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Federal Energy Incentives | 179D Deduction & 45L Credit

Published
May 7, 2024
By
Sara E. Brown
Jeff Goldberg
Bill Harbeson
Terri S. Johnson
Topics
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In this webinar, join EisnerAmper and X-Caliber professionals as they talk about the passage of the Inflation Reduction Act of 2022 (IRA) has transformed energy-efficient tax incentives for commercial real estate. The IRA has altered and amplified both the 179D Deduction and the Section 45L Tax Credit, with significant implications for taxpayers and their advisors.  


Transcript

Jeff Goldberg: Thank you, Astrid. I'm very excited to be here and joined by three of our esteemed colleagues. We have Sara Brown, who is the Director of EisnerAmper, Bill Harbeson, who is the Director of Energy Incentives at Capstan Tax Strategies, and Terri Johnson, who's also a partner at Capstan Tax Strategies as well. As Astrid mentioned, we'll be delving into two federal tax credits that were introduced as part of the Inflation Reduction Act. So I'll hand it off to Bill to start, as he explores and explains that 179D.

Bill Harbeson: All right, Jeff, well, thank you so much for the introduction, and Astrid as well. Again, my name is Bill Harbeson, and I'm a Director at Capstan Tax. Very excited to be speaking with you all today. This is a subject that I've been working with for some time. And the last couple of years have been a really exciting time to be a practitioner in this space. I'm going to focus on a couple of incentives, 179D deduction, which is the Energy-Efficient Commercial Buildings Deduction. We're going to talk about its history briefly. We'll talk about the current state of things and why it is that it's important today more than ever. So it's been around actually for some time, but it was recently expanded as part of the Inflation Reduction Acts, which went into law in 2022, and it'll take effect for buildings placed into service in 2023 and later. But it's actually been around for quite some time. This is a misunderstanding about the incentive. In fact, it's been around for almost 20 years. It was enacted as part of the Energy Policy Act of 2005, along with a slew of other energy incentives that are still around today.

However, it's expanded in size and scope almost every single year since its inception, again, with the Inflation Reduction Act being a paradigm shift in how we analyze these buildings, but also, the benefit that goes to the clients. And we'll talk about that here in a little bit. So what is it? It is a deduction that allows for building owners to claim immediate depreciation in their building for installing certain energy-efficient features. It applies for all commercial buildings. Well, what is a commercial building? The tax code is nice enough to describe that to us, and that is anything that is not a residence, including high-rise residence as well. So you'll see here on the page that anything four stories above in a multifamily residence is considered commercial for the purposes of a 179D analysis. So that means anything that's not a residence, so strip malls, shopping malls, but also, manufacturing facilities, office buildings, condo buildings, of course, all of these things are considered commercial, expanded even further that schools are considered commercial, post offices, military bases.

All of those things are considered commercial buildings for the purposes of this analysis. And then, of course, we're going to talk about 45L here in a little bit, which covers residences. So really, if you are constructing, purchasing, you own, you're renovating, expanding upon, designing energy-efficient building in the United States, there is some sort of tax incentive available to you. But of course, we're going to focus on 179D. So as I mentioned, it is available for not only renovated buildings, but also, brand new construction. And you can claim it retroactively. So because it's been around since 2005, you can claim it for a building placed in the service in 2006 and later. However, the longer you wait, the less impact that the deduction will get. So it's important that, as you're putting these projects into service, you're considering 179D in real time. So that's kind of 179D up to date.

However, as I mentioned, the Inflation Reduction Act expanded on these concepts immensely. Well, what's changed? One of the big things is that it's actually easier than ever to claim a deduction. So up until 2023, to get a deduction of a $1.80 per square foot, you had to get a 50% energy cost savings calculated for your building versus a benchmark standard. Now, to get a deduction, starting 2023 and forward, that requirement's now 25% versus a benchmark standard. And what does it mean to compare it to a benchmark standard exactly? Well, one of the most common misconceptions about this incentive is that it focuses on reduction of energy or reduction of energy costs, that I have to be saving power this year versus last year. And that's just not the case. What it does is it incentivizes buildings that beat a baseline standard.

Right now, that baseline standard is ASHRAE 90.1 of 2007. So the way that a deduction is calculated is that we will, as part of our services, take your building as it exists today, we will build it in our energy modeling software, using all of the equipment that's in the building, focusing on the interior lighting, the HVAC system, and the building envelope. We'll take into consideration everything about that building, including its geography, its North-South orientation, certain other factors, that really give us a clear picture of what that building is and how it operates. We will then take the exact same building, as if it were built to ASHRAE 90.1 of 2007 standards, so almost a 20-year-old standard at this point. We will run both of those hypothetical models for 365 hypothetical days and then, compare hypothetical energy costs. And the percentage that we are able to calculate saved is going to directly reflect in the deduction that's available.

One of the most common questions I get is, "Wow, 25% going up to 50% is the maximum. How often does that happen?" And I'll tell you all the time, 50% energy cost savings or even 25 sounds like a really high benchmark. But again, we're comparing to 2007 standards. If you all remember being in an office building in 2007, we still used fluorescent lights, we still had pneumatic control systems in our buildings. And just the technology in the past 15, almost 20 years has gotten to the point where if you build a building to minimum building standards today, you will get some sort of deduction. Maybe not the maximum, especially for power hungry buildings, like hospitals, but you'll certainly going to beat that 25% threshold. So that's a really exciting part about it, but that's only one major change under the Inflation Reduction Act. The probably biggest or most exciting... Oh, sorry, go ahead.

