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Modified Section 179D tax deduction a highlight of the Inflation Reduction Act

January 24, 2024 / 9 min read

The Inflation Reduction Act expanded Section 179D eligibility requirements and increased the possible deduction when building owners complete energy-efficient upgrades. Learn about Section 179D basics, the changes that were made, and how to take advantage of this tax deduction.

The Inflation Reduction Act (IRA) of 2022 substantially revamped the Section 179D tax deduction with important changes going into effect starting Jan. 1, 2023. The slew of changes made to Section 179D not only increase the potential deduction available, but also expand eligibility for various building owners. Section 179D was previously made permanent, so these changes are now here to stay. 

The basics of the Section 179D tax deduction

Also known as the Energy-Efficient Commercial Buildings Deduction, Section 179D allows owners of commercial properties to claim an additional tax deduction in the year that energy-saving systems are placed in service. These rules generally require that the energy saving property be depreciable, located in the United States, and installed as part of a plan designed to reduce the building’s total annual energy and power costs by 25% or more compared to an applicable reference standard. 

Upgraded property systems include interior lighting systems; heating, cooling, ventilation, and hot water systems; and the building envelope (i.e., roof, walls, doors, and windows). The ultimate deduction is then calculated by applying a stated “per square footage” value to the subject building. For purposes of Section 179D, the square footage of a building only includes “conditioned spaces.” Section 179D was originally enacted in 2005, but it was subsequently modified by Congress on multiple occasions. More recently, the Consolidation Appropriations Act, 2021 permanently extended its life. The IRA has now gone further in expanding the benefits of Section 179D, albeit with key caveats.

What changes were made to the Section 179D tax deduction?

The following points include key changes made to Section 179D that went into effect for tax years beginning after Dec. 31, 2022:

Under the new model, two pathways exist with both being subject to a sliding scale based on energy efficiency, both of which are also indexed for inflation. The initial path involves projects that do not meet prevailing wage and apprenticeship hour requirements. In such case, the deduction begins at $0.50 per square foot and is increased $0.02 for every percentage point over 25% that energy and power costs are reduced — to a maximum of $1.00 per square foot. As such, the deduction is increased on a sliding scale for each percentage point above 25% energy cost savings and is capped at 50% energy cost savings.

The second path is available for projects when construction meets prevailing wage and apprenticeship requirements, which are discussed in more depth below. When applicable, the deduction begins at $2.50 and increases by $0.10 for every percentage point of energy savings over 25%, up to a maximum of $5.00 per square foot. The table below outlines how deductions will be calculated.

Chart showing preliminary and enhanced deductions for Section 179D.

The IRS has released initial guidance interpreting these rules in Notice 2022-61. A key date established by that notice is Jan. 29, 2023. Projects for which construction began prior to such date will not be required to satisfy the prevailing wage and apprenticeship hour requirements.

Table showing apprenticeship hour requirements.

How to take advantage of the modified Section 179D tax deduction rules

The changes to Section 179D are expected to have a long-lasting impact on energy-efficient building upgrades for the foreseeable future. Due to these modifications, Section 179D provides a great cost-benefit opportunity to a wide range of building owners. With these potential benefits come various points to remember as building owners plan upgrades.

Furthermore, because building owners rely on independent engineers to certify and document that energy and power cost savings meet the ASHRAE requirements, it is imperative that the owners keep this documentation on hand. Additionally, any building owner claiming the deduction for government property would also need to keep an “allocation letter” on file from the government entity that verifies the party’s involvement with the project, the cost of the property installed, the year it was placed in service, and the amount of the Section 179D deduction.

To learn more about how you might qualify for the Section 179D energy-efficient commercial buildings deduction, please contact your tax advisor. 

Have additional questions on how IRA tax credits, incentives, and monetization options could impact your organization? Explore more from our tax leaders as they track the latest developments.

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