Fixing the 179D tax deduction
The section 179D tax deduction has been a valuable tax planning tool for architects, engineers and building owners for more than a decade. However, it never spurred energy efficient design the way it was intended. At the time of this writing, 179D has expired for 2018 and 2019. This is a good time to look at why the tax incentive did not spur expected growth and how Congress could fix it with some minor changes.
For years, 179D has been a temporary provision of the U.S. tax code. It was originally included in the Energy Policy Act of 2005 as a deduction for 2006 and 2007. Every few years the deduction expires and then Congress includes it in an extender bill, often on a retroactive basis.
The 179D incentive allows a deduction of up to $1.80 per square foot for the installation of energy efficient property. It behaves similarly to bonus depreciation as it is an immediate write-off, which reduces the depreciable basis of the asset.
To meet the deduction criteria, builders have been required to complete detailed engineering models of the property proving they reduced energy consumption in relation to the standards set by the American Society of Heating, Refrigerating and Air Conditioning Engineers. Specifically, builders had to show a 50 percent reduction in the energy utilized by the building’s envelope, lighting and HVAC systems. Reduced deductions were allowed for meeting the requirements of only one section.
In addition, the deduction could be claimed by the designer of energy systems, but only in buildings owned by a federal, state or local government. This was added as a way to incentivize the design of energy efficient government properties. It is important to note the IRS is very clear that the deduction goes to the designer, not the installer, of the energy efficient property.
The original law enacted this deduction for two years, and Congress has continued it on a periodic basis by including it in extender bills. Unfortunately, that leads to one of the biggest shortcomings of this tax incentive.
Often, large buildings take months, if not years, to design and build. This means a building under design in 2019 may not be completed until 2020, 2021 or later. However, the 179D criteria required that a building be modeled and considered for the deduction only once, when it is placed in service. Therefore, builders had no way of knowing at the time the building was designed if this deduction would be available when it was completed.
The temporary nature of the deduction took all of the incentive out of the tax deduction.
Let’s look at 2017, the last year the deduction was in effect. The deduction was passed on a retroactive basis in early 2018 for properties placed in service in 2017. Properties completed in 2017 were designed in 2015 or 2016, so builders had no way of knowing during the design phase if this deduction would exist once the building was finalized. As such, designers could not adjust the design for the deduction. Even if a building were completed in 2017, the deduction was not assured until the extension was passed in 2018.
By continuing to renew this deduction on a temporary, short-term basis, Congress is effectively eliminating 179D’s original purpose and incentives.
That’s not to say this type of incentive cannot be done in a way that spurs green building investment and growth, but Congress needs to be aware of the time it takes to design and construct an asset. As new incentives, or extenders, are studied, Congress needs to build in longer-term provisions if it truly wants to utilize the tax code to spur investment and growth.
Most industry professionals want 179D to be extended, including me, but it needs to be extended for five or 10 years to be effective. That way, designers could plan around this tax benefit.