Jeff Goldberg: I was going to say, before we move into the next slide and get some of the details here, we're getting a couple of questions on eligible property types. And just because you had mentioned hospital and the energy usage that hospitals use, we're being asked if either hospitals or nursing homes would qualify for this credit.

Bill Harbeson: Good question. So hospital is very much a yes. No question about it. With a nursing home, it gets a little trickier, because what the definition of a nursing home versus a retirement community, the names can kind of intermingle with each other. A residence does not qualify if it's low-rise. Most nursing homes are low-rise, so they would typically not qualify, unless that facility is providing healthcare on site, in which case it's a healthcare facility. So if you are there because you need some sort of regular medical treatment or because there's doctors and nurses, things like that, then yes, that would be considered a healthcare facility for these purposes. Otherwise, again, if it's just a retirement community, maybe they have physical therapy on site, but no real medical facilities or medical function, then no, it would not qualify. But very good question, one I get a lot. What other questions do you have for us?

Jeff Goldberg: Related to condos, I guess not for rents residential, but for sale residential, I guess, as long as...

Bill Harbeson: Absolutely. Right, right. Absolutely. So high-rise residential falls within ASHRAE 90.1, which is our guiding standard. So as long as you're four stories or above, regardless of did you build the building and then, sell condos out of it, then yes, absolutely, we could pursue a deduction there. In fact, Ian, when we're going to find out here in a little bit, that they actually mesh really well now with 45L, which is kind of a new development as part of the Inflation Reduction Act. So if I'm a condo developer and I'm building a high-rise condo, I can take advantage of cost segregation, which we won't cover today, but that's available to you 179D and 45L all kind of in one go. So some real advantages to high-rise multifamily builders these days. So getting back to some of the changes under the Inflation Reduction Act, probably the most exciting or the most noticeable one is the increase of the deduction amount.

So as I mentioned, up until 2023, the maximum deduction was $1.80 per square foot adjusted for inflation. So in 2022, the maximum was $1.88 per square foot. Well, starting in 2023, the maximum deduction goes to $5 per square foot, again, adjusted for inflation. So in 2024, that maximum is $5.65 per square foot. So almost triple of the original deduction is really getting people excited to look into these deductions more so than ever, and that's one of the reasons why we're talking to you all here today. However, that $5 per square foot does not come free. A major change that happened in the Inflation Reduction Act is tied to multiple incentives is the new requirements of prevailing wage and apprenticeship hours. So now, if you want to qualify for these maximum deduction amounts of $5 per square foot, you will need to pay prevailing wage to all laborers, all mechanics, all contractors, all subcontractors.

The entire project must been paid a prevailing wage. In addition to that, the project, all contractors, subcontractors, must make what's called a good faith effort to participate in a registered apprenticeship program. There's a lot of information available. We'd certainly be happy to connect you with that some information. But there's things like apprenticeship.gov, which will take you through all of the details about how to qualify and how to, again, make that good faith effort to participate. So if you don't meet those requirements, there's still money on the table for you. There's a deduction of up to $1 per square foot for a energy-efficient building. But of course, the exciting part is that $5 per square foot. You'll see that these new requirements are tied again to a lot of incentives, things like the investment tax credit, the production tax credit, 45Q, anything that was expanded as part of the Inflation Reduction Act has these writers attached to it, and you'll see the same thing with 45L here in a little bit as well. But let's get into some examples.

Jeff Goldberg: Maybe one question before we jump into the examples here, Bill, being asked on your analysis, since it is used for new construction, can you perform that analysis based on the specs of the to-be-built commercial building or high-rise residential to give developers and borrowers an estimate of what the savings may be or deduction may be?

Bill Harbeson: Absolutely. Not only is that a preferred prescriptive way to review these projects, so the energy model, when you look at ASHRAE 9.1, the energy model that we use is actually called the proposed model. So we will take your completed set of drawings, even before you've broken ground, we'll do the energy model for you, and we'll let you know what deductions is going to be available for that building. And after the fact, again, as required by the tax code, we will, excuse me, execute an inspection of that building, using a professional that's licensed as either a contractor or an engineer in the jurisdiction of that building. But before any of that happens, again, we do that energy model, and we can do that at any stage of construction or even before construction starts, so long as we have a completed set of drawings. But good question. Any other questions? And we'll have a little bit of time after the presentation to catch up on everything, so if we miss anything, we will be able to get an answer to you. But Jeff, any pertinent ones you've seen out there?

Jeff Goldberg: Yeah, we're seeing a lot of questions, but don't want to mess up your flow too much. So we'll hold a bunch to the end. So appreciate everyone and their very frequent and good questions, and we'll make sure to get them answered before the end of this session.

Bill Harbeson: Well, good. I see a lot of questions coming through about prevailing wages. We'll spend a little bit of time talking about that after the fact or after the presentation to make sure that we've covered everything, but just keep in your mind prevailing wage and apprenticeship program requirements. So given some extra detail here on some of these projects, so you'll see here a multifamily project that we worked on, 124,000 square feet, which is a fairly large building. However, when it's completed, is going to have a major effect on the actual deduction available. So if it were put into service before 2023, of course, the deduction amount is $1.80 per square foot. However, if it's placed into service after 2023, then the maximum deduction becomes $1 per square foot, unless you meet those prevailing wage and apprenticeship program requirements, in which case it goes to $5 per square foot.

