The Section 179D or the Commercial Building Energy-Efficient Tax Deduction has become permanent, providing architecture, engineering, and construction firms with possible long-term tax benefits.
After construction on designed projects for government-owned structures is completed, these entities can claim the deduction. However, there are several requirements and regulations that businesses must be aware of before receiving the deduction, based on time and contract terms.
Understand how Section 179D tax deduction can save your organization money, as well as industry-specific criteria and restrictions in the following sections below.
What is Section 179D Tax Deduction? How does it work?
Taxpayers can claim a Section 179D credit for up to $1.80 per square foot when implementing efficiency upgrades to commercial buildings above specific energy criteria. To accommodate for inflation, the $1.80 per square foot deduction now increases each year slightly.
The Consolidated Appropriations Act, 2021, made Section 179D a permanent element of the US tax code on December 28, 2020. Because of this change, architectural, engineering, and construction firms will be able to claim the deduction beyond 2021 – allowing them to prepare for and achieve significant tax savings from government construction projects.
Could Architecture, Engineering, and Construction Firms Take Advantage of the Section 179D Tax Break?
Yes. Engineering, architectural, and construction firms that design portions of government-owned, energy-efficient buildings are eligible for the Section 179D credit.
The deduction is subsequently transferred to the principal designers of the structures, in this instance, engineering, architectural, and construction businesses that qualify as designers—because the proprietors of these government facilities are nontaxable corporations. The deduction is intended to encourage designers of government-owned structures to incorporate energy-efficient systems and components into their designs.
If an entity provides the technical specifications for a structure, it is regarded accountable for the building’s design components. For the purposes of this deduction, any company that installs, fixes, or maintains a facility does not fit the criteria of a designer.
Engineers and Architects
Typically, architecture and engineering firms are in charge of developing a property’s technical specifications. As a result, they have a great chance to meet the qualifications for the Section 179D deduction when making improvements to any of the following categories:
• Building Envelope
• A system for HVAC (heating, ventilation, and air conditioning)
• Lighting system
A business may claim the deduction only for design elements of a building for which they are directly responsible. For instance, a mechanical engineering firm that is solely responsible for designing an HVAC system in a government-owned building may deduct only the portion derived from the HVAC system.
A construction contractor may be eligible for the Section 179D deduction if they contributed to the design or are contractually obligated to participate in the design. For example, contractors engaged in design-build work for a government agency will have a possibility to qualify for the Section 179D deduction than contractors acting solely as project managers.
Will Section 179D Deduction Claims Lead in an IRS Audit?
The answer is no. Claiming the deduction as a developer of government-owned buildings does not automatically trigger an IRS audit. Albeit, it is critical to follow the proper procedures for determining eligibility for the deduction.
Section 179D has been added to the IRS’s file of so-called practice units that offers a framework for designers who may be eligible for the deduction. The IRS’s Section 179D practice unit recently published a knowledge-based document outlining the procedures the IRS should follow when auditing Section 179D studies.
How Does a Business Take Advantage of the Section 179D Deduction?
A business may claim the Section 179 deduction if it receives a Section 179D study during the same tax year as the building is put into service. If the entity satisfies the study’s requirements, it may claim the deduction on its recent tax return.
The deduction is up to $1.80 per square foot, inflation-adjusted. A business claiming credit for a single system, such as the HVAC system, will claim the credit at a rate of $.60 per square foot. Additionally, this can be completed retroactively if a business submits an amended return.
Section 179D Assessment
A qualified third-party—unrelated to the designer claiming the Section 179D deduction—use IRS-approved energy modeling software to simulate the energy performance of the building and improvements in a Section 179D study.
The energy model then compares the building’s performance to a reference building that complies with applicable energy and power cost requirements based on the American Society of Heating, Refrigerating, and Air-Conditioning Engineers (ASHRAE). Additionally, the third party conducts a physical site inspection of the facility.
The qualified third party must be a licensed contractor or professional engineer in the state in which the structure is located. The third party should review the energy model results and verify that the improvements reach the relevant energy-savings thresholds defined by ASHRAE. Additionally, they must sign a Section 179D certification document stating that they have evaluated the energy model and support allocating the deduction to the appropriate designer.
Letters of Allocation
These documents certify that a structure complies with Section 179D’s energy and operating cost requirements. They are signed by both the designer and an authorized representative of the government entity. The government entity may choose to allocate the total deduction to a single designer or distribute it proportionately to multiple designers.
When Does a Section 179 Deduction Occur on a Tax Return for an Entity?
While a business should claim the deduction in the year the building is put into service, building owners can claim the deduction retroactively as far back as the 2006 tax year by submitting an accounting method change.
However, if an engineering, architecture, or construction entity does not claim the deduction on their current-year tax return, they must file an amended return to claim it. This can result in significant administrative burdens, particularly if an entity needs to claim the deduction retroactively for multiple years.
If you believe your business meets the qualifications to claim for the Section 179D deduction, you must act quickly because each project is limited to a certain amount. The designer must obtain a signed allocation letter from the government entity, which an authorized official should sign.