Part Two: Enhancements to Existing Incentives
By Kory Reynolds, Senior Manager, Baker Newman Noyes
This is the second of a two-part series discussing the impact of the Inflation Reduction Act of 2022 on the real estate industry. Part one focused on entirely new incentives, while part two covers modifications to existing incentives.
In addition to the new incentives covered in part one of our series, the Inflation Reduction Act (IRA) of 2022 expanded many existing programs, with both expansions of the amount of tax credits available and of the efficiency metrics to qualify for the projects. Tax incentives expanded by the IRA include the Energy Efficient Commercial Buildings Deduction (Internal Revenue Code (IRC) Section 179D), Energy Efficient Home Credits (IRC Section 45L), Commercial Energy Property Credits (IRC Section 48), and Electric Vehicle Charging Credits (IRC 30C). The expansions roll out new tests that determine qualification for the credit or deductions, including Prevailing Wage and Apprenticeship requirements. Projects that meet these requirements are available for enhanced amounts of the credit.
The Prevailing Wages requirement requires that all employees, contractors, subcontractors, laborers and mechanics (note that this excludes management, supervisors, foreman), are compensated at a rate not less than the prevailing rate for construction, alteration, or repair as determined by the Secretary of Labor for the area where the project is located.
The apprenticeship requirement is that no less than an applicable percentage of the labor hours on the project is performed by qualified apprentices. This applicable percentage starts at 10% of the hours, and phases up to 15% of the hours by 2024. Every taxpayer or contractor who has at least 4 employees in the applicable roles is required to employ at least 1 or more qualified apprentices. There are several exceptions to the apprentice requirement – one if a good faith effort is made to obtain apprentices, but no qualified apprentices were available, and one exception if there is an agreement to instead pay a fine to the Department of Labor in the amount of $50 per hour to achieve the applicable percentage of labor hours.
Author Note: It appears that substantially more guidance will be needed in this area – record keeping requirements, ongoing tracking of qualifications for several credit programs, required certification from your contractors, or if a level of certification will be required from an independent party.
Energy Efficient Commercial Buildings Deduction (IRC 179D)
The Energy Efficient Buildings Deduction (179D Deduction) has been around for many years and is being expanded by the IRA. The 179D Deduction is a form of accelerated depreciation on the acquisition of energy efficient property for a commercial building – either a retrofit to an existing building or acquisition of a new construction building. The deduction allowed is calculated based on square footage, depending on the level of efficiency that the building is certified.
Beginning in 2023 for buildings that meet the energy reduction requirement of at least 25% on the overall building, there is an allowed tax deduction of up to $2.50 per square foot. For each additional 1% increase over 25% of efficiency the deduction is increased by $0.10 per square foot, up to a total deduction of $5 per square foot, which is up from the $1.88 maximum per square foot for the 2022 Section 179D Deduction. This measurement of efficiency improvement is on the entire building, which is in contrast to the Pre-2023 179D Deduction, which allowed for a partial deduction based on improvements to specific building systems. The energy standards for this deduction have become stricter, now based on the ASHRAE 90.1 standard affirmed no earlier than 4 years prior to the improvements going into service.
If a project does not meet prevailing wage and apprenticeship requirements, there is a significant reduction in the deduction, down to a base deduction of $0.50 per square foot for a 25% energy improvement, and an additional $0.02 per square foot for each additional 1% efficiency improvement, up to a maximum deduction of $1.00 per square foot.
Author Note: Historically these studies have been expensive to implement, making it cost prohibitive for all but the largest of new projects. With the near tripled deduction per square foot we expect that more taxpayers will find this deduction attractive.
Energy Efficient Home Credit (IRC 45L)
The Energy Efficient Home Credit under IRC Section 45L (45L Credit) is another credit that has been in place for some time, but is being expanded significantly with the IRA. This incentive is available to contractors and builders who build Energy Star Certified or Zero Energy Ready homes. The credit is equal to $2,500 for Single Family Energy Star Requirement Homes, and $5,000 for Single Family Zero Energy Ready Homes.
For multifamily properties, a similar credit is available if the Energy Star Multifamily housing requirements are met. The base credit for a multifamily project is $500 per unit for Energy Star certified projects, and $1,000 for Zero Energy Ready certified projects. This credit increases to $2,500 and $5,000 per unit respectively if prevailing wage requirements are met.
The 45L credit is also available for substantial improvements to existing properties. While this is not defined by the regulations, presumably this would apply to substantial renovations to existing properties that includes energy efficiency improvements.
Investment Tax Credit (ITC) (IRC 48)
The investment tax credit is a near mirror of a similar residential program offered for the installation of solar panels and other renewable energy technologies, including geothermal, qualified fuel cells, or small wind energy projects.
The credit as it exists currently and in earlier years provides a base amount of the credit calculated on the cost of the project. For 2022 through 2024 the credit equals 30% credit of the project costs. The IRA introduces a two tiered system with additional complications to the credit beginning in 2025 – first and foremost reducing the base amount of the credit to 6% of the qualified project cost. If prevailing wage and apprenticeship requirements are met, the credit is multiplied by 5 – giving a taxpayer up to the same 30% credit that was available in 2024 and prior tax years. The IRA also introduces a bonus amount of credit of up to 10% for projects with primarily US based production, with increasing levels of required US based production over the next 10 years. Combined with the 30% credit, this can provide a tax credit of up to 40% on a qualified project. If prevailing wage and apprenticeship requirements are not met, this bonus of 10% drops to 2% – for a total credit available of 8%.
Additional requirements have also been introduced that require the prevailing wage requirements to exist for the 5 years after the property is in service, as well as the initial installation. If these requirements are not met there would be a partial recapture of any tax credit benefits received.
Most tax credits require that a taxpayer reduce the depreciable basis of the property acquired by the amount of the credit received (to avoid double-dipping). ITC-specific rules allow the basis to be reduced only by half of that amount, allowing eligible property to receive a 30% credit applied to the property cost, while depreciating a basis of 85% of that same property cost.
A new function of the ITC is that is that a taxpayer may transfer it to another taxpayer for compensation (previously the credit was nontransferable). This allows a taxpayer who may otherwise have minimal tax liability to nevertheless benefit from the credits, a common occurrence for growing real estate developers.
Author note: For projects eligible for the entire credit the tax savings can be substantial. With a $50k installation a taxpayer could receive up to a 40% credit ($20,000), and then have a depreciable asset of $40,000. If 100% bonus depreciation is applicable in the given year, at maximum tax rates this is a tax savings of $14,800. Between the credit and tax deductions, $34,800 of the project is paid for immediately.
Electric Vehicle Charger Credit (IRC 30C)
A tax credit for installation of electric vehicle charging stations has consistently been available in the past and is being expanded by the IRA. The expanded credit is 30% of the project cost, up to a total credit of $100,000 per project. If prevailing wage and apprenticeship rules are not met, similar to the ITC, the credit is reduced to 6% of the project costs.
Author note: This could be a significant benefit to multifamily or commercial office developers looking to add EV charging to their new or rehabilitated projects.
With the Inflation Reduction Act’s explosion in new and existing green energy incentives, real estate developers and investors will have their plates full digesting the programs that are available to them for their next projects. The qualification rules are technical and complex, however, and it is highly advisable to include the party that will be certifying the project in the initial planning stages and throughout the process, to ensure the work being performed is going to be eligible for the rebates and tax credits that you are planning for. Additional guidance is expected, but planning can begin as soon as your next project is identified.