Deduction overlap: One of the most significant Tax Cuts and Jobs Act (TCJA) provisions included 100% bonus depreciation. For years since the passing of TCJA, taxpayers enjoyed the benefit of a 100% first-year deduction for assets placed in service during the tax year. There is a definitional overlap between bonus depreciation and other deduction rules. As such, Section 179D was less impactful for certain properties in comparison to 100% bonus depreciation. However, starting in 2022, 100% bonus depreciation began to phase out to the tune of a 20-point decrease each year until 2027. Therefore, while a 100% (or even 80%) bonus depreciation likely outweighed Section 179D, building owners may begin to reconsider comparing the two deductions and could see the benefit in claiming a Section 179D deduction in the immediate future.
Applicable Prevailing Wage for 179D Energy Tax Incentives
The Inflation Reduction Act of 2022 (“IRA”) expanded several clean energy tax incentives and added additional incentives to include increased amounts for meeting the prevailing wage and apprenticeship (PWA) requirements. By paying prevailing wages and using qualified apprentices, taxpayers can increase the base amounts of energy tax incentives, in general, by 5 times. There are limited exceptions available where taxpayers may be eligible to claim the 5 times increase on a particular clean energy tax incentive without meeting the PWA requirements
PWA requirements provide a tax deduction for installing certain energy efficient property in a commercial building, as part of its interior lighting systems; heating, cooling, ventilation, and hot water systems; or building envelope. Energy Efficient Deduction Amount: $0.50-$1 per square foot, depending on increase in efficiency (a minimum of 25% energy and Commercial Buildings power cost savings must be achieved in order to qualify). Caps based on deduction taken in preceding years and Deduction (§ 179D) capped at $1 per square foot. $2.50-$5 per square foot if PWA requirements are met. An alternative deduction is available for building retrofit projects that are expected to reduce a building’s energy use intensity by 25% or more.
The Inflation Reduction Act created an alternate deduction path for renovation projects based on reducing a building’s energy-use intensity by 25% or more.
Alternative deduction Path for retrofits
Under prior law, the retrofitting of many older buildings was not eligible for the Sec. 179D deduction because the 50% energy savings threshold could not be met. The new law provides two amendments that make it easier for these retrofits to be eligible for a Sec. 179D deduction. First, the sliding scale discussed above under Sec. 179D(b)(2) provides a benefit for older properties that could only achieve the lower threshold of 25% or more in energy savings.
Second, Sec. 179D(f) adds a new alternative deduction for retrofits that is elective on a building-by-building basis. Under this alternative, the level of energy usage, rather than the level of energy cost, is used to determine the extent the building is more energy efficient. To make this computation, the building’s specific level of energy usage intensity (EUI) before the retrofit is measured against the building’s EUI after the retrofit to determine a percentage reduction in annual energy usage. The same sliding scale described above is used to determine the amount of incentive allowed. The amount of this incentive is limited to the cost of the energy efficient property placed in service. Using the building’s own energy usage as a baseline helps taxpayers with older buildings that cannot meet the contemporary one-size-fits-all ASHRAE Standard 90. 1 to qualify for a deduction.
This alternative requires a “qualified retrofit plan” that specifies the modifications to the building that are expected to reduce the building’s EUI by 25% or more. No governmental agency is required to review or approve the plan, although it must be certified by a professional (e.g., an architect or engineer). Under this alternative, the Sec. 179D deduction is not taken when the property is placed in service but rather is allowed one year later, upon the completion of a “final certification” establishing the percentage reduction in annual energy usage.”
“A base deduction with a sliding scale starts at 50 cents per sq. ft., provided an energy savings of 25% has been achieved. An additional deduction of 2 cents per sq. ft. Is allowed for each additional percentage point of energy savings achieved above the 25% baseline, up to a maximum of $1.00 per sq. ft. For energy savings of 50% or more (see Sec. 179D(b)(2)
If the prevailing wage and apprenticeship standards are met, the amounts described previously are significantly increased. The sliding scale starts at $2.50 per sq. ft., provided the requisite 25% energy savings baseline has been achieved. The additional deduction for each additional percentage point of energy savings above the 25% baseline is 10 cents per sq. ft., up to a maximum of $5.00 per sq. ft. For energy savings of 50% or more (see new Sec. 179D(b) (3) and Rev. Proc. 2022-38). Consistent with prior law, the amount of the deduction is also limited to the amount spent for the improvements, regardless of whether the prevailing wage and apprenticeship standards are met.”