Because of recent legislation, tax deductions may be awarded for part or all of the costs associated with new construction and/or equipment installations or retrofits that improve the energy efficiency of commercial buildings. On Oct. 3, President Bush signed H.R. 1424, Emergency Economic Stabilization Act of 2008, which extends the benefits of the Energy Policy Act of 2005 through Dec. 31, 2013, into law. Section 1331, Energy Efficient Commercial Buildings Deduction, of the Act establishes energy-efficiency commercial-building tax deductions for expenditures related to interior-lighting, HVAC, and hot-water systems and building envelopes. This opportunity potentially allows for the immediate expensing of costs that otherwise would be capitalized and recovered through depreciation over 27½ to 39 years.
Section 1331 makes provisions for a tax deduction limited to $1.80 per square foot on new construction after Dec. 31, 2005, if total annual energy and power costs of interior-lighting, HVAC, and hot-water systems and the building envelope are at least 50-percent below the minimum requirements of ANSI/ASHRAE/IESNA Standard 90.1, Energy Standard for Buildings Except Low-Rise Residential Buildings.
If an entire building does not qualify for the $1.80-per-square-foot deduction, partial allowances may be made for individual systems. If within the scope of Standard 90.1-2001, HVAC and hot-water systems and building envelopes may qualify for deductions of up to 60 cents per square foot. However, building owners are encouraged to focus on lighting systems first because they are easily available to upgrade and their potential energy-efficiency achievements are known. Owners may receive a deduction of 30 cents per square foot for reductions in lighting-power density of 25 percent of the minimum requirements in tables 9.3.1.1 or 9.3.1.2 of Standard 90.1-2001 and 60 cents per square foot for reductions in lighting-power density greater than 40 percent. Prorated partial deductions may be permitted for reductions in lighting-power density between 25 and 40 percent.
Deductions are permitted in the year in which a property is placed in service. For tax purposes, “placed in service” generally refers to the time at which a property is ready for its intended use.
Certain certification requirements must be met to qualify for deductions. Internal Revenue Service (IRS) Notice 2006-52, Deduction for Energy Efficient Commercial Buildings, and IRS Notice 2008-40, Amplification of Notice 2006-52: Deduction for Energy Efficient Commercial Buildings, describe methods of calculating and verifying energy and power costs using the performance rating method, the Nonresidential Alternative Calculation Method Approval Manual, and approved computer software.
Notice 2006-52 requires that a taxpayer must obtain certification for updates made to the property before he or she can claim a deduction. Certification must be provided by a “qualified individual” (i.e., a professional engineer/contractor properly licensed in the jurisdiction in which the building is located who is not related to the taxpayer and represents in writing that he or she has the proper qualifications to provide the required certifications and inspections). The certification process determines whether deductions are available but not the cost of the qualifying energy-efficient property. Therefore, a professional knowledgeable in cost-segregation services should verify the proper deduction amounts. Those seeking deductions are encouraged to look for a tax firm that specializes in energy-efficiency deductions and can provide representation and documentation in the event of an IRS audit.
The person or organization that pays for construction is generally the recipient of the tax deductions. This usually is a building owner, but could be a tenant for some HVAC or lighting-efficiency projects.
Notice 2008-40 allows tax deductions for government-owned commercial buildings, such as public schools, to be allocated to the person primarily responsible for designing the property in lieu of the public entity.
Although a property's base value is reduced by the tax-deduction amount and the property's remaining asset value depreciates over its tax life for the property class, the good news is that many cost components can be written off. This includes anything that can be capitalized, even labor.
Deducting the cost of a capital investment is not special. However, with energy-efficiency tax deductions, taxpayers potentially can write off the entire cost of a commercial-building improvement in the tax year in which it is placed in service, instead of the addition being capitalized and depreciated/amortized over time.
Director of cost-segregation and energy-efficient building-tax-deduction services for SourceCorp, Matthew Rader began his career at Arthur Andersen LLP. He received a bachelor's degree in construction science from Texas A&M University. Upon graduation, he worked as a consultant specializing in cost reviews, due diligence, construction monitoring, and representation of banks and investors regarding real-estate development and construction loans. He can be contacted via his company's Website at www.sourcecorptax.com/contact/contact_srcp.htm.