There is an asterisk with that, as with all things on the tax code, of course, and that is that there is a grace period of getting the project started and not having to meet these prevailing wage requirements. You'll see that at the top of the page here. So if your building was placed into service 2023 or later, but construction started before January 30th of that year, then you do not need to meet prevailing wage and apprenticeship program. So you'd be grandfathered in, and we're seeing a lot of people take advantage of this kind of window here, before it closed in February of 2023. So if you've got a recently completed project in the past 12 months or so or if you've got one that's coming online in the next 12 months or so and you started construction, which is to say that you broke ground before January 30th last year, you'll get that $5 per square foot, again, adjusting for inflation.

So another example for you here, this is another multifamily high-rise condo, 138,000 square feet this time. This was a great project, in that it had really high efficient, but still reasonable energy-efficient features. So things like LEDs, you'll see that all these projects take advantage of the LEDs. Well, to meet minimum building requirements these days, you pretty much have to put LEDs in, which is why I keep going back to the fact that, excuse me, just by virtue of being newer projects, these buildings are routinely getting 40, 50, even 55% energy cost savings, even though 50 is our ceiling for the purposes of a deduction amount.

And again, here's another example of what it means to meet the requirement versus not to meet the requirement, a significant savings here of over half a million dollars difference for meeting those requirements versus not. And again, the grandfather period of before January 30th of 2023 would allow you to take advantage of the maximum deduction amount, adjusted for inflation, of course. So we've been talking a lot about the increased deduction amounts, which is a really exciting part, but it's not the only thing that got expanded as part of the Inflation Reduction Act.

Most notably perhaps is the expansion to include tax exempt entities. So up until 2008, the people who could take advantage of this deduction were building owners. If I renovate, construct, expand upon a building, and it's my commercial building that I do business out of, whether it's a high-rise residential, whether it's a commercial building, factory, warehouse, et cetera, government owners, governments do not pay taxes, and so, it allows for a deduction to be allocated to an eligible designer. A designer is an architect, engineer, energy service provider, even contractors will qualify as designer under the requirements of the tax code.

Again, the government doesn't pay taxes. So it allows for these companies that are doing this good work, to do this nice design work, to bring these government buildings into the 21st century, to get some tax benefit from it. It was some of the worst offenders of energy usage in the country are, as you might guess, government buildings and bureaucracies. They're older buildings, sometimes, they don't get updated. So here's a way to kind of incentivize companies to raise the standard a little bit. Well, as part of the Inflation Reduction Act, that government requirement or government ability has expanded to include tax exempt entities. So now, things like churches, tribal lands, non-profit hospitals, non-profit private schools, all of those things, they don't pay taxes.

They're 501s, they can't take advantage of a tax deduction like 179D. Well, once again, like we did with the government projects, these entities can now allocate that deduction to an eligible designer. So if I'm an architect, I go in and I do this great design for a large church. Let's say it's 100,000 square foot church, that church doesn't pay taxes. So as the architect, I can claim this deduction on my tax return, reduce my taxable income by the amount of that deduction. In this case, it would be $500,000. I'd say, of the people that take advantage of the 179D incentive, the people in the tax exempt sector are probably the largest group of them. So while it was, first and foremost, for commercial buildings and commercial building owners, we see these architects and engineers, contractors take full advantage of these deductions that are tied to these tax exempt projects. So really exciting time, again, to be in this space, as we see not only the deduction amounts increase, but the people who can claim them increase, as well as the kind of buildings that can claim these deductions have expanded greatly.

Jeff Goldberg: Maybe before jumping to the next slide, a couple other questions, if that's okay. Getting a couple questions about, say, the cost of energy-efficient equipment versus, say, conventional sources. And what are the typical items that you see installed or implemented at these new projects to, say, qualify for the maximum deduction?

Bill Harbeson: Very good question. So again, I will emphasize that these projects, while this is called the Energy-Efficient Commercial Building Project Deduction, these projects do not need to be especially energy-efficient by today's standards. Just by meeting minimum building requirements, we're going to beat that 2007 standard by quite a bit. However, if I'm interested in doing some energy upgrades, getting the full 179D deduction, one of the biggest bangs for your buck that you're going to get is upgrade to LED lights, take out those old fluorescent or, in some cases, halogen bulbs, put in T5, T8 LED bulbs in their place. And you're going to reduce your energy costs by a significant amount, close to 25% in a lot of cases, as compared to that 2007 standard. You won't see that amount of savings on your power bill, but you will in our energy modeling process.

The other place that is an obvious power suck and probably the largest power user of any commercial building is going to be the HVAC system. So an upgrade to a high-efficiency boiler or a high-efficiency chiller, even spending the money on a controls upgrade, is going to have drastic impacts on that energy-efficiency. So if you're looking to maximize your energy cost savings, along with a 179D deduction, those are the kind of areas I'd focus in. And then, a close second to that, of course, insulation upgrades, new roofs. New white reflective roofs are all the rage right now. As you can imagine, they bounce the sunlight back off the building, versus a black tarred roof, a great way to save energy there. But there's a ton of opportunity, and if it's an older building, then putting equipment in it that's the standard for today, again, not even that especially energy-efficient, is going to beat that standard by quite a bit in 2007.

