The Inflation Reduction Act: Energy Efficient Tax Deductions

The Inflation Reduction Act seeks to invest in clean energy and provides tax incentives that can benefit certain contractors. The 179D deduction is one of those incentives, and it is available to contractors who design and build energy-efficient buildings for certain customers.

179D has been in effect since 2006, but the Inflation Reduction Act significantly increases the potential deduction. Currently, tax law allows a maximum deduction of $1.88 per square foot under 179D. The new act increases the maximum deduction by $5 per square foot.

Additionally, the act allows more types of organizations to allocate this deduction to the designer/builder. Currently, contractors are only eligible for this deduction when designing government-owned buildings. Under the Inflation Reduction Act, contractors would also be eligible for this deduction when designing/building for nonprofit organizations, schools and universities, churches, and other public entities. This is because the owners of these public buildings are not taxable entities and therefore cannot take this deduction for themselves. Thus, they can allocate this deduction to the designers, contractors, and engineers of the building.

This results in a significant benefit for the contractor because they will essentially receive the 179D deduction without any corresponding additional income or any loss of future deductions. For example, if the owner of the building took the 179D deduction, it would be an accelerated depreciation deduction which expenses some of the cost of the building in the current year instead of expensing it in later years. But a contractor who is allocated a 179D deduction gets an expense that they would otherwise never deduct.

With the increase in the deduction and the expansion of the eligibility for contractors, 179D becomes significantly more attractive. Contractors should be on the lookout for large-square-footage projects for governments, schools, or nonprofits and consider whether they are good candidates.

Contractors that wish to take advantage of this deduction should do the planning before starting the project. Claiming this deduction requires communication with the project owner beforehand to maximize the benefit and handle the reporting properly. If the design, engineering, architecture, and building are all performed by different companies, then the 179D deduction could potentially need to be split between them. A project owner cannot allocate the same 179D deduction to two different companies.

Certain energy efficiency standards are required to qualify for 179D, which should be known ahead of time. Also, a consulting firm will likely need to be hired to certify the work. That means the benefit of the tax deduction will need to be weighed against the additional fees incurred for tax planning and independent certification before a decision is made.

If you think you have a project that is a good candidate for this deduction, please get in touch with your tax advisor to discuss your options.