Understanding 179D Deductions and 45L Credits

Those in the construction and building improvement industry are always looking for ways to improve their finished products and save money along the way. Of course, one of the ways developers improve their finished products is to make their buildings as energy efficient as possible. Doing so helps their clients save on operational costs, which in turn helps them to pass their savings down to their own customer/client base.

As developers continue to look for ways to deliver exceptional products to their clients, the federal tax system provides further incentives in the form of tax credits and deductions to support their efforts.

WHAT IS A 179D TAX DEDUCTION?

A tax deduction such as the 179D deduction decreases the amount of income subject to, in this case, federal taxation. More specifically, the 179D federal tax deduction is available to those who make energy-efficient upgrades to key components such as a structure's HVAC system, lighting, or insulation. The 179D tax deduction is also available to those involved in the construction of new buildings that include energy-efficient components that meet certain requirements. 

WHAT IS A 45L TAX CREDIT?

Tax credits work differently than tax deductions, which zero in on lowering an entity's taxable income. Tax credits reduce the amount of actual tax due. In the case of the 45L credit, developers, and builders can claim a tax credit on their federal taxes for certain structures that meet the 45L requirements for energy efficiency.

WHO IS ELIGIBLE FOR A 179D DEDUCTION/45L CREDIT?

The 179D Deduction

This tax deduction is available to construction businesses and architectural or engineering companies involved in developing certain structures. More specifically, an entity that wants to take advantage of the 179D tax deduction must be involved in the design of a building or structure. In other words, simply installing, maintaining, or repairing components involved in making a structure more energy efficient is not enough to qualify for the deduction.

The 45L Credit

This tax credit is available to "eligible contractors" who are responsible for the construction of residential dwellings that meet certain energy efficiency criteria. These eligible contractors must also own and have a basis in the property being constructed/renovated. Who does the IRS consider an "eligible contractor"? Among others, the 45L tax credit is available to companies, corporations, and partnerships that finance and own a building project during its construction phase.

THE INFLATION REDUCTION ACT OF 2022

The Inflation Reduction Act, which was signed into effect on August 16th, 2022, modifies and increases certain energy-efficient credits/deductions for taxpayers. Among them are the 179D deduction and 45L credit. Amendments made to sections 179D and 45L by the Inflation Reduction Act apply to taxable years beginning after December 31st, 2022.

WHAT PROPERTY IS CONSIDERED ELIGIBLE?

The 179D Deduction

Before the Inflation Reduction Act, the only type of property/construction project eligible for the 179D deduction was government-owned structures. Eligible government-owned structures may be commercial in nature or residential rental buildings that are at least four stories high (within certain thresholds).

Starting in 2023, entities can receive deduction allocations for their design work on tax-exempt entities. This means many building types that were previously ineligible to participate in the 179D deduction will now be eligible. Newly eligible tax-exempt entities include:

• Charitable organizations
• Churches and religious organizations
• Private schools and universities
• Private foundations
• Political organizations
• Other non-profits
• Native American tribal governments
• Alaska Native corporations, and
• Other non-profits

The 45L Credit

Properties that qualify for the 45L tax credit include:

• Single-family dwellings
• Trailer homes
• Manufactured housing (eligible for $1,000 credit w/ a 30% reduction)
• Condominiums
• Multi-family townhomes
• Apartment buildings - must be at least three stories above grade (or less) and may not include below-grade parking
• Senior housing
• Student housing

The above properties are only eligible for the 45L tax credit if they are within the United States. Other than that restriction, the requirements are quite flexible. The tax credit applies whether a property is considered a primary or vacation residence. Both renovated (before sale to owner) and newly constructed buildings are eligible as well. Perhaps the best news is that dwellings that meet all the above criteria are eligible as long as they were substantially completed between August 8th, 2005, and December 31st, 2032.

HOW MUCH IS A DEDUCTION/CREDIT WORTH?

The 179D Deduction

For tax years before 2023, the maximum amount of a 179D tax deduction is $1.80 a square foot. This maximum can be achieved if a project meets the requirements of at least a 50% reduction in total annual power and energy costs of the following three structural systems:

• Interior lighting
• HVAC system (including hot water systems)
• The building envelope

Partial deductions are also available if a project meets certain (lesser) requirements.

The Inflation Reduction Act increases the maximum deduction up to $5.00 per square foot if prevailing wage and apprenticeship requirements are met. The act also decreases the efficiency standard from 50% to 25%, making the deduction is easier to achieve.

Other changes to Section 179D with the Inflation Reduction Act include:

• Elimination of partial deductions
• A new alternative deduction for energy-efficient building retrofit property, which can be taken in the year of qualifying final certification as long as a qualified retrofit plan is in place.

The 45L Credit

For tax years before 2023, The 45L tax credit is $2,000 per dwelling unit constructed/substantially renovated. The tax credit is also available for prior tax years (by filing an amended tax return). Eligible tax years are typically only those going back less than three years.

The Inflation Reduction Act modifies the 45L credit amount and energy-saving requirements for homes to qualify. Starting in 2023, a dwelling unit qualifies for the credit if it’s certified as a zero-energy ready home under the zero-energy ready home program of the Department of Energy as in effect on January 1st, 2023. Dwelling units are further categorized as single-family homes and multi-family homes under the program. Also starting in 2023, the credit can be $500, $1,000, $2,500, or $5,000, depending on which energy efficiency requirements the home satisfies and whether the construction of the home meets prevailing wage requirements. 

HOW LONG ARE THEY IN EFFECT?

The 179D tax deduction is now part of the permanent tax code. In addition, commercial building owners who made improvements after January 1st, 2006, may also be eligible. Building designers may be eligible for any open tax years during the past three years. 

The 45L tax credit was set to expire as of December 31st, 2021, but was extended until December 31st, 2032, with the Inflation Reduction Act.

Anyone who thinks they may be eligible for a tax credit in a previous tax year should speak with a tax professional to determine if they should file an amended tax return. If you would like to know more about the eligibility requirements for the 179D deduction, 45L credit, or both, please contact us.