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December 15, 2022

Major Changes to 179D Deduction and 45L Tax Credit in 2023 to Incentivize Energy Efficient Building Design

The Inflation Reduction Act of 2022 (IRA) has expanded the 179D deduction and 45L tax credit, adding several new requirements to the tax breaks for energy efficient building and home deductions. To qualify for either tax break, real estate owners must comply with the new guidelines if they want to max out the credit. We cover those updated guidelines below and what benefits real estate owners might expect to see from these expanded tax credits and deductions.  

Key Takeaways: 

  • New rules take effect in 2023 for both the 179D deduction and 45L tax credit 
  • More savings available, but stricter energy efficient requirements 
  • Prevailing wage must be met to maximize savings 

Writing for Accounting Today, David McGuire detailed the new law change. As a stakeholder in McGuire Sponsel, which also covered the law change, he provided keen insight into the tax credits’ new guidelines.  

Previously, the 179D deduction allowed real estate owners to claim a deduction of up to $1.80 per square foot if energy efficient improvements are made to a building. If a building is owned by federal, state or local government, the deduction can be transferred to the entity responsible for the energy efficient design implementation.  

This deduction was made permanent under the Consolidated Appropriations Act of 2021. At the time, the taxpayer had to show an energy savings of 50% as measured by the American Society of Heating, Refrigerating and Air Conditioning Engineers standard 90.1 (2007) to qualify for a full deduction.  The previous rules allowed partial deductions as well at $0.60/sf for savings related to lighting, HVAC and building envelope.  

New Guidelines for 179D Deduction  

Under new rules, which take effect in 2023, the partial deduction has been replaced with a sliding scale which goes into effect when a building realizes a 25% to 50% energy consumption reduction. If the building’s energy consumption is reduced by 25% then the taxpayer may be eligible to a deduction of $0.50/sf. That amount is raised to $1/sf if the building reaches a 50% drop in energy consumption. 

To receive the maximum deduction amount, the property must be constructed using prevailing wages, as set by the Department of Labor. As long as prevailing wage requirements are met, the maximum deduction increases to $2.50/sf for a 25% reduction in energy consumption. If the building realizes a 50% reduction, the real estate owner may be eligible for up to $5/sf. 

The current rules governing the 45L tax credit will remain in effect through 2022. To qualify under the 2022 conditions, a home’s energy efficiency is compared to the 2006 International Energy Conservation Code (IECC). As long as the home is 50% more efficient than the IECC requirements, the contractor is then eligible for $2,000 per residence tax credit.  

How 45L Tax Credit Changes in 2023 

In 2023, those rules will undergo a modification for tax years through 2032. The base credit will rise to $2,500 or potentially up to $5,000 for a single-family home. For multifamily homes, the base credit is $500 per unit, though it can potentially go up to $1,000.  

To qualify for these credits, however, the new law stipulates that homes must meet the efficiency requirements of the Energy Star Residential New Construction Program. To qualify for the higher credits, the real estate owner must meet the Zero Energy Home Program, which has the strictest requirements of all.  

Meet Prevailing Wages to Qualify for Full Tax Credits 

Multifamily homes have the potential to earn an increased amount of tax credits, from $2,500 up to $5,000 per unit if prevailing wages are met. To satisfy prevailing wage requirements, all laborers, including mechanics, contractors and subcontractors must be paid wages at the prevailing rate set by the Secretary of Labor. Apprenticeship requirements must also be met. States where union labor is more common may have an easier time meeting this requirement.  

An advisor experienced in tax credits and the real estate industry in general can help guide you through this policy change while still maximizing your savings. Contact an Anders advisor below to learn more about Anders Real Estate and Construction.

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