So one question that I got, and again, we're going to try to get as much of these, but one of the questions that I got is, "Do architects buy the deduction for the tax exempt entity?" The answer is no. The tax exempt entity, they don't pay taxes. And so, it's simply an instrument, it's a form, it's called an allocation letter or an allocation form, passing that deduction along to the taxpayer, the architect, engineer, et cetera, in this process. There is no money coming from the tax exempt entity. They're not having to write a check, they're not getting a reduction in their budget or anything like that. These are federal tax dollars coming from the Treasury. So there's really nothing to buy.

However, if you wanted to enter into an equitable agreement with one of these tax exempt entities, we see favorable project costings, we see just donations back to the tax exempt entity. There's nothing on the books that keep you from entering that practice, but as a letter of the law goes, there's really no purchasing involved, like you would an energy credit such as the investment tax credit. So excuse me, getting back to the Inflation Reduction Act and some of the changes that we're seeing, under the old law, 2022 and before, the deduction was one time in the lifetime of the building, which made sense maybe almost 20 years ago when this was implemented. However, those upgrades are now 20 years old. So what can we do about that? Well, Congress thought of that, and they now include a three to four year reset of the deduction. So three years for a commercially owned building and then, four years for a tax exempt building.

As long as you're doing relevant upgrades to that building in a three year, four year period, you can claim a new $5 per square foot deduction. So if you are an architect or a construction manager or a contractor or something like that out there and you've got regular clients and you're going out there and doing regular work for them, you can claim these new deductions every four years, which for, let's say, a million square feet worth of high schools, in a particular school district, that are constantly getting worked on, that's a huge bump in your bottom line as one of these contractors. However, of course, that also includes if it's your building as well. So if you're doing incremental upgrades, I'm going to install new lights this year, and then, in a couple of years, I'm going to install new HVAC system, or in a couple of years after that, I'm going to do new insulated windows, all of those things will allow for us to claim that new deduction every three years.

So the idea here is pretty straightforward, in that the government wants you to not just make these upgrades once, they want you to keep up with the times and keep putting this new equipment in and make your building more efficient throughout the years. So a last couple of notes about the 179D and all the changes here. So there is, however, a kind of alternative path for claiming this deduction. As I mentioned, we compare your building to a baseline standard. Well, let's say your project doesn't quite get there, it doesn't quite meet those standards. Well, we have another prescriptive path and one that actually literally analyzes the energy use intensity of your building, which is to say that we will take your power bills today, look at your actual energy consumption, kilowatt hours, et cetera.

We'll also look at natural gas consumption, if you're using that. And then, after you implement a qualified retrofit plan, go back and analyze the project a year later. And then, if we can demonstrate a reduction in energy use intensity of 25% or greater, then you can claim a 179D deduction that way. There are some sticky parts with doing it this way. It takes longer. It is harder to do. The standards are increased because of it, but if you've got, let's say, a really old building and you need to bring it in again to the 21st century, here's an opportunity to do that in a very measurable, clear way.

I'll say one of the big things that you have to take into account is that a qualified retrofit plan is one that has been certified by a licensed engineer or architect. The IRS has not given full guidance on exactly what it means to be qualified, but just know that it is not going to be enough that you go and buy a bunch of light bulbs and throw them in your building and compare energy bills. You'll need to have somebody that's licensed in your jurisdiction to make these kinds of calls to say that, "Yes, this is going to have a meaningful impact in your energy intensity and this is the expected results of it." So we have this in our toolbox. Of course we always want to rely on the first methods, and we're going to help you pursue it using this alternative path as well. But before we get to it, Jeff, did you see any additional questions that came through, that are maybe brand new?

Jeff Goldberg:Yeah, we have a cou ere. One of them is related to maybe the distinction between this new 179D deduction and acceleration of depreciation. Is there a difference? Is it another name for it?

Bill Harbeson: So really good question. Excuse me. 179D is a form of accelerated depreciation that reduces the basis in your building by the amount of the deduction that's calculated. It really dovetails very well with cost segregation. So it kind of picks up where cost seg leaves off. Cost seg will inevitably leave some kind of 39 year property that can be untouched and you can't accelerate it. Well, 179D can go in and immediately reduce the basis from some of that 39 year property. So it is very similar in the mechanism, how it works. It is even applied the same way onto a tax return via 3115 if it's an older project. So if you are considering cost segregation, absolutely consider 179D with it.

I would also encourage that, if you're going to do accelerated depreciation in form of cost segregation, that you partner with a company that can do both, because A, it's just easier, because you're not having to provide the same information to different companies. But also, because prevents any situation where we might accidentally accelerate the same property from cost seg and 179D, and you certainly want to avoid that. But I kind of went off on a tangent there a little bit, but yes, it is an accelerated depreciation and if you're familiar with cost seg, you'll be pretty familiar with 179D as well. All right, I think we're finished with 179D here.

Astrid Garcia:Polling Question #2.

Jeff Goldberg: And maybe while we give folks some time to answer this latest poll question, have one more question for you, Bill. Obviously, it seems like, based on your description, a lot of the new buildings do qualify for some semblance of 179D deduction. Are there any instances where you've seen them not qualify for that minimum 25% deduction?

