Have you ever been involved in the construction of energy-efficient buildings? If that is the case, you might consider section 179D to minimize your next tax bill. The section 179D tax deduction is now permanent, which benefits construction, engineering, and architecture companies. These entities can claim 179D tax credits after the construction of designed projects for buildings owned by the government. But there are rules and regulations that organizations should know before claiming said tax credits.
In today’s article, you will learn how the Section 179D tax deduction works and how you can qualify.
Understanding the 179D tax credits
As energy costs continue to rise, minimizing those costs is a priority for many organizations, both private and public. Designers of public building projects, as well as commercial building owners that apply sustainable building components, are eligible for the 179D tax deduction.
This tax deduction provides them up to $1.80 per square foot for installation systems that help minimize the total power and energy costs by 50%. This amount increases slightly because of inflation. Qualifying building systems can include hot water systems, ventilation, cooling, heating, interior lighting systems, and the building envelope.
In 2020, section 179D became permanent, which means that construction, engineering, and architecture companies can claim the tax credits beyond 2021. They are the entities behind the design components of energy-efficient buildings owned by the government, allowing them to generate significant tax savings.
Because non-taxable entities own these public buildings, the primary designers (construction, engineering, and architecture entities) acquire the deduction. The purpose of the 179D tax deduction is to reward designers of government-owned establishments that incorporate energy-efficient systems and components. This tax deduction only covers entities that make the tech specifications for government-owned buildings. Those responsible for installation, repairs, and maintenance do not meet the definition of a designer.
- Architecture and engineering entities – design a property’s tech specifications, so they are likely to qualify for the tax credits because of the improvements they made to the following: building envelope, HVAC system, and lighting system.
- Construction contractors – qualify for the tax credits only if they have input in the design based on the terms of their contract.
Which buildings can qualify for the 179D tax credits?
The energy-efficient building property must meet the following in order to qualify for a full or partial tax credit:
- Must be in the United States
- Must have become in service after December 31, 2005.
- Must receive certification from an IRS-qualified professional contractor or engineer
- Any installation must be a part of HVAC and hot water systems, interior lighting systems, and the building envelope
The following building types do not qualify for a tax credit:
- Buildings for cold storage
- Buildings that do not have electricity
- Buildings owned by non-profit organizations
- Manufactured homes
- Multi-family residential buildings with three or fewer stories
- Single-family houses
Claiming the 179D tax credits
Companies can claim the 179D tax credits by receiving a 179D study on the same tax year the building becomes in service. If they meet the requirements, they will receive the tax credits on their tax returns. They can get up to $1.80 per square foot, plus adjustments due to inflation. Companies claiming the credit for one system would receive $0.60 per square foot.
How does the 179D study work? A qualified third-party entity uses energy software approved by the IRS to model the energy performance of the establishment and the improvements. And then, the model compares the performance with a reference building that meets power and energy cost requirements, following the ASHRAE standards. The third party also visits the facility to conduct a physical inspection.
The qualified third-party entity must be a professional engineer or a contractor licensed in the state where the building stands. They must review the energy model results and check if the enhancements meet the energy-savings thresholds, following the ASHRAE standards. Also, they must sign a certification document for the 179D tax credits, stating that they have reviewed the energy model and agree with the distribution of the credit to the respective designer.
What are allocation letters? They are documents stating that an establishment meets the power cost requirements in Section 179D. Someone within the government and the designer must both sign these letters, allowing the government to allocate the deduction to one designer or split them among multiple designers.
When do you see the tax credits on your tax return?
Companies must claim the tax credits the same year the building becomes in service. However, building owners may claim the credits retroactively back to the 2006 tax year by filing an accounting method adjustment.
However, an amended return might be necessary if any entity (construction, engineering, or architecture) failed to receive the credit on a current-year tax return. Filing an amended return ensures that the designers will receive the deduction. While it can create a considerable administrative burden, it is worth going through to ensure they receive the 179D tax credits.
If your company qualifies for the 179D tax deduction, you must act quickly because not enough time is available for each project.
How do entities report the 179D tax credits?
- Designers – Contractors, engineers, and architects also report the tax credit under the other expenses for the applicable tax year. Designers do not need to know the gross income or minimize future credits by the amount allocated by the Section 179D deduction.
- Building owners – report the tax deduction under the other expenses for the applicable tax year to minimize the tax basis of the property by the deduction amount.
Will it trigger an IRS audit?
Some people ask, “will claiming 179D tax credits trigger an IRS audit?” The answer is no. It doesn’t automatically trigger an IRS audit. However, it’s extremely important to abide by the rules and follow the steps to determine qualification.
The IRS LB&I division has included the 179D section in its list of practice units. It means that they provide a framework for the designers that would qualify for the tax deduction. In fact, they have released a knowledge base document outlining the actions the IRS would do when they audit 179D studies.