May 12, 2023

The Inflation Reduction Act Sparks Green Revolution in Real Estate Development with Billions in Tax Breaks

By Kelly Yim, Director, Tax & Business Services

The Inflation Reduction Act Sparks Green Revolution in Real Estate Development with Billions in Tax Breaks Tax Credits & Incentives

It may be said that when President Biden signed the Inflation Reduction Act of 2022 (“IRA”) into law on August 16, 2022, a new “Green” era began. The IRA is the most comprehensive and ambitious attempt to combat climate change in US history, with over $360 billion in climate provisions dedicated to accelerating the country’s transition to clean energy, reducing greenhouse gas emissions by half in 2030, and reaching net zero by 2050. Among the many incentives and initiatives in the IRA, three key provisions stand out for their potential impact on real estate development and investment: the Energy Efficient Tax Credit, the Energy Efficient Commercial Building Deduction, and the solar and renewable energy credits. These measures offer billions of dollars in tax breaks and deductions, making it easier and more financially attractive for developers and investors to pursue environmentally sustainable projects.

§45L Energy Efficient Tax Credit

About 40% of total carbon emissions are estimated to come from real estate construction and home operations. So, Congress recognized that a fundamental key to combating the climate crisis might have to start there. You are in luck if you are a home builder or a homeowner. The §45L tax credit of $2,000 that expired on December 31, 2021, was once again revived by the IRA. The §45L tax credit is a federal tax credit offered to builders, developers, and homeowners to develop new residential units that meet energy-efficient building standards or remodel existing residential units to meet energy-efficient building standards. The new law retroactively extends the §45L tax credit for ten more years through December 31, 2032. This means you may again be eligible for the §45L tax credit on energy-efficient homes meeting specific standards.

In addition to extending the credit, the IRA increases the maximum credit from $2,000 to $5,000. Starting January 1, 2023, units sold or leased that are Certified Star Energy or Zero Energy Ready Homes Certification and meet the specified prevailing wage and apprenticeship requirements will qualify for the $5,000 credit.

The credit applies to new single-family, multifamily, and manufactured homes, and existing homes that undergo a deep retrofit. Starting January 1, 2023, mid-rise and high-rise projects are eligible for §45L tax credit; 3 stories or less above grade is no longer a requirement. In other words, the credit is now open to any size development.

§179D Energy Efficient Commercial Building Deduction

The IRA also extends and expands incentives for commercial building owners. The §179D Energy Efficient Commercial Building deduction (“§179D deduction”) is designed to encourage commercial building owners to reduce the energy consumption of their commercial and residential rental buildings that are four stories or higher. Commercial building owners may claim a federal tax deduction for installing energy-efficient equipment in new or existing buildings. Multifamily projects that are four or more stories tall will be eligible for both §45L tax credit and §179D tax deductions.

Prior to the passage of the IRA, you could claim up to $1.88 per square foot for certain energy-saving commercial building properties that are part of the interior lighting system, the heating, cooling, ventilation, or hot water systems, or the building envelope. The §179D deduction will operate in its current form through the end of 2022. Starting January 1, 2023, the following changes apply:

§ 179D
Old Law New Law (IRA)
Maximum deduction $1.88/Square Feet $5.00/Square Feet
Energy-efficient commercial building A reduction in annual energy & power costs by at least 50% A reduction in annual energy & power costs by at least 25%
Partial allowance $0.63/Square Feet Eliminated
Interim lighting rules Reduced lighting power density by at least 25% percent (50 percent in the case of a warehouse) Eliminated
Deduction reset Once over the life of the building The deduction is reset every 3 years on a commercial building and every 4 years on a government instrumentality, not-for-profit or tribal government building
Alternative deduction for qualified retrofit property N/A A maximum deduction similar to the § 179D deduction. Reduce energy usage intensity by at least 25%

These changes are quite attractive because the IRA reduces the energy efficiency standard from 50% to 25% while increasing the deduction amount from $1.88 per square foot to $5 per square foot.

Alternative deduction for energy-efficient retrofit property

Effective January 1, 2023, taxpayers may elect to take an alternate deduction under §179D(f) for installing energy-efficient equipment in a building that has been altered, improved, modified, remodeled, or renovated under a qualified retrofit plan. A plan is a qualified retrofit plan if it reduces the building’s energy use intensity by at least 25%. The qualified professional preparing the plan must certify that the equipment installed is an energy-efficient retrofit building property, the building’s energy usage intensity, and the building’s energy usage intensity a year after the completion of the plan. The building subject to the retrofit must be located in the United States and placed in service at least five years before the creation of the qualified retrofit plan.

§48 Business Energy Tax Credit (“Energy Tax Credit”)

If you are not eligible for the §179D deduction because your building is less than four stories high or your building doesn’t meet the requirements for the alternative deduction for energy efficient retrofit property, you may want to consider another option, such as the §48 energy tax credit. Like §179D deductions, the credit is available to both residential and commercial building owners.

Businesses may claim a federal tax credit for investment in the following energy properties:

  1. Solar property
  2. Geothermal property
  3. Qualified fuel cell property
  4. Microturbine power plants
  5. Combined heat and power system property
  6. Qualified small wind energy property
  7. Waste energy recovery property
  8. Energy storage technology placed in service after 2022
  9. Qualified biogas property placed in service after 2022
  10. Microgrid controllers placed in service after 2022
  11. Interconnection property placed in service after 2022

The credit is generally equal to a percentage of the taxpayer’s basis in the qualified energy property. For properties placed in service after 2021 (or after 2022 as indicated above), the base percentage is 2% for qualified microturbine power plants; and 6% for all other types of qualified energy properties.

Taxpayers who had begun construction projects before January 29, 2023, could multiply the credit by five. For example, a 6% credit would automatically be increased to 30% if the construction had begun before January 29, 2023. Taxpayers who haven’t begun construction before January 29, 2023, could multiply the credit by five if they satisfy the one megawatt or prevailing wage and apprenticeship requirements.

Too good to be true? Wait, there is more. In certain situations, you can increase the credit to 70% using bonus credits. These stackable bonuses are the 10% domestic content bonus, 10% “Energy Community” bonus, and 10% bonus for low-income communities, or 20% bonus for affordable housing and low-income economic benefit projects.

If you are not able to use all these credits, no worries. The IRA allows you to make an election to transfer all or a portion of the energy tax credits to an unrelated taxpayer as long as the amount paid as consideration is:

  1. In cash
  2. Excluded from the transferor’s gross income
  3. Not deductible by the transferee for federal tax purposes

New § 48E tax credit – Clean Electricity Investment Tax Credit

Projects that commence construction on or after January 1, 2025, are not eligible for the energy tax credit but may be eligible for a new tax credit, the Clean Electricity Investment Tax Credit (§ 48E). The credit amount is generally calculated like an energy tax credit and will be phased out as the U.S. meets greenhouse gas emission reduction targets. When greenhouse gas emissions in the US are equal to or less than 25% of the 2022 level, construction projects beginning in the year following this achievement can apply the full amount of the credit. However, for projects started in the second year following the target being met, the tax credit will be worth 75% of what it would otherwise be. Projects commenced in the third year will receive a credit worth 50%, and all projects commenced after then will not be eligible for a tax credit.

Given these significant tax benefits, there are plenty of reasons to go GREEN. Are you ready?