Bill Harbeson: Yes, there's a couple instances where that could happen. Really power hungry buildings, hospitals, for instance, they'll routinely beat 25%, but we often see it come in a little under 50, just because the requirements for a healthcare facility to change air quite a bit, which means that it's a little bit harder to condition, things like that. The other times that we don't see it qualify is less an energy-efficiency factor and more a minimum building standards factor. And what I mean by that is let's take into account or take for instance a warehouse. You have a really big like million square foot warehouse and it's not centrally cooled. You just have unit heaters throughout the whole warehouse, and then, it's sparsely lighted. Because it's a warehouse, it's not a surgery center. You don't need it to be super bright in there. Well, actually, 90.1 requires that a building has a minimum level of lights, that it'd be a certain level of brightness, and sometimes, we'll go into a building and it just doesn't meet those requirements.

Same thing with the heating. We've got enough unit heaters in there, kind of electric unit heaters, to keep the building from freezing during the winter, but not much else. If you do not meet the minimum standard of what's considered a conditioned building, then we wouldn't be able to analyze it for 179D. These are very rare occurrences, and we'll do the math. When we're looking at some of these buildings, we'll take light readings, when we're doing the inspection, to ensure that they do meet those building minimum requirements. But that is a factor that comes into play when we're looking at some buildings. But again, that's really not tied very closely with the energy-efficiency component of it. I’ve been doing this for some time and been working with the Inflation Reduction Act for as long as anybody else has for, I think, about 18 months. And I haven't seen a building not qualify yet from the energy-efficiency side of things, but good question.

Astrid Garcia: Wonderful.

Terri Johnson: Hey, Bill. Hey, Bill, I wanted to jump in for a minute. This is Terri Johnson. I thought one of the questions that I'm seeing is really interesting about, and it's an example, like retail buildings of, "How do you complete a 179D study if some of the tenant spaces are not yet fit out? Do you have to wait until all the spaces are completed?" Because we see that a lot where you have, it's not just like one day, everything's finished. I just wanted to jump in, because I thought it was a great question.

Bill Harbeson: Yeah, and that's a question that we get a lot. And really, it can go either way. When we look at a building, when we consider it, is it complete? Has it been placed into service? Has the envelope been placed into service? Have the HVAC systems been placed into service? And more importantly for this, has the interior lighting systems been placed into service? So if I've got a tenant fit out and it's just a completely empty box with nothing in it, except I got duct work running, no lights, then the building's not placed into service for the purposes of 179D. However, if I'm going to put in drop down ceilings and I've already got my light fixtures in place and the tenant's going to go in and fill the rest of the building in, then the lights are in service as well as everything else. So we could pursue a 179D deduction there.

It's a real kind of minutiae of, is it or isn't it? But that's the key factor is, are the lights on as part of the shell of the building? Or does the tenant put the lights in themselves? If that's the case, then we would have to wait until the tenant fill out was done. There's one question on here that I want to capture before we move on. We got a question about that non-profits, tribes, et cetera, could apply directly for this credit via direct payment, and that is a common misunderstanding. There are incentives in the Inflation Reduction Act that allow for these non-profit government facilities, government institutions, to take what's called elective pay and get paid directly for energy-efficient upgrades, such as solar, things like that. That is available. Things like 179D, there is no such direct payment. There is no way for a tax exempt entity to get paid from the treasury for these deductions. That's why they have the mechanism to allocate it to a taxpayer, such as an architect or an engineer. But that's a question we get a lot, especially with the passage of the Inflation Reduction Act.

Astrid Garcia: Wonderful, Bill. I'm going to be closing the polling question now. If you haven't submitted your answers, please make sure you do so now. Back to you.

Bill Harbeson: All right, well, that does it for 179D. Again, if we've got some time at the end of the call, we'll stick around and answer some questions about it. But I'm really excited to turn things over to Terri, who's going to cover the 45L tax credit, which is kind of the sister incentive to 179D. Terri?

Sara Brown: Actually, I'm going to start us off, Jeff. This is Sara Brown from EisnerAmper. Good afternoon, everyone. Terri and I are both going to walk you through the Section 45L Energy-Efficient Home Credit. The Section 45L tax credit actually dates back to January 1st 2006 and initially allowed builders to claim a $2,000 credit on qualifying homes. The credit most recently expired though at the end of 2021. However, with the passing of the Inflation Reduction Act of 2022, the credit was retroactively extended and the existing credit, through 2022, and modified to expand it for 2023 all the way through 2032. So for 10 years. And significantly, the credit was increased from $2,000 to $5,000 per unit.

Let's go through a little bit of the basics, under both the old and the new programs. The credit is claimed per dwelling unit, which includes single-family homes, multifamily homes, apartments, assisted living, and campus housing. You can still claim the old Section 45L credit through 2022, and also, in prior years, by amending any open-year tax returns. The credits are claimed by the home builder or the developer. This is typically the entity who owned the home when it was built or financed its construction. One of the most significant changes under the new credit is the height requirement of the building was eliminated. So after 1/1/23, the credit is available to any size building. Previously, under the old credit, the building had to be three stories or less. So now, it applies for high-rises. We mentioned the single-family homes, multifamily, apartments, condos, assisted living facilities. And Terri's going to walk us through specifics of how you can qualify for the credit.

Terri Johnson: Thanks, Sara. Yeah, that was a big change, that height requirement. And because it really limited, before, it was three stories or less, and we'd see a lot of projects that were like four stories and with retail on the first floor, and there was nothing really that you could do about them, unless you go the path of 179D. So what we're going to do now is really talk about 45L under the IRA. So different from what Bill was talking about being a deduction, the 45L is a tax credit. So what we saw under the old program was you had to get a 50% efficiency gain under the 2006 IECC energy code. So now, they kind of just threw that away. And we saw a big change in this program, in that they changed the standard that you had to meet. So we were looking to be Energy Star certified or Zero Energy Ready Home standards that you have to meet.

