David McGuire is a leading expert on cost segregation, fixed assets and depreciation law and a co-founder of McGuire Sponsel.
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In August of 2022, President Biden signed into law the Inflation Reduction Act of 2022 (IRA). This legislation extended and increased many tax credits and deductions for green energy projects and energy reduction initiatives. Additionally, the law created new credits and concepts, including prevailing wage and apprenticeship requirements. With the dust beginning to settle on the law and updated IRS regulations, it’s a good time to look at how businesses can access the incentives in this law.
One of the key provisions in this law relates to the Energy Efficient Building Deduction under Section 179D of the tax code. Section 179D allows businesses to take a deduction against the capital cost of building or upgrading buildings to be energy efficient. While 179D has been part of the tax code since 2006, the IRA drastically changed the qualification criteria.
The first major change to 179D surrounds the amount of the deduction businesses are eligible to take. Prior to these changes, the deduction was limited to $1.80 per square foot, indexed to inflation. This index means that at the end of 2022, businesses were eligible for a deduction of $1.88 per square foot. Under the new law, the base deduction amount is reduced. The new deduction is based on a sliding scale starting at $0.50 per square foot and going up to $1.00 per square foot. However, Congress added a provision that if prevailing wages are paid, the taxpayer gets a potential increase in their deduction (or $2.50 per square foot and up to $5 per square foot).
This means that under the right conditions, a business constructing a new building in 2023 could be eligible for a much larger deduction than it would have received for a comparable building in 2022. This legislation also expands eligibility in addition to the deduction amount.
Under the original 179D rules, written as part of the Energy Policy Act of 2005, 179D deductions could be transferred to the person or persons responsible for the design of the energy-efficient property. However, this transfer was only eligible in the case of government-owned property.
The IRA expands the ability to transfer deductions to tax-exempt entities as well. Tax-exempt entities such as churches and private schools can transfer this deduction to the architects and engineers that design their energy-efficient properties. The idea of this transfer is that it should reduce the design cost for eligible entities by providing their design team with a tax incentive.
In addition to the 179D deduction, the IRA expanded and changed other energy credits, including the Alternative Fuel Vehicle Refueling Credit (30C) and the Energy Investment Tax Credit (section 48), as well as creating an Advanced Energy Project Credit (48C), along with multiple other credits and incentives.
These new and expanded credits create opportunities for businesses that cater to these areas or are looking to upgrade facilities to do it more cost-effectively. Take the Section 48 Investment Tax Credit. This credit is for investment in “energy property,” including solar panels, geothermal systems and other green energy systems (IRC Section 48). This credit is being used to offset the cost for companies to add solar panels to their facilities.
Under the new law, this credit grows to 30%. However, to get the full credit, a project needs to either be under one megawatt of electrical output or be constructed meeting prevailing wage guidance. In addition, there are bonus credits of up to 10% for utilizing domestic content and being in specific “energy communities.” A project that meets both the domestic content and is in an energy community could receive a tax credit equal to 50% of the installed cost.
Additionally, the remaining basis of the property is eligible for a five-year life and bonus depreciation. This means that a company with a 30% tax rate getting the 50% credit (30% base credit and both 10% bonus credits) and the depreciation benefits would get almost 70 cents for every dollar spent from the federal government in the first year of installing solar panels.
While these credits have been expended, the majority of the credits are expansions of existing credits in the tax code. However, in the IRA, the drafters recognized that tax-exempt organizations and governments could not access the tax benefits available to for-profit corporations. Recognizing this, they added code Section 6417. Under Section 6417, certain entities that do not pay tax can monetize their tax credits by treating them as direct payments.
This will allow tax-exempt organizations, government organizations, schools and other eligible entities to monetize these valuable credits. For example, a private university can now install a solar field and monetize the tax credits just as a for-profit business would. The expansion of these credits gets even better for many businesses.
Under Section 6418, many of these credits are now eligible for a one-time transfer. Meaning that businesses lacking the taxable income to absorb these lucrative tax incentives can now sell the credits to a third party. This will also allow businesses with limited taxable income to monetize these incentives.
These credits and incentives have become significantly more lucrative with the enactment of the IRA. Of course, with the addition of new tax provisions, and additional requirements such as prevailing wages, it is more important than ever for businesses to work with qualified professionals to walk through these confusing areas of tax law. That said, the incentives are too lucrative for many businesses to ignore.
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