The Money Tree: Monetizing the IRA
December Issue, Part 2 of 2: Who and what is eligible? Who gets the money? How? What are the rules? Drivers, opportunities and barriers for CxPs and clients.
By Diana Bjornskov
The Inflation Reduction Act (“IRA,” U.S. Public Law 117-169, August 16, 2022) provides federal tax incentives to commercial building owners, developers, building-related businesses and individuals. Building incentives take the form of tax deductions that reduce taxable income, and tax credits that reduce the tax bill by an identical dollar amount.
The IRA updates take effect on January 1, 2023 and apply to tax years beginning after 2022. That means it’s a good time to prepare stakeholders for the tax benefits to be gleaned in 2023 by planning and implementing projects starting in the coming year. As is often the case – the IRA is a 10-year plan – not all changes will happen right away. The IRS recently sought public comments answering questions about how best to manage the incentive process, and more amendments to the IRA may evolve.
Building industry stakeholders will be most affected by Sections 179D and 45L of the revised tax code, which contain new conditions to qualify for deductions and credits including carbon management, energy efficiency, and workforce development.
How Can CxPs Take Advantage of IRA Incentives?
Although there are no direct funding mechanisms from the federal government to commissioning providers, here are ten ways for you to take advantage of opportunities offered through the IRA:
1. Participate in new construction project design or existing building retrofit plan
2. Review accuracy and outcome of existing building retrofit plan
3. If CxP or firm is a licensed designer (licensed architects and/or engineers), certify the required design plan accuracy and outcome
4. Assist owner or design team to identify commissioning requirements for eligible incentives
5. Conduct the Cx process in a way that can confirm energy savings are achieved
6. Provide ongoing commissioning services over time during the designated tax incentive period
7. Contract with design firms to receive a portion of “allocation” of the 179D project tax deduction or credits. Previously, only public agencies were allowed to “allocate” the deduction.
8. Work with new tax-exempt incentive candidates to help identify IRA opportunities and limitations (The IRA has expanded allocation recipients to all tax-exempt entities, including charitable organizations, religious institutions, private schools or colleges; private hospitals, museums, tribal governments, and other organizations).
9. Educate owners, developers, tenants and other taxpayer entities about the role of commissioning in obtaining certified documentation and receiving incentives
10. Help clients (owners, designers, developers, construction firms and others) understand the benefits of facility-related and workforce-related changes to their tax structure.
New Mandated Eligibility and Inclusion Requirements
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. Another new category of commercial buildings is hospitals. For the first time effective January 1, 2023, all hospitals can directly claim 179D tax benefits.
Building Size and Energy Efficiency Threshold. The base building square-foot limitation for purposes of computing the deduction is now 50 cents for property meeting the minimum certified energy-efficiency threshold and is increased by 2 cents for each energy-efficiency percentage point above the minimum, to a maximum of $1 per square foot of building space. The minimum threshold in annual energy and power costs is a 25% reduction as compared to a reference building.
Building Size and Prevailing Wage/Apprenticeships. The building square-foot limitation range is now $2.50 as the base and $5 as the maximum for taxpayers that meet new requirements that mandate 1) prevailing wages, and 2) a percentage of labor hours on the project are performed by individuals in an apprenticeship program, 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.
What Are the Tax Deductions?
Section 179D of the 2005 Energy Policy Act (EPAct), “Energy Efficient Commercial Buildings Deduction” is the backbone of the commercial property tax deductions. It was intended to provide a deduction for the cost of new construction and existing building energy efficient commercial property.
The IRA increases the maximum federal tax deduction and changes this deduction from a lifetime cap to a 3-year cap, with a bonus deduction for building owners, developers and designers who meet prevailing wage and apprenticeship requirements.
