How 503C Entities Can Benefit from the 179D Tax Deduction
The Section 179D Deduction, also known as the Energy Efficient Commercial Building Deduction, is a federal tax incentive designed to encourage taxpayers to construct energy-efficient buildings as well as to make improvements in existing structures that will reduce energy and power costs.
Internal Revenue Code Section 179D allows a deduction per square foot for energy-efficient commercial building property (EECPB). This provision was first introduced in 2006 and was made permanent in 2020. For most of that period, the deduction was $1.80 per square foot of qualifying property. However, as Congress continues to emphasize the importance of green buildings and energy independence, it recently increased the maximum deduction to $5.00/square foot through 2032.
Who Can Take Advantage of Section 179D
Prior to 2022, construction projects for tax-exempt entities were excluded from the scope of the deduction. But, beginning in tax year 2023, the program was expanded and now allows government-owned, not-for-profit organizations, churches, Tribal organizations, and not-for-profit schools and universities to allocate deductions to eligible designers.
Building owners, architects, contractors, and designers are eligible to receive this deduction, although there can be only one deduction per property. Consequently, institutions looking to enter into a large construction project can use this deduction as a negotiation tool, allowing the architect or contractor to utilize the deduction in exchange for a reduced project cost. This can create substantial savings for both the not-for-profit organization and the builder. It’s a win-win!
What Buildings Qualify
In order to qualify for this deduction, projects must reduce energy consumption in any of the following areas:
- Interior Lighting System
- HVAC System
- Envelope (building shell).
The deduction is based on square footage and is calculated using a sliding scale based on the reduction in energy costs. Note that the amounts given below are the deductions for the 2023 tax year. They will be adjusted for inflation in subsequent years:
- Maximum deduction is $5.00/square foot for a 50% reduction in annual energy and power costs.
- A sliding scale from $2.50 to $5.00/square foot for energy savings of 25-50%.
The above savings are applicable when prevailing wage requirements are met. If prevailing wage requirements are not met, the deduction is reduced to a sliding scale of $0.50 - $1.00/square foot.
For example, a 50,000-square-foot building, such as an elementary school, would have had a maximum deduction of $90,000 prior to the expansion of the deduction but now would be eligible for a maximum deduction of $250,000. Similarly, the maximum deduction for a 500,000-square-foot hospital increased from $900,000 to $2,500,000.
How the 179D Tax Deduction Obtained
To claim the 179D deduction, energy savings must be certified by an unrelated “qualified individual” who is a contractor or professional engineer licensed in the same jurisdiction as the building. A site visit of the property and energy modeling using software approved by the Department of Energy are required.
Because there is a cost to performing this certification study, ideal projects will be facilities with square footage of at least 50,000 square feet with a wide range of improvements. These improvements could be simple lighting retrofits to full-scale construction projects.
As mentioned previously, the designer of the project is the one taking the deduction and does so simply by reporting the deduction as a line item under other expenses for the applicable tax year. Building owners will also reduce their tax basis in the property by the amount of the deduction.
Because the tax-exempt entity is not the one actually taking the deduction (but rather allocating the deduction to the designer), it has no specific reporting requirements.
A special thank you to John Hanning and Brian Wages with Specialty Tax Group for their technical advice on this article.
If your organization is considering a new construction project or significant improvements to an existing structure, please contact us to discuss the potential for cost savings.