As every commercial property owner knows, operational costs are often the make-or-break factor for property investment. Improving a building’s energy efficiency creates long-term savings that go straight to the bottom line. But the upgrades can be costly. Now, with the passage of the Inflation Reduction Act (IRA) in 2022, commercial real estate property owners and designers have additional incentives available when making energy-efficient improvements.

The IRA includes significant enhancements to the Section 179D federal tax deduction, which was originally established in 2005 and became a permanent part of the tax code in 2020. Section 179D provides immediate tax deductions for qualifying commercial property owners and designers who implement energy-efficient improvements to a building’s HVAC and hot water systems, interior building lighting or the building envelope. The provisions apply to renovations and new construction.

The updates to Section 179D, which went into effect for properties placed in service Jan. 1, 2023 or later, broaden both the eligibility definition and the deduction amounts. Here’s a look at the provisions — before and after the IRA.

Who qualifies for 179D tax deductions?

Before: Prior to the passage of the IRA, owners of commercial buildings could claim the 179D deduction. In addition, designers, such as architects, engineers and contractors, could claim the deduction for energy-efficiency measures implemented in tax-exempt buildings owned by local, state or federal governments.

After: The IRA expands 179D eligibility to allow tax-exempt building owners, beyond governmental entities, to allocate the deduction to the designers responsible for the energy-efficient projects. This expansion is designed to incentivize non-profit, religious and tribal organizations, as well as non-profit schools or universities, to undertake energy-efficient improvement projects.

The new provisions also expand eligibility to include Real Estate Investment Trusts (REITs) by providing the ability to utilize the deductions when calculating earnings and profits.

What is the maximum deduction available under Section 179D?

Before: The original 179D provision allowed building owners to claim a maximum deduction of $1.80 per square foot. In 2020, the amounts were adjusted to account for inflation, increasing the annual maximum to $1.88 per square foot in 2022.

After: The IRA more than doubles the available 179D deduction amount, raising the maximum to $5.00 per square foot. In addition, the deduction can now be taken every three years in most cases. Previously, the deduction was only allowed once over the life of the building.

How are 179D tax deductions determined?

Before: Initially, Section 179D allowed commercial property owners to claim up to $0.60 per square foot for qualifying improvements to the building’s lighting systems, improvements to HVAC systems and improvements to the building’s envelope. Again, these amounts were slightly adjusted to account for inflation over time.

Through 2022, qualification was based on meeting the energy-efficient standard set by the American Society of Heating, Refrigerating and Air-Conditioning Engineers (ASHRAE) two years prior to the start of construction or renovation.

After: As of Jan. 1, 2023, the IRA reduces the minimum required energy savings from 50% to 25%. The base deduction is calculated using a sliding scale that starts at $0.50 per square foot for improvements that achieve 25% energy savings and goes up to $1.00 per square foot for improvements that achieve 50% energy savings.

Under the IRA, 179D’s requirement for meeting ASHRAE standards has loosened a bit. Now, the project needs to meet the standards as of four years before the completion of construction. 

In addition, a new bonus rate is available on top of the base deduction. To qualify for the bonus deduction, the commercial real estate property owner needs to meet local wage and apprenticeship requirements for laborers and mechanics employed for the project.

How can I claim a 179D deduction?

Determining eligibility and calculating Section 179D deductions can be complicated, but the higher amounts and lower requirement thresholds are designed to make it worth the effort for more property owners.

To claim a 179D deduction, a project’s energy efficiency must be measured and certified by an independent engineering firm. In the case of tax-exempt buildings, the owner must provide a letter allocating the ability to claim the deduction to a qualifying design partner, such as the architect, engineer or contractor.

The dedicated commercial real estate team at CBIZ can help you maximize the 179D deduction opportunities. Explore more commercial real estate resources today.

This article includes input from Christopher Steedly, Director at CBIZ, Inc. Chris has extensive experience in public accounting for the Manufacturing and Distribution industry, specializing in tax compliance and planning services.