Section 179D allows a deduction for the cost of Energy Efficient Commercial Building Property (EECBP) “placed in service” (unclear whether this refers to the certificate of occupancy) during the taxable year. The IRA definition of EECBP now includes property that is certified by a licensed designer as being installed as part of a plan designed to reduce the total annual energy and power costs of the interior lighting systems, heating, cooling, ventilation, and hot water systems of the building by 25 percent (or more), in comparison to a reference building, meeting minimum requirements of the most recent ASHRAE Standard 90.1 (in 2021 DOE issued final determination for ASHRAE Standard 90.1-2019). Section 179D also –
1. changes the deduction amount
2. revises the energy efficiency requirements
3. removes the partial deduction and the interim rule for lighting systems
4. broadens the type of entities that may allocate the deduction to a designer, and
5. provides a new “alternative deduction” for energy efficient building retrofits.
Deduction Tax Schedule
Section 179D deductions are to be taken over a five-year period against earnings and profits rather than in the year they are incurred – with the exception of real estate investment trusts (REITs) which can take the deduction against earnings and profits immediately.
Until now, the maximum 179D deduction could be taken once over the life of the building. The IRA makes the maximum deduction available every three years on a commercial building and every four years on a government, instrumentality, not-for-profit, or Tribal Government building.
Section 179D also 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. This deduction was made permanent as part of the Consolidated Appropriations Act of 2021, but it is unclear whether the IRA language supersedes or forfeits this deduction.
Existing Building-Specific Deductions
The bill allows a taxpayer to elect the deduction based on meeting an alternative energy efficiency requirement. For existing building retrofits, the “alternative deduction” applies to property placed in service, established through a “qualified retrofit plan,” after December 31, 2022. This deduction includes the date of the qualifying final certification of the retrofit plan, and is determined by substituting “energy use intensity (EUI)” for “total annual energy and power costs.” The annualized site EUI must be measured in British thermal units, cannot be more than 75 percent of the baseline EUI of the building, and must be adjusted to account for weather.
“Qualified retrofit plan” means a written plan prepared by a qualified professional (a licensed architect or licensed engineer) who specifies modifications to a building that, in aggregate, are expected to reduce EUI by 25 percent or more in comparison to the baseline EUI of that building. A qualified retrofit plan must require the qualified professional to –
1. certify the EUI of such building as of any date during the 1-year period ending on the date on which the property installed pursuant to a plan is placed in service;
2. certify the status of property installed pursuant to such plan as meeting the requirements of 179D;
3. certify the EUI as of any date more than 1 year after the date on which the property installed pursuant to the plan is placed in service.
The taxpayer may elect to take the retrofit project deduction if the project is certified as having reduced the EUI of the building by 25% or more compared to the building’s pre- and post-retrofit EUI, instead of a comparison to a standard ASHRAE energy efficiency model.
The taxpayer will not be eligible for the deduction until the final EUI computation is completed, which cannot be done earlier than one year after the energy-efficient property is placed in service (usually the warranty period). As of this time, Year One depreciation deductions are not affected by the 179D deduction, but the current depreciation benefit begins to step down in 2023 and beyond.
Allocations
Tax-Exempt Entities. Previously, only federal, state and local government entities agencies were allowed to “allocate” the 179D Deduction they earn to the licensed project architect or engineer firm. The IRA expands allocations beyond public agencies to all tax-exempt entities, including charitable organizations, religious institutions, private schools or colleges; private hospitals, museums, tribal governments, and other organizations.
In the case of Energy-Efficient Commercial Building Property (EECBP) installed on or in property owned by a specified tax-exempt entity, regulations or guidance will be provided to allow the allocation of the deduction to the person primarily responsible for designing the property, in lieu of the tax-exempt owner of such property, who is treated as the taxpayer.
Calculations
Methods for calculating and verifying energy and power consumption and cost are to be detailed, and will be based on the provisions of the most recent California Nonresidential Alternative Calculation Method Approval Manual(explains the requirements for approval of Alternative Calculation Methods (ACMs), which include compliance software used to demonstrate compliance with the performance approach to the 2019 Building Energy Efficiency Standards).
Credits
Commercial buildings utilizing alternative energy sources can receive substantial tax savings. In addition to traditional alternative energy projects like solar qualifying for substantial tax credits, big winners include projects installing ground source heat pumps, combined heat and power or thermal storage. These HVAC equipment technologies previously had a mere 10 percent credit or no credit at all and now can achieve 30 percent credits and even a 40 percent credit if the project meets the U.S. domestic content requirements.
