Inflation Reduction Act Expands Energy-Efficient Deductions and Credits

By Nick Price, CPA, Manager, Tax & Advisory
ASL Real Estate Group

The Inflation Reduction Act (IRA), which was signed into law on August 16, 2022, included expanded and extended tax credits and incentives to encourage energy efficient housing, commercial buildings, and vehicles. Our previous blogs discussed incentives for homeowners (A Greener Home Can Save You Green Under the Inflation Reduction Act) and vehicle buyers (Inflation Reduction Act Restructures Alternative Fuel Vehicle Credit).

The bill provided enhanced incentives for owners of residential single family and multifamily homes to reduce energy consumption in newly constructed residences by modifying and extending the Internal Revenue Code Section 45L credit for energy efficient residential construction. The bill also provided an incentive to commercial building designers and owners by enhancing the Code Section 179D deduction for energy efficient commercial buildings.

Section 45L Energy Efficient Home Credit

In general, the amended Section 45L credit provides a per dwelling unit tax credit for owners of residential property in an effort to reduce energy usage in newly constructed residences, including remodels with substantial rehabilitation. When initially adopted in 2006, the tax credit was intended to end on December 31, 2021. The Inflation Reduction Act has retroactively extended the existing credit through 2022. Additionally, the IRA modified the tax credit beginning in 2023 with the following changes:

  • The Section 45L credit is now extended through 2032;
  • The maximum credit allowed has been increased from $2,000 per dwelling unit to $5,000 per dwelling unit;
  • Implemented new Department of Energy, ENERGY STAR and Energy Zero Energy Ready Home (ZERH) standards. The ZERH program requirements vary by housing sector and location.
  • The required development size of three-story or less has been removed, and now allows for any size building; and
  • Section 45L credit can now be used in combination with the Section 179D Energy Efficient Commercial Building deduction for residential buildings four stories and larger.

Planning point – In order to maintain compliance with the new requirements, builders, and developers will need to begin planning for certification at an earlier stage of development than previously as there are new inspection requirements that will be needed during the construction phase.

Section 179D Energy Efficient Commercial Building Deduction

While the Section 45L tax credit applies to only residential real estate, the Section 179D deduction can apply to both multi-family (greater than three stories) and commercial real estate. Prior to the passage of the IRA, the 179D tax deduction was an opportunity for business owners to claim a tax deduction for installing qualifying systems in buildings. The IRA has expanded the 179D deduction, including but not limited to, eligibility of the deduction, the range of the deduction, and the technical requirements for attaining the deduction. The new 179D deduction changes are effective as of January 1, 2023, and include the following:

  • Increased eligibility for claiming the deduction;
  • Reduction of the minimum required savings;
  • Increase to the minimum and maximum deductions; and
  • Removal of the lifetime limit.

The IRA has expanded the eligibility for the 179D deduction beyond commercial building owners and designers of buildings owned by government entities. Beginning on January 1, 2023, the eligibility for the 179D deduction has expanded to all of the following:

  • Commercial building owners constructing new buildings, performing renovations, and adding additions;
  • Architects and designers of buildings owned by:
    • Government entities;
    • Not-for-profit organizations, including schools and universities;
    • Churches and other religious organizations;
    • Tribal organizations; and
  • REITs.

The IRA has expanded the guidelines of the 179D deduction to further compel builders to move towards greater energy reduction but allows for more projects to qualify by lowering the minimum required savings in total annual energy and power cost. Prior to the IRA, the minimum required savings was a 50% reduction over the energy standard baseline model. With the passage of the IRA, buildings can now be eligible with merely a 25% reduction in total annual energy and power costs.

In addition, the IRA has increased the potential deductions under Section 179D by imposing “prevailing wages and apprenticeship” requirements.  If these requirements are met, and the building achieves a 25% reduction in energy and power costs, then the 179D deduction is $2.50 per square foot. If the energy and power cost reduction exceeds 25%, the 179D deduction increases by $0.10 for each additional percentage of reduction, which ultimately could result in a maximum deduction allowed of $5.00 per square foot. If the prevailing wage and apprenticeship requirements are not met, and the building achieves a 25% reduction in energy and power costs, then the 179D deduction is $0.50 per square foot. If the energy and power cost reduction exceeds 25%, the 179D deduction increases by $0.02 for each additional percentage of reduction, which ultimately could result in a maximum deduction allowed of $1.00 per square foot.

Lastly, the IRA has allowed for an increase to the frequency of the 179D deduction. Beginning in 2023, the lifetime limit has been removed for the 179D deduction, and now allows for the 179D deduction to potentially be taken every three years (four in certain circumstances) for the same building unit.

With these expanded incentives, make sure to discuss any of your construction or remodel projects with your tax advisor so the proper tax deductions and tax credits can be claimed and/or considered.

If you have any questions regarding any of these new tax credits or programs, please reach out to Nick Price, CPA, or another member of the ASL Real Estate Group to answer your question!