So as Sara said, the maximum credit that you can get is $5,000 per dwelling unit, if you meet the prevailing wage standard. So you're probably getting used to this whole idea of meeting prevailing wages. So that was a big change, because it really impacted the whole way we did these studies. Whereas, with 179D, you're still using the same energy model and there's some different tweaks and different requirements, but sort of the bones of it, the program, was very similar. Whereas, with 45L, all of a sudden, we're focused on getting this whole process started very early on, when you're really, you've got projects on the drawing boards. So I like this slide, because it really summarizes the program. So I'm going to just kind of step through. So let's look at the bottom line. We're going to focus on multifamily. So if you have a multifamily project that's Energy Star certified and you pay prevailing wage, you're going to be in that third column, the $2,500 credit per unit, per dwelling unit.

If you, on the other hand, you received a Department of Energy Zero Ready Homes, you meet that standard, you're looking at a $5,000 per unit credit, which is, as Sara said, is the max that you can get. But you also have to pay prevailing wages. So what happens if you don't pay prevailing wages, but you're meeting one of these two requirements? Under the multifamily home program, you have to, as I mentioned, pay prevailing wages. So if you don't pay prevailing wages, your credit ends up being $500 per unit under Energy Star and $1000 per unit under the Zero Ready Homes. So it's a big difference. And the other thing I wanted you to just note on this, if you have different types of projects, manufactured homes, single-family homes, those type of projects, they do not require the prevailing wages. So you would just have to meet either Energy Star or DOE Zero Ready Homes. So that's a big difference as well.

Jeff Goldberg: Terri, we see a lot of our bars pursue other, I guess, green building certifications, besides Energy Star, like say LEED or the National Green Building Standards. Would those certifications be good substitutes for Energy Star? Or for this credit, you'd have to go through the Energy Star certification?

Terri Johnson: Jeff, that's a great question. And when this all came out, I must've spent months just trying to figure all this out and read everything I could get and understand. And that was one of the big questions that we were getting from our developers, because they, under the state programs or even more regional programs, they were qualifying green building and things like that. Under this program, you have to use either Energy Star or the Zero Ready Homes. So there are a lot of similarities. So it might be, if you're getting one, it's not that big of a step to get Energy Star rated, but it's two separate programs. So you've got to make sure, when you're working with a consultant, that, if you're doing one, that you're also adding on the Energy Star and that they can do both of those for you. So it's just something to be very aware of. So on this example, we had 63 luxury units, one and two bedroom, and there was a lot of energy-efficient features of the apartments. And they had good wall insulation, high window U values, and they were Energy Star 3.1 certified.

So let's take a look at what happens. Okay, so you've got your Energy Star 3.1, you've got that. So did I pay prevailing wages or not? So if I pay prevailing wages, I'm going to get that $2,500 per unit, and if I didn't, I'm going to get $500 per unit. So you can see, really quick, these are real tax credits, 157,500 versus 31,500. So it is a huge difference, and we'll talk a little bit in a minute about what some other impacts of that. Here's another example that is, notice this is another three story, I guess, you should say... I don't know if that top four really counts. It's more of a three story, but 48 homes, energy-efficient furnace, AC split units, all the bells and whistles, and now, this one meets DOE Zero Energy Ready Home standard. So again, if you meet the prevailing wages and get that $5,000 a unit in this particular situation, and this wasn't a ton of units, you're going to be at $240,000 tax credit versus $48,000 if you haven't met the prevailing wages. I think we're at another polling question.

Astrid Garcia: Polling Question #3.

Jeff Goldberg: Sorry, I know you highlighted a couple of the items in these examples that may make your project or may make a developer's Project Zero Home Ready. Do you mind highlighting a couple of other items that you'd expect developers to install at their projects?

Terri Johnson: Well, any of these energy-efficient projects, what's really driving it is your HVAC system, the insulation that you're using, any of your lighting packages. Specific to multifamily, the insulation is a really big deal, because let's say you have stick construction and you've got a really good window ratings and insulation, it's going to keep the cold out. And that makes a huge difference, depending on the locale that you're at. So we see, again, the SEER rating of the HVAC systems and certainly the windows and insulation that you're using. And they do what they call blow testing. So they're actually coming in and see how tight those units are.

So when you have the Zero Ready Homes, those projects are so tight and they pass those blower tests with flying colors, but it's really expensive. And to go to that next level of what you have to install and the type of equipment, it's kind of cost prohibitive. So I would say, just, when you look at the type of equipment that you install, probably most developers, if they're going to do this, are going to end up in that kind of striving for Energy Star certification versus based on the expense of that equipment that they need to go to that next level.

Astrid Garcia: All right. Well, I'm about to close the polling question. Please make sure you've submitted your answer. All right, back to you.

Terri Johnson: Thanks, Astrid. I see one question I just wanted to jump on real quick, and it was mentioned about the assisted living facilities are eligible or nursing homes. So if you look at what qualifies as a nursing home or multifamily, it's really that your average stay is greater than 30 days. And that's really the test. So if you have a nursing home an average stay is greater than 30 days, they would qualify for 45L. If it’s a facility that has less than an average of 30 days stay, such as a vent care facility or rehab then they would be looking more at the 179D program.

