How to Use Tax Deductions to Build the Case for Energy Efficiency
How to Use Tax Deductions to Build the Case for Energy Efficiency
Tax strategy. Sometimes it's a part of the business that just doesn't receive the respect it deserves. However, for companies looking to manage both energy use and the bottom line, it should be an important element of business strategy.
On a daily basis, on websites such as GreenBiz.com, we read about the energy management efforts being implemented by companies. Generally, such efforts are guided by at least one of four business drivers: revenue generation, cost reduction, stakeholder expectations and/or government regulation. These efforts themselves tend to focus on one of four categories:
- Reducing the carbon intensity of supply chain operations through energy efficiency,
- Switching to low-carbon energy and fuel sources,
- Innovating new solutions, or
- Offsetting carbon emissions (see graphic on last page).
When you start to examine the lucrative opportunities the tax function can unlock, the financial prospects certainly command respect. Take Internal Revenue Code §179D, for example. More commonly known as the §179D "Deduction for Energy Efficient Commercial Buildings," it's a great example of how tax deductions can act as a "cost reduction" business driver for companies as they reduce carbon emissions by better managing energy use.
With the U.S. Department of Energy estimating building energy consumption to be 40 percent of total domestic energy use, as part of their sustainability strategies, architects and engineers are assisting their clients in reducing energy consumption at corporate facilities.
In addition to incentives offered by utilities and state governments, the 179D deduction is an excellent opportunity to further recoup the financial benefits of retrofitting properties with more energy efficient alternatives, or of installing property in a newly constructed facility.
What is the 179D Deduction?
IRC §179D offers a tax deduction for the cost of eligible energy-efficient commercial building properties, namely for:
- Interior lighting systems (fixtures and controls),
- Building envelope (walls, windows, roofs or doors),
- And/or HVAC (heating, ventilation and air conditioning) systems.
Originally introduced as part of the Energy Policy Act of 2005, and later extended under the Emergency Economic Stabilization Act of 2008, 179D permits a deduction between $0.30 and $1.80 per square foot of the facility, up to the total cost of the energy-efficient property placed in service. The deduction value depends on the property's performance against ASHRAE (American Society of Heating, Refrigerating and Air-Conditioning Engineers) Standard 90.1-2001. The 179D deduction applies to property placed in service between January 1, 2006 and December 31, 2013.
The most common application of 179D may be for lighting alone. In 2006, the Internal Revenue Service (IRS) published Notice 2006-52, allowing for a deduction between $0.30 and $0.60 per square foot, solely under the lighting qualification pathway.
More specifically, by achieving an LPD (Lighting Power Density, measured in watts per square foot) reduction between 25 percent and 40 percent of the ASHRAE standard, a facility is eligible for a deduction between $0.30 and $0.60 per square foot under lighting alone. It may sound small, but this deduction can really add up at large commercial properties.
And of course, a facility may be eligible for a higher deduction by combining the performance of multiple building systems, such as lighting and the building envelope or HVAC system, for example.
Perhaps one of the most opportune aspects of 179D is its applicability to government facilities.
In April 2008, the IRS, under Section 3 of Notice 2008-40, announced a special rule for government-owned facilities: In such an instance, the government entity property owner may allocate the deduction to the facility's designer, including the architect, engineer, contractor, environmental service provider or consultant. A person who merely installs, repairs or maintains the property is not considered a "designer."
How Can Companies Take Advantage of this Opportunity?
Having explained all this, how can companies identify the best facilities that would potentially qualify for 179D? From Ernst & Young LLP's experience as a firm, attractive candidates under the qualifying pathway of lighting tend to include parking garages, warehouses, distribution centers and manufacturing facilities.
Also attractive are facilities that have transitioned to linear fluorescents (T8s, T5s, T5HOs, CFLs and LEDs), and that have spaces sharing similar lighting layouts, such as hospitality and retail buildings.
Ernst & Young LLP's recent work with a hotel client demonstrates the financial potential of 179D. The client's facility, which consisted of 4 million square feet in area, was awarded LEED Gold certification. By analyzing lighting drawings, and confirming the findings with a site walkthrough, Ernst & Young LLP was able to calculate a $2.2M deduction for the client.
How can architectural and engineering firms identify opportunities where they may be eligible to claim 179D? When advising clients, we suggest reviewing their government project rosters to target which properties may be eligible for the 179D allocation from the government entity. The targets in these portfolios typically include facilities such as schools, airport terminals, parking garages, public school and university buildings, and correctional institutions.
The government assignment aspect of 179D is perhaps best highlighted by an example of an engineering firm Ernst & Young LLP advised regarding the deduction. The client was the primary designer of a 2 million square foot government distribution center made up of two buildings. Ernst & Young LLP approached the project using a three-phased process:
- Determining the eligibility and potential value of the deduction for the client. This included assisting the client with the allocation request from the government entity;
- Verifying the deduction value by supporting the client's energy models, as well as reviewing qualifying costs and contract records; and
- Obtaining the required certification from a licensed professional engineer, and assembling an audit support package for the deduction.
By achieving the full $1.80 per square foot deduction for one building, and $1.20 per square foot for the other building, the client was able to secure a deduction of over $2 million.
The 179D deduction is one of several energy-related business incentives available to companies. Many other financial benefits are available from federal, state and local sources, including utility incentives.
By "stacking" these incentives, and examining internal sustainability initiatives utilizing the Reduce/Switch/Innovate/Offset framework, a company can optimize the tax benefits from its energy management strategy to produce tangible bottom line benefits.
We encourage sustainability officers, facilities managers and tax directors to examine their respective companies' prior and proposed sustainability expenditures. By doing so, they can determine how such expenditures may be accelerated or more cost- and tax-effective when taking into account tax and financial incentives intended to accelerate adoption of sustainability strategies.
The views expressed in this article are those of the author(s), and do not necessarily represent the views of Ernst & Young LLP.
Tax forms photo via Shutterstock.