Energy + Environment, Legislation + Regulation

Energy Efficiency Tax Deductions Expanded By The Inflation Reduction Act

The Inflation Reduction Act (IRA) of 2022 was signed into law on August 16, 2022. Among the provisions included in this bill is the expansion of the Section 179D tax deduction for building energy efficiency. Thousands of commercial building owners have utilized the 179D tax deduction since its inception in 2005, and this expansion potentially allows for many more to not only utilize the deduction but also claim larger amounts than previously available.

Under the Energy Policy Act (EPAct) of 2005, Section 179D allows for energy efficient investments in new and existing buildings to qualify for immediate tax deductions up to $1.88 per square foot through the 2022 tax year. Eligible projects include those related to interior lighting, HVAC, and building envelope. The 179D deduction was made permanent as part of the Consolidated Appropriations Act of 2021. Owners of commercial buildings can utilize the 179D deduction for building projects completed since January 1, 2006. Owners in all major building categories are utilizing the deduction, including warehouse, industrial, retail, office, hospitality, and restaurant chains.

The Inflation Reduction Act of 2022 includes numerous updates to the 179D deduction, which take effect on January 1, 2023. Notable updates include:

  • Deduction levels up to $5.00 per square foot – the qualified deduction range for projects meeting prevailing wage and apprenticeship standards will be between $2.50 and $5.00 per square foot, depending on the building’s energy efficiency level. For projects that do not meet prevailing wage and apprenticeship standards, the deduction level range will be between $0.50 and $1.00 per square foot.
  • Inclusion of not-for-profits, instrumentalities and Tribal Government buildings – Designers of energy systems in these buildings are now allowed to claim the 179D deduction for qualifying projects.
  • Deduction reset – currently, the maximum 179D deduction can be taken once over the life of the building. With the passage of this new law, the maximum deduction would now be available every three years on a commercial building and every four years on a government, instrumentality, not-for-profit, or Tribal Government building.

With the growth of e-commerce, many new distribution centers / warehouses have been built in the United States. This is an excellent category for large EPAct tax deductions which are based on square footage. Under the IRA a 1 million-square-foot distribution center could qualify for a $5 million tax deduction.

With warehouse lighting projects, facility managers are required to understand which items are picked more frequently. One strategy is to use sensor-controlled digital fixtures and organize the aisles so that the most frequently picked items are all in the same aisles with the easiest access. With this technique, large portions of the warehouse can be kept dark, meaning virtually no lighting-related electric costs are incurred. Such retrofits can qualify for EPAct 179D deductions.

Another category of commercial buildings is hospitals. For the first time effective January 1, 2023, all hospitals can generate 179D tax benefits. For-profit hospitals and government hospitals (for designers) have also been eligible for 179D tax benefits.  Now, the largest hospital category, tax-exempt hospitals, can generate 179D designer benefits.

With the passage of the Inflation Reduction Act, companies are now positioned to monetize the 179D deduction in a greater capacity than ever before. The increased deduction levels lead to a quicker payback and improved return-on-investment (ROI) for distribution center owners who are considering installing energy efficient equipment. For designers, the deduction can now be used on energy efficient designs for non-profit, instrumentality, and Tribal government buildings. The increase in potential tax savings allows companies to fuel further energy efficient upgrades and improvements.

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