or more likely, paid for an extensive renovation as discussed below—the tenant or lessee can take the 179D deduction if it owns the equipment or material being used, for example an HVAC (heating, ventilation and air conditioning) system. The tenant or lessee would then reduce his or her basis in the equipment he or she owns.
If the building, including significant improvements, is owned by a government entity, then the government can benefit by assigning for consideration the tax benefits to the architect and/or engineer responsible for the building. In drafting the legislation, Congress envisioned that this assignment of the 179D tax deduction could result in a benefit for the government. This benefit typically takes the form of lower fees or goodwill.
All federal, state, local and affiliated, governmental entities are eligible to benefit from Section 179D. A public state university, a county utility company or a local school board are all typical examples of the wide reach of what is considered the “government” for the purposes of Section 179D. The definition, however, does not include Native American tribes.
The government reduces its basis in the property, but because the government is not subject to tax, this is not an issue. It is noteworthy that under the law, nonprofits and charities cannot assign their Section 179D tax benefit.
CPAs with architectural and engineering firm clients doing work for the government—for example, designing a new wing for the country hospital—are in an excellent position in terms of benefitting from Section 179D.
An architect or engineer client, or even a design-build contractor client, working on a government building can have the tax benefits of Section 179D assigned to them by the government. While in some cases the government may seek consideration or lower fees, it is often the case that the government will assign the benefit as a matter of goodwill. The Section 179D tax benefit is a direct deduction for the architect or engineering firm and there is no basis reduction by the architect or engineer, which is something the government does. This is not a timing benefit, but a way in which CPAs can lower the taxes benefit for their clients.
But there is one problem. The government can potentially assign the Section 179D benefit to a number of different entities involved with the design of the building. For example, the designer could also be the architect, the engineer or the consultant, etc. The designer does not include the person who repairs, maintains or makes installations on the property. The government can assign all or a portion of the Section 179D deduction to any party that meets the definition of a designer.
Basically, it is like a race, which is why any CPA with architect or engineering clients should not wait to contact them. CPAs don't want to find out later, or worse have their clients find out first, that the clients could have qualified for the Section 179D deduction, but were beaten to the punch.
What Qualifies as a Commercial Building?
Section 179D is only for energy-efficient property that was installed or placed into service for a commercial building, such as retail or office space or property being used for manufacturing purposes or as a warehouse. A multifamily structure that is four stories or taller also qualifies as a commercial building. For the government, the rules are the same, meaning that schools, prisons, courts, dormitories, airports, police stations or military bases all qualify.
Given the fees and costs associated with qualifying for the deduction, it generally makes sense for CPAs to consider buildings that are 50,000 square feet or larger.
For an owner, the energy-efficient property must have been placed into service since the beginning of 2006. For designers, as in architects or engineers who are assigned the 179D benefit by the government, the energy-efficient property must have been placed into service within the last three tax years. But while the energy-efficient property being installed or placed into service often coincides with the building itself being placed into service, the clock only starts ticking when the energy-efficient commercial building property, i.e. the HVAC systems, lighting, insulation, etc., is placed into service.
Section 179D benefits are good until the end of 2013. The provision, which has been extended previously, enjoys support from both Congress and the current administration.
Eight Ways to Qualify as Energy-efficient
There are essentially eight ways to qualify for Section 179D. The policy of Section 179D is to award a tax deduction to improvements-related energy efficiency over a baseline set out in ASHRAE (American Society of Heating, Refrigerating and Air-conditioning Engineers) 90.1-2001.
This is where New York law becomes a factor. New York law already requires lighting standards that are higher than those delineated by ASHRAE, thus making it likely that New York clients, at a minimum, will qualify for at least the 60 cents per square foot (SF) on lighting, as discussed below. In brief, the government is looking to award improvements that are higher than the standard practices outlined in 2001 by ASHRAE.
The deduction amounts are as follows:
- $1.80/SF is awarded if the total annual energy and power costs related to lighting, HVAC and hot water are reduced by 50 percent or more.
- $.60/SF is awarded for building envelope—the area that separates conditioned space from unconditioned space or the outdoors—if there is at least a 10 percent reduction.
- $.60/SF is awarded for HVAC and hot water if there is at least a 16.67 percent reduction.
- $.30–.60/SF is awarded for interior lighting if there is at least a 16.67 percent reduction in costs or at least a 25 percent reduction in lighting power density.
The chart below provides a useful breakdown of the eight ways clients can qualify for a Section 179D deduction.
There are three deduction subgroups: building envelope, HVAC/hot water and interior lighting. Interim lighting rules offer buildings the chance to gain an accelerated deduction that is equal to the projected complete cost of installing energy-efficient interior lighting.
It is likely that a New York commercial building will qualify for lighting and could well qualify for HVAC/hot water and/or building envelope deductions, which means CPAs should make sure to take a closer look at any clients who are required to swap out new boilers in New York City.
