How designers of energy-efficient buildings can get tax benefits normally earmarked for the investor.
By: Dhaval R. Jadav and David Ji
As many architects, engineers, and design-build contractors today struggle with the worst economic downturn since the Great Depression, they may be overlooking a significant source of cash that can help them hire additional employees, more competitively price their jobs, and expand their business: the Energy Efficient Commercial Buildings Deduction. This relatively new tax incentive remains under utilized because many taxpayers do not know it exists or how it works.
According to the U.S. Energy Information Administration, the building sector consumes nearly 50% of all energy and nearly 75% of all electricity produced in the country. All indicators suggest that this trend is likely to get worse. Between 2010 and 2030, total building sector energy consumption is predicted to increase by about 7 quadrillion Btu. To give you a point of reference, 1 quadrillion Btu is the energy equivalent to 36 million tons of coal being burned at a power plant.
In order to counter these and other problems that we are facing in energy, Congress passed the Energy Policy Act of 2005. That bill created, among other things, the Energy Efficient Commercial Buildings Deduction found in section 179D of the Internal Revenue Code. In a nutshell, the deduction allows for an immediate depreciation deduction of up to $1.80 per square foot for commercial buildings that achieve certain reductions in total energy and power costs with respect to their interior lighting, HVAC and hot water, and building envelope systems.
So who gets the benefit? Well normally, it's whoever pays the cost of putting the energy efficient property into service. This would be the owner or landlord of the building. But in addition, designers of government-owned buildings can also get the benefit. So if you are an architect or engineer who has done design work, or is doing design work for new government buildings or renovations/retrofits of existing government buildings, i.e. schools, state universities, libraries, town halls, airports, transportation facilities, post offices, court houses, military bases, offices, etc., this incentive can be yours. In fact, this is the only green building incentive targeted towards designers.
There are multiple ways to qualify for a 179D deduction, and the amount of the deduction depends on the energy efficiency levels that your project meets. In order to qualify for the full deduction, your design must reduce the total annual energy and power costs related to lighting, HVAC, and building envelope by 50% or more compared to the minimum requirements established in ASHRAE standard 90.1-2001. If you cannot meet this whole deduction threshold, all is not lost.
Partial deductions are available for partially qualifying buildings and reductions of as little as 10% in some cases can result in a deduction of up to $0.60 per square foot. For interior lighting, there's even another way that you can get a fractional benefit of $0.30 to $0.60 per square foot depending on reductions in lighting power density.
The full deduction is very difficult to get and typically requires proactive design with the 179D deduction in mind. But you should not stop there. It's much easier to obtain partial qualification or fractional qualification. In fact, with most states today adopting codes stricter than 2004 standards, there's a good chance that if you're dealing with a new construction or major retrofit, you will qualify under one of the partial qualification methods. These partial deductions can result in very significant tax benefits, so do not leave this money on the table.
One example of this is a group of four California Department of General Services Buildings which undertook recent major retrofits. The architect on record did not feel that their design would qualify for a 179D deduction. Although the buildings did not qualify for a full deduction, we were able to help the architect secure a $718,000 deduction worth an estimated $251,000 in net tax savings through one of the partial qualification methods with respect to interior lighting. Too often, architects and engineers forego this benefit due to a lack of understanding about the various ways in which their projects may qualify. Think about what you could with an extra $250,000 of found money.
Another example is a student housing building for a state university in Louisiana. The building was about 92,000ft2 in size. In this case, the architect was able to claim a $110,000 deduction that resulted in an estimated net tax savings of $38,700. Two systems qualified on this project - the lighting and the HVAC system. The lighting consisted of two tubes 4ft super T-8s throughout, while the HVAC was an efficient variable air volume system.
These two examples illustrate how architects, engineers, and design-build contractors are able to take advantage of this important energy tax incentive program. While the process is somewhat complex, it essentially begins with a careful tax and energy modeling analysis and ends with certification and the filing of amended returns. It can also result in a brand new source of valuable funds in these trying economic times.
The U.S. Congress and many state governments realize how critical energy efficiency is to the future of our economy. A collective reduction in national consumption of energy protects us from recurrent energy-related problems caused by tight energy supplies and rising import dependence. They also know that companies designing energy efficient systems and/or putting into place energy efficient property are supporting millions of high skilled, well-paying jobs.
For these and other reasons, the effort by Congress and recent administrations to foster energy efficiency and the adoption of renewable energy sources is a trend that is here to stay. In fact, the Department of Energy and IRS are working together through the Better Buildings Initiative to develop a proposal for expanding and extending the 179D deduction, so this incentive is likely to become even more powerful in the future.
The time to act is now. If you have worked on any public property in the past few years, you need to consider a 179D analysis. And act quickly, because this deduction is claimed on amended tax returns which are only typically open until three years after the date of original filing. Don't let the statute of limitations run on you for older projects that are already completed. Also for current projects, there may be multiple designers who are eligible for the deduction so being first to act can be the difference in being able to secure a deduction versus being left out in the cold.