So starting in 2023, the 45L process, it must begin before the construction starts. And this is a huge change, because under the old law, what would happen is, you'd have what we call the HERS raters would come out and they would do their inspections and verify. And you would follow a plan, but you could do all this work at the end and then, you would get your certification. So now, you basically have to apply for the Energy Star certification process up front. And we have some resources at the end where you can go and look at what the requirements are, but it requires you to apply for the certification during the planning stages and before the construction begins.

And that's really important, because if you do it kind of midway through or after the fact, there's a pretty low chance that you're going to qualify, if you didn't plan to qualify, if that makes sense. So that was a huge change in, when we were looking at the 45L projects, from the old to the new, is that it kind of turned everything upside down, because you had to start early on versus just building for energy-efficient projects. So moving forward, I think one of the takeaways here is, if you are doing this type of development, it's really important that you're planning, if you like this program, that you're planning this into your project early on.

So what do you need to do? You got to assemble your team. You need to have an energy consultant. And oftentimes, you always have to have a HERS rater that we mentioned that does the inspections. And a lot of times, that's the same company that does that. And then, you also have to find out if you're paying prevailing wages, and then, you've got to begin that process for getting the project Energy Star certified up front. So we put together a couple of flow charts, I like flow charts myself, that kind of walks you through this. So if you look at the top line, "Have you hired an Energy Star certified HERS rater to inspect and verify the property?" Yes. "And to which standard are you trying to achieve?" So it's either Energy Star or the Zero Ready Homes, and then, you go on to the next. "Are you paying prevailing wages?"

And then, you can see the 2,500 or 500 or 5,000 or 1000. If the answer is no, then you really need to be looking at hiring a consultant and starting this whole process before you start ordering equipment and going much further, because it can affect your budget as well. Now, if you're already well into a project, which, by the way, we saw a lot of this when the 45L program came out. Because remember Bill was talking about, with 179D, that you could get grandfathered in, well, under 45L, for whatever reason, Bill and I particularly think that that was a mistake, but they made no accommodation. So if I had built something started in 2022, finished it in '23 or '24, there's no grandfathering in. I didn't know about Energy Star, so I didn't plan for that. So I'm kind of out until I start my next project.

So if you walk through this flowchart, you're going to see that what happens is, if you get to a point where you're kind of right here in the middle, "Was an application filed with an Energy Star up front?" the answer is no, you're probably not going to qualify, just because you need to make one little tweak. You need to raise the SEER rating of your HVAC system. Well, you're not going to be pulling out all those units and reinstalling other units. It would not be cost-effective. So you're not going to do that. So I would say 99% of the time, you're not going to pursue Energy Star if you're pretty far along with your project.

So as far as what the process is going to look like, you're going to have, as I mentioned, the energy consultant is going to model that project to ensure that the equipment that you are speccing is actually going to have you meet those Energy Star requirements. And then, if not, you need to make an adjustment, you're going to have to look at the budget and see how that affects everything. And then, that's when you apply for the Energy Star certification, and then, your energy consultant is going to be providing the oversight and guidance. The HERS rater will be coming out making field inspections and verifying that everything's done according to plan.

And then, everything is uploaded throughout this process to what we call a HCO, a home certifying organization, like RESNET, where it's like a repository, where everything is kept. So it's very transparent, which I think is a good thing. And then, the project will be determined, by the Energy Star consultant, if it's compliant. And then, the 45L certificates are issued. So Sara, I think this is where you're going to jump in and talk a little bit more about who can claim the credit and kind of finish this up here.

Sara Brown: Yep. I'm going to talk about who can claim the credit and how do you actually claim the credit. And then, we'll provide some resources for everyone. And we talked about this a little bit before, the builder or the developer of the dwelling, the entity that actually owns the structure, when it was built, or finances construction qualifies for the credit. If the entity is an S-corp or a partnership, the credit will be claimed by the entity and pass through to the owners. Non-profits, they obviously won't get to use the credit, but they can still be an owner of an entity that a credit is claimed.

How does this interact with the low-income housing tax credits? Under the old program, there was a mandatory basis reduction, which would actually decrease the low-income housing tax credit. Now, under the new program, the impact is not the same. It will not decrease the low-income housing credit. So it doesn't preclude people from claiming full credit, getting the full benefit. The entities also cannot sell the credits. So how do we actually claim the credit? It's part of the general business credit, and it's claimed on form 8908, which is part of the entity's tax return. And the entire project does not need to qualify. I think that's a really important point. So it's per dwelling unit. So it's possible that you have certain units in your project that do qualify, where you can claim the credit. It doesn't have to be your entire project.

And if the credit's not used in one year, it can be carried forward up to 20 years. And we talked about claiming retroactively or filing amended returns, if that's available. The documentation under the legacy program, the old 45L, Terri touched on this a little bit, it really happened after the fact. Whereas, the new program, you really need to get ahead of it and do your documentation and talk to your consultants before you start your project. But under the old program, some of the documentation that was required was full set of architectural, HVAC plans, rent roll, number of units expected to be leased. This all happened after the fact though I think Terri, right? We just documented this afterward and kept it in the file.

Sara Brown: Okay, good point.

Astrid Garcia: Polling Question #4.

