COVER STORY, APRIL 2008

A GREEN TAX ADVANTAGE
An extended tax deduction could save owners big money.
William F. Becker Jr., CPA, MBA

Whether due to the increasing cost of energy, tougher building codes or concern about the nation’s dependency on foreign oil, there is a renewed interest in energy efficiency that has not been seen in almost a quarter century. Whatever the reason, a movement towards energy-efficient buildings is clearly underway.

Although there can be additional costs associated with green buildings, a provision in the Energy Policy Act of 2005 is intended to offset some of the costs by potentially allowing taxpayers to take an immediate expense for the cost of property. That expense would normally be required to be recovered through depreciation over as many as 39 years.

The Energy Efficient Commercial Buildings Deduction, included in Section 179D of the Internal Revenue Code, allows building owners or lessees to deduct up to $1.80 per square foot for energy efficient improvements to a building’s lighting system; heating, ventilation and air conditioning (HVAC) system; hot water system; or building envelope. This provision was originally set to expire on December 31, 2007, but has been extended through 2008, allowing building owners another year to claim this valuable deduction.

As the name implies, the deduction is primarily intended to apply to commercial buildings. However, the deduction is also available for multifamily residential properties that exceed three stories above grade. To qualify, the improvements must meet certain standards. First, the improvements must be depreciable property. Second, the improvements must be made to a building that is located in the United States and within the scope of Standard 90.1-2001 of the American Society of Heating, Refrigeration and Air Conditioning Engineers and the Illuminating Engineers Society of North America (ASHRAE). Third, the improvements must be made to one of the building systems discussed above. Finally, the improvements and energy savings must be inspected and certified by a qualified contractor or engineer.

A building qualifies for the full deduction if the energy efficient improvements are installed as part of a plan to reduce the building’s total annual energy and power costs by 50 percent when measured against a reference building. For the purposes of this evaluation, a reference building is one that is located in the same climate zone and is otherwise comparable except that its systems do not meet the minimum requirements of Standard 90.1-2001. The 50 percent reduction must come solely from the energy efficient improvements. Reductions that result from other improvements are not considered for the purposes of calculating the deduction.

For buildings that meet the 50 percent reduction in annual energy costs as a result of the energy efficient improvements, the deduction is equal to the lesser of $1.80 per square foot or the total cost of the improvements resulting in the reduction. On larger buildings, the tax savings can be substantial. For example, a 250,000-square-foot building with systems that meet the 50 percent energy savings over a reference building would be equal to savings of $450,000. Let’s further assume that the builder is in a 35 percent tax bracket. This could mean a cash savings of $157,500 in the year the improvements are put into service.

If the improvements do not result in an overall 50 percent energy savings over a comparison building, partial deductions may be available for energy efficient improvements in each of the building’s systems. If improvements to any individual system results in a 16.27 percent energy cost savings over a reference building, a deduction of up to 60 cents per square foot may be claimed. All of the other requirements discussed above still apply.

If a full or partial deduction is claimed, then the cost of the property for depreciation purposes is reduced by the amount of the deduction. Using the above example of the 250,000-square-foot building, the cost of the property for depreciation purposes will be reduced by $450,000. During the life of the property, the entire cost of the building would ultimately be expensed. However, considering the time value of money, the additional tax savings of $157,500 allowed in the first year is far more valuable than $157,500 recognized over 39 years.

Regardless of the amount of energy savings improvements, the maximum lifetime deduction for a particular building is limited to $1.80 per square foot. Once this amount is attained, no additional deductions are allowed for energy efficient improvements. Any future improvements must be depreciated over their useful lives. This is an important consideration for improvements being made over multiple years or when improvements are being made by both the building owner and a lessee.

To satisfy the requirements of IRC §179D(c)(1), the taxpayer claiming the deduction must obtain certification of the property by a qualified individual. In Notice 2006-52, the IRS defined a qualified individual as an engineer or contractor licensed in the jurisdiction in which the property is located. To ensure an independent analysis and certification, the person making the certification cannot be related to the person or entity claiming the deduction.

The certification process involves an inspection of the improvements by an engineer or contractor who calculates the energy savings of the improvements as compared to the reference building using Department of Energy-approved software. The certification must include a written report signed by the individual certifying the property that contains information about the building and improvements and the processes used to determine the energy savings. The certification document is not filed with the tax return that includes the deduction, but must be provided to the IRS in the event the tax return is examined.

One of the more interesting provisions in the legislation involves energy-efficient improvements installed in public buildings. For buildings owned by federal, state or local governments, the deduction may be taken by the person primarily responsible for designing the property. This can include the contractor, engineer or architect. However, for the purpose of the deduction, only one person can be primarily responsible. For professionals involved in the construction of public buildings, this can be a valuable benefit that should not be overlooked.

The green movement in commercial real estate is much more than merely a trend. Local building codes are mandating more efficient buildings and even large tenants are beginning to demand improvements that will reduce their operating costs. Given the growing number of incentives available to encourage incorporating energy efficient improvements into commercial buildings, it is important to consider any federal and local tax incentives available. With proper planning, it is possible to see the green in a green building.

William F. Becker Jr. is a tax partner in the Tampa office of Cherry, Bekaert & Holland, L.L.P. (CB&H) and a member of the Firm’s Real Estate and Construction Industry Group.

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