Energy Efficient Commercial Buildings Tax Deduction

OVERVIEW
On August 8, 2005, President Bush signed H.R. 6, The Energy Policy Act of 2005 (Public Law 109-58) into law. This legislation created a new tax incentive for constructing energy efficient commercial buildings. Specifically, Section 1331, the Commercial Building Tax Deduction, establishes a tax deduction for expenses related to the design and installation of energy-efficient commercial building systems. The AIA strongly supported this provision and played a major role in its legislative development. AIA National also helped form a partnership with other concerned stakeholders and through this partnership, developed implementation recommendations for building owners to obtain this tax deduction. Please note that the tax deduction is not a tax credit (an amount directly subtracted from the tax owed), but a deduction –an amount subtracted from gross taxable income. Tax deductions result in benefits to the taxpayer; thus this newly created program can be used as an incentive to urge clients to choose energy efficient building systems. However the deduction is only applicable to building systems installed before January 1, 2009 so it is important to take advantage of this deduction before its expiration.


WHAT IS THE BUILDING TAX DEDUCTION?
Section 1331 provides that a building owner may claim a tax deduction for expenditures made as part of a building designed to reduce the total annual energy used in the operation of the building. Building owners can claim a tax deduction of up to $1.80 per square foot of building area for the installation of systems that reduce the total energy and power costs by 50 percent or more when compared with a reference building. The building systems eligible to secure the tax deduction include:

1.) Interior lighting systems;
2.) Heating, cooling, ventilation, hot water systems; and
3.) Building envelope systems.

A reference building is defined as “a building that is located in the same climate zone as the taxpayer’s building and is otherwise comparable to the taxpayer’s building except that its interior lighting systems, heating, cooling, ventilation, and hot water systems, and building envelope meet the minimum requirements of ASHRAE standard 90.1-2001.”

The required 50 percent reduction must be accomplished solely through energy and power consumption reductions for the heating, cooling, ventilation, hot water, and interior lighting systems. Reductions in any other energy uses are not taken into account in determining whether the 50 percent reduction is achieved. The method to compute the percentage reduction is discussed further below.


CAN I GET PARTIAL CREDIT?
Yes, because 50 percent energy savings may not be possible in all eligible building systems, partial credit may be attained for efficiency improvements in each of the 3 eligible building systems. The deduction can be obtained by an owner depending on whether one wishes to achieve energy reduction targets for the entire building (i.e. the scenario mentioned above) through interior lighting, HVAC/water heating, and building envelope systems, or one or two of these systems individually. If a 50 percent overall energy reduction is achieved independently in lighting systems, HVAC/water heating systems, or building envelope systems, each qualify for up to a $0.60 per square foot deduction for that particular system’s energy savings. Thus a tax deduction may be claimed if a 16 2/3 percent energy reduction can be achieved through installing lighting, HVAC/heating, or building envelope systems, or through a combination of the three systems.


HOW DO I COMPUTE SAVINGS FOR EACH SYSTEM?
The Internal Revenue Service has issued interim guidance on the Commercial Buildings Deduction. For efficiency improvements to interior lighting systems, the IRS has issued very detailed guidance relating to the applicable tax deduction. Essentially, the tax deduction is the lesser value of the complete cost of installing energy-efficient lighting or $0.30 to $0.60 per square foot proportional lighting power to achieve density savings of 25 – 40 percent below the standards established by ASHRAE Standard 90.1-2001. For more information on this and to see a table computing the tax deduction values’ proportionate percentage of energy savings, please click here.

With regard to HVAC, hot water, and building envelope systems, if the installation of one of these systems results in 16 2/3 percent energy reduction, a building owner may claim a deduction of $0.60 per square foot. However, if the building owner has claimed deductions in prior years for the installation of energy efficient HVAC, hot water, or building envelope systems for the same building, the maximum deduction would be $0.60 per square foot divided by the aggregate amount of tax deductions claimed in previous years.


HOW IS THE DEDUCTION APPLIED FOR PUBLIC BUILDINGS?
The legislation also allows for a tax deduction on energy savings systems installed in new or existing public buildings. In the case of energy efficiency improvements in a building owned by a federal, state, or local government, the legislation states that “the allocation of the deduction (will be) to the person primarily responsible for designing the property in lieu of the owner of such property.” The legislation requires the Secretary of the Treasury to issue a regulation defining who would qualify as “the person primarily responsible for designing the property.” The AIA has been working to ensure that architects are included under this definition though at the time of writing, the IRS is yet to issue further guidance. The AIA drafted a letter to the IRS explaining our position and are awaiting response. If the IRS utilizes this advice, architects will be eligible to receive a federal tax deduction for designing energy efficient public buildings that meet the energy reduction criteria established within this legislation.


HOW DO THEY CALCULATE ENERGY SAVINGS?
The legislation illustrates a clear method for calculating power savings. In order to determine power savings achieved by installing energy efficient systems in a “Proposed Building” (the building where energy efficient improvements will be made), one would first calculate the total energy and power costs for interior lighting, heating, cooling, ventilation, and hot water in a reference building. Then, one would calculate the equivalent energy and power costs from the Proposed Building (with energy efficient systems installed) and then subtract Proposed Building energy and power costs from reference building energy and power costs. The resulting number is then expressed as a percentage of reference building energy and power costs.

It is important to explain this computation method to a building owner as they will then have to provide the specific energy savings statistics to their tax-professional in order to correctly file for the deduction.  To claim the deduction, the tax preparer will need a certified document signed by an engineer or contractor who is licensed in the jurisdiction in which the building is located.  The certification must contain information stipulated in the IRS guidance document (please see page 34 of the document).  The National Electrical Manufacturers Association has also developed a guidance document which offers detailed, step-by-step instructions to compose a certification document.  This document can be viewed by clicking here.


WHAT’S NEXT?
This tax deduction is applicable only to building property installed before January 1, 2009. Thus one of the AIA’s major priorities is to urge Congress to make the deduction permanent or at least extend it beyond its sunset. A number of bills have been introduced to extend this tax deduction and AIA National has weighed in with the appropriate officials on each of these pieces of legislation. AIA National is also awaiting further regulations from the IRS regarding the public buildings stipulation. AIA National will continue to work to ensure this important tax deduction will be extended beyond its expiration and can be used by architects to promote the development of energy efficient buildings.


MORE INFORMATION
The AIA has joined a coalition with other major stakeholders to ensure that this tax deduction is correctly applied and extended beyond its expiration.  The coalition has developed a webpage which provides more information on this tax deduction.  To view the website, please click here.