There is widespread acceptance that the renewed focus on green building is good for the planet, but current tax legislation is also making it good for your wallet. The stimulus package signed into law earlier this year extended a key provision of the Energy Policy Act of 2005 (the “Act”) that allows a tax deduction of up to $1.80 per square foot for certain energy efficiency improvements.
The Energy Efficient Commercial Buildings Deduction, included in Section 179D of the Internal Revenue Code, allows building owners or lessees to deduct up to $1.80 per square foot for energy efficiency improvements to a building’s lighting system; heating, ventilation and air conditioning system; hot water system; or building envelope. As the name implies, the deduction is primarily intended to apply to commercial buildings. However, multi-family residential properties that exceed three stories above grade may also be eligible.
To qualify for the deduction, the improvements must meet certain standards. First, the improvements must be depreciable property. Second, the improvements must be made to a building that is located in the United States and within the scope of Standard 90.1-2001 of the American Society of Heating, Refrigeration and Air Conditioning Engineers and the Illuminating Engineers Society of North America. Third, the improvements must be made to one of the building systems discussed above. Finally, the improvements and energy savings must be inspected and certified by a qualified contractor or engineer.
A building qualifies for the full deduction if the energy-efficiency improvements are installed as part of a plan to reduce the building’s total annual energy and power costs by 50% when measured against a reference building. For purposes of this comparison, a reference building is one that is located in the same climate zone and is otherwise comparable except that its systems do not meet the minimum requirements of Standard 90.1-2001. The 50% reduction must come solely from the energy-efficiency improvements. Reductions that result from other improvements are not considered for the purposes of calculating the deduction.
For buildings that meet the 50% reduction in annual energy costs as a result of the energy-efficiency improvements, the deduction is equal to the lesser of $1.80 per square foot or the total cost of the improvements resulting in the reduction. On larger buildings, the tax savings can be substantial. For example, assume that you build a 200,000-sq-ft building with systems that meet the 50% energy savings. The deduction would be equal to $360,000. Let’s further assume that you are in a 35% tax bracket. This could mean a cash savings to you of $126,000 in the year the improvements are put into service.
If the improvements do not result in an overall 50% energy savings, partial deductions may be available for energy-efficiency improvements in each of the building’s systems. If improvements to any individual system results in a 16-2/3% energy cost savings over a reference building, a deduction of up to 60 cents per square foot may be claimed. All of the other requirements discussed above still apply.
A notable aspect of this law allows the deduction to be claimed by parties other than just the property owner. In the case of public buildings owned by government entities, the law also allows the deduction to be passed through to the designer primarily responsible for the energy-efficiency improvements. This means that the architect, engineer or contractor may be able to claim the benefits for public buildings certified as achieving a specific level of energy efficiency.
Best of all, if you were responsible for designing the energy-efficiency improvements in qualified public buildings in the last three years, you may still be able to realize the tax savings you missed. For professionals involved in the construction of public buildings, this can be a valuable benefit that should not be overlooked.
The green movement is much more than merely a trend, and although there can be additional costs associated with green buildings, the Energy Efficient Commercial Buildings Deduction can potentially offset some of those costs. If you have been involved in the construction of energy-efficient buildings in the last three years or will be responsible for these improvements in the future, contact your tax advisor to learn more about this valuable tax deduction.