The bottom line is that all CPAs should consider Section 179D deductions for all their clients with commercial buildings of 50,000 square feet or more, for government clients, and, absolutely, for architect and engineering client firms that do work for the government.
Luckily, CPAs do not have to figure out the energy efficiency of the building. The law requires that there be a certification conducted by independent engineers.
Certification of Energy Efficiency
To receive Section 179D benefits, the taxpayer needs to obtain a certification for the building of its energy-efficient status performed by an unrelated third party engineer or contractor licensed in the jurisdiction in which the building is located.
The energy modeling must use a performance rating method and utilize Department of Energy-approved software, of which there are roughly 20 to choose from. The certification includes an analysis of design plans and specifications. Once the building is placed into service, a field inspection of the building is also carried out, after which the taxpayer will receive a certified letter stating that the building meets the required energy efficiency standards.
In order to ensure that clients get the maximum benefit, it is vital to use an engineer that is knowledgeable about both the law and the science. Not every engineer with a slide rule can effectively perform this work, which includes intricate knowledge of how to calculate the proper baseline, an understanding of the proper standards and the creativity to examine all the possible ways that a client could potentially qualify for Section 179D. For example, a subpar engineer will often ignore the interim lighting rules. CPAs should make sure the engineer they hire is qualified and has experience in performing these certifications.
Requirements for Assignment/Allocation: Special Rules for Architects and Engineers
As mentioned above, architects and engineers who design an energy-efficient building and have the tax deduction assigned to them by the government can benefit greatly from Section 179D.
The assignment is done by an official allocation letter signed by an authorized representative from the agency. IRS guidance states that the letter should include a number of facts, including the name of the designer, the owner of the building, the date the building was placed into service and the amount of the deduction allocated to the designer. The letter is signed under penalty of perjury. There is no rule regarding which government official signs the letter, simply that he or she be an authorized representative. Typically the letter is signed by the facilities director, assistant superintendent, director of purchasing/contracts or the project director. Be aware that obtaining an allocation letter can sometimes be a long and drawn-out process.
Property owners with property that was placed into service in the current tax year can list the 179D deduction as an “other deduction.” There is no requirement that the property owner file the engineer's certification with the return, though the certificate must be kept with the owner's records, as per Notice 2006-52 and IRC Section 6001.
Property owners with property that was placed into service in a prior year for which the owners have already filed must typically use Form 3115, Application for Change in Accounting Method to claim the deduction on the current year return. This is because such property owners have likely already started depreciating the property.
Preparers must include the engineer's certificate with Form 3115 per Rev. Proc. 2011-14. Note that it does not matter whether the year it was placed into service is an open year or not because the preparer is making the accounting adjustment on the current year return, although the property must have been placed into service after Dec. 31, 2005. “Property” here does not necessarily refer to the entire building, just the energy-efficient commercial building property.
Designers who were allocated the deduction can claim it as an “other deduction” on the return for the taxable year in which the property was placed into service.
Regardless of whether the property was placed into service currently or in a prior year, the deduction will go on the return for the year the property was placed into service because there should be no existing accounting method for the property which should not be on the designer's books. There is no requirement to attach the engineer's certificate or the allocation letter to the return, though the taxpayer must keep these documents in their records.
Consider the following examples.
A precision metal stamping company conducts a major retrofit of its 115,000 thousand square foot facility. The retrofit includes upgrades to the building envelope, HVAC and lighting systems. The envelope was upgraded with insulated glass, double-pane thermal break windows and doors, as well as a cool roof using reflective coatings. The HVAC system was a split-unit constant volume system with an energy-efficient direct gas-fired industrial heater. The lighting system upgraded from metal halides and T12s lights to high output fluorescent T5s. Both the lighting and HVAC systems qualified for the Section 179D tax benefits, providing a tax deduction of $140,000 and an estimated tax savings of $50,000. The owner takes the $140,000 deduction immediately on this year's tax return and reduces his basis in the buildings by $140,000.
An architect designs 92,000 square feet of student housing for a state university. Both the HVAC and interior lighting systems qualify. The HVAC has a variable air volume system, resulting in a 20.1 percent reduction of annual costs. The lighting uses 2 Lamp 4' Super T-8 lights, producing an 18.8 percent reduction of annual costs. The tax deduction is $111,000. The university allocates the full amount to the architect. The architect takes a deduction of $111,000 with an estimated tax savings of $40,000.
Accounting firms and their clients can benefit enormously from Section 179D deductions. The tax incentives provide much-appreciated cash infusions directly into the pockets of business owners. It does take some effort to reap the benefits of the tax incentives provided by Section 179D, but it is worth it—especially for New Yorkers who have the advantage of high-standard state rules, and therefore already qualify.
Now all New York CPAs have to do is call their clients with the good news.
This article originally appeared in the August 2011Tax Stringer and is reprinted with permission from the New York State Society of Certified Public Accountants.