Jeff Goldberg: While the participants are answering this last polling question, we've got a lot of questions on prevailing wages. So I'll open it up to all the panelists here, just to delve a little deeper. A couple of questions just on the cost differential between prevailing wages and non-union wages, especially in certain parts of the country. Historically, there's been quite a large difference between the two. Are there one certain geographies that you're seeing more developers, builders use prevailing wages to take advantage of these deductions and credits than others? And overall, just maybe some general commentary on prevailing wages and how those numbers are determined.

Terri Johnson: I would think the prevailing wages we're seeing in bigger Northeast cities, like New York City, for example, you see prevailing wages. I don't know, Bill, what you've seen, but I see certainly more in the Northeast.

Bill Harbeson: Yeah, obviously, in stronger union areas, it's kind of an automatic. So Illinois, coastal Indiana, Northeast, things like that. But also, we're seeing in certain areas where, without really intending to, prevailing wages get paid out. So what I mean by that is, in North Carolina, for instance, I've gotten the feedback from some builders there that, just to afford the labor, that's the going rate of labor, you're paying well above the prevailing wage, even though it's not like they're putting in their contract that, "Shall pay prevailing wage." It's just that's how much labor costs in that area. So we're seeing some people meet the requirements without really knowing that they're meeting requirements as well. But in other parts of the country, no, it's pretty far off from the going rate versus prevailing wage. And in some cases, the bridge, it's worth gapping that or crossing that gap to get the credits. And sometimes, it isn't. It's just a business decision from there.

Astrid Garcia: Back to you guys.

Sara Brown: Thanks, Astrid. So this is just a quick card kind of comparing the old and the new programs. Again, really significant changes is the height requirement's been eliminated and the increase in the credit now up to $5,000 per dwelling unit. And the other thing is the documentation and the requirements to get ahead of the new credit and make sure that your certifications are in place before your project starts, so you're getting the maximum benefit. Key takeaways, just to reiterate, the old requirements are still in place for projects through 2022. You can amend those returns, if possible. We have this new 45L tax credit for 10 years, so plenty of time to plan for upcoming projects and also keep in mind that you can use it or claim it in conjunction with other tax credits, 179D and there's probably some others that we haven't touched on here as well. These are just some links you can find out additional information on these programs. That's it. Back to you, Jeff.

Jeff Goldberg: Thanks, Sara. We have reached the top of the hour here, so Astrid, I don't know if you want to run through a couple more questions here or we just want to make our emails and contact information available to the participants, if they'd like to reach out, post-call, to have those answered. I'll defer to you and the rest of the panelists.

Astrid Garcia: I guess, if we have a couple of questions, we could do one or two more minutes. If our audience are you able to stay on, that would be great. I think we're getting a lot of engagement, so go ahead.

Jeff Goldberg: Quickly scan through. I know a lot were on prevailing wages, so thank you all for answering that one. I guess a specific one on prevailing wages, for either of the programs here, can the site work be separated from vertical construction? So can you use non-prevailing wages for, say, the site work and use prevailing wages for the vertical construction and still qualify for either the deduction or credit?

Bill Harbeson: So for 179D, the requirement is that the energy-efficient commercial building property be installed using prevailing wage and apprenticeship program requirements. Things like dirt work or not energy-efficient commercial building property, neither is stick steel, we're looking at, again, building envelope, interior lighting, and HVAC systems.

Jeff Goldberg: Terri and Sara, would that be similar on the 45L side?

Terri Johnson: Jeff, I think that stands for both of those programs, from what I understand.

Jeff Goldberg: Okay, wonderful.

Bill Harbeson: Where it could get possibly a little bit trickier with 45L is because Energy Star is a holistic approach, you may have a harder time picking which ones to not pay prevailing wage, and once you get in your minutiae of what categories does all this fall into, whereas again, 179D is very specific in the systems that they look at.

Jeff Goldberg: Maybe one last question here. I think this was direct on the 45L side, but in terms of application or putting together, I guess, the Energy Star certification, could that be completed post-construction? Or will it need to be completed prior to construction? The questions relates to, I guess, getting the credit retroactively.

Terri Johnson: Go ahead, Bill.

Bill Harbeson: Oh, okay. Well, so the short answer is yes, but with great difficulty. To pursue an Energy Star certification after the fact would be, in my experience, frankly, it's not been worth it to the building owners to pursue. It's not to say that you couldn't do it. One of the things, one of the requirements of an Energy Star certification is that they have to observe certain equipment being installed. So the installation. So if you wanted to go in and get a retroactive certification, you'd be taking holes to your drywall, so that they can inspect the installation. We haven't found anybody who is willing to take that extra step for the credit, but it is available if someone wanted to. Even though, yes, you can go back three years and apply it to your tax return, you would need to have gotten your Energy Star certification in real time for it to be a practical exercise.

Jeff Goldberg: Wonderful. So maybe we will stop here, as we're a couple minutes past the top of the hour here. Just want to thank everyone for joining. Hopefully, this was helpful and informative and will help to guide your development decisions going forward. Astrid, are we providing the participants with contact information, so they can reach out to additional questions?

Transcribed by Rev.com

 

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Clean Energy Credits Guide

The energy credit guide provides an overview of the major credit changes in the law and breaks down the complicated changes and requirements in an easy-to-understand manner. 

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Sara E. Brown

Sara Brown is a Tax Director with more than 10 years of public accounting experience working with consolidated groups, pass-through entities, closely held businesses, and high net worth individuals operating on multistate and international platforms.


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