Prevailing Wage & “Qualified” Apprenticeship
Section 45(b)(7)(A) provides, in general, that a taxpayer satisfies the prevailing wage requirements with respect to a qualified facility if the taxpayer ensures that any laborers and mechanics employed by the taxpayer or any contractor or subcontractor in the construction of such facility, and with respect to any taxable year for any portion of such taxable year that is within the period described in Section 45(a)(2)(A)(ii), the alteration or repair of such facility, are paid wages at rates not less than the prevailing rates for construction, alteration, or repair of a similar character in the locality
Section 45(b)(8)(A)(i) provides that a taxpayer satisfies the apprenticeship requirements with respect to the construction of any qualified facility if the taxpayer ensures that not less than the applicable percentage of the total labor hours of the construction, alteration, or repair work (including such work performed by any contractor or subcontractor) with respect to such facility is performed by “qualified apprentices,” defined as “an individual who is employed by the taxpayer or by any contractor or subcontractor and who is participating in a registered apprenticeship program…”
The percentage of total labor hours to be performed by a qualified apprentice is (qualified facility):
· construction begins before January 1, 2023, 10 percent
· construction begins after December 31, 2022, and before January 1, 2024 12.5 percent
· construction begins after December 31, 2023 15 percent
Section 45(b)(8)(D)(ii) provides for a good faith effort exception to the apprenticeship requirement.
Domestic Content (U.S. Based Materials)
Sections 45(b)(9)(A) and 45Y(g)(11)(A) provide for a 10 percent domestic content bonus credit amount if the domestic content requirements are satisfied. Under SectionSection 48(a)(12)(C) and 48E(a)(3)(B), the domestic content bonus credit amount is reduced from 10 percent to 2 percent if certain other requirements are not satisfied.
Direct Funding Incentives
The IRA provides direct federal funding mechanisms to attract investment in carbon emissions reduction, although these are mainly dollars (loans, grants, etc.) for distribution through financial institutions or for state and local programs supporting building code design, such as:
· $1 Billion for State Energy Program (SEP) and other grants helping state and local governments adopt and implement building energy codes,
o $330M for meeting 2021 IECC or ASHRAE 90.1-2019
o $760M for meeting or exceeding zero energy provisions in the 2021 IECC or equivalent
o $225 million remaining in the 2021 Infrastructure Investment and Jobs Act for state/local adoption of the latest building energy codes.
· $250M to the U.S. General Services Administration (GSA) from FY22 to 2031 to convert federal buildings to high-performance buildings
· $975M to the GSA to be spent through 2026 on emerging and sustainable technologies
· $10B investment tax credit meant to fund the construction of clean technology manufacturing facilities
· $40B available until 2026 for loans from DOE Loan Programs Office, aimed to support commercial implementation of innovative clean energy technologies.
· Large multifamily residential building credits of $2,500 per unit for meeting ENERGY STAR or $5,000 per unit for meeting DOE zero energy ready, accessible to all multifamily buildings at $2,500/$5,000 per unit with established wage requirements.
· $11.97B for competitive grants for projects that reduce or avoid greenhouse gas emissions to leverage new resources to reach target emissions deadlines, improve building performance and energy efficiency.
Happy 2023! All of the entities named in this article are your clients and/or business partners for success in the energy efficient built environment!
P.S. This is my “swan song!” Wishing love and peacefulness to all members of the BCxA and CxPs everywhere,
Diana
Selected Sources
https://www.irs.gov/pub/irs-drop/n-22-48.pdf
https://www.irs.gov/pub/irs-drop/n-22-51.pdf
https://www.ncsl.org/Portals/1/Documents/NCSL/NCSL-Summary-Inflation-Reduction-Act.pdf
https://ics-tax.com/news/inflation-reduction-act-179d/
https://www.energy.gov/sites/default/files/2022-09/bto-qs-trace-3d-v4-13-207.pdf
https://stok.com/insights/inflation-reduction-act-guide-to-impact-on-commercial-real-estate/