Green Tax Breaks for Designers of Government-owned Facilities

Added to the Internal Revenue Code as part of the Energy Policy Act of 2005 (Public Law 109-58), Section 179D(2)  provides owners of energy efficient buildings federal income tax deductions of up to $1.80 per square foot for energy efficient improvements made to commercial buildings placed in service between December 31, 2005 and January 1, 2014.(3)   

As major real estate holders in the United States, federal, state and local governments ("government-owners") have a significant impact on how facilities are designed, constructed and operated.  Recognizing a federal income tax deduction provides no benefit to non-taxable government-owners, Congress provided a special rule under Section 179D(d)(4).  With respect to qualifying property, a government-owner may allocate the tax deduction to the person(s) primarily responsible for designing the property ("designer")(e.g., an architect, engineer, contractor, environmental consultant or energy services provider).(4)  

To the extent the designer could utilize the allocated tax deduction by reducing its taxable income on its federal and state income tax returns, the designer’s income tax liability will correspondingly decrease.(5)  
Accordingly, a designer may be willing to negotiate with the government-owner to receive an allocation of the Section 179D deduction. 

While many designers may be aware of the provision and may have even approached contracting officers on a one-off basis, government-owners understandably may have a level of discomfort with implementing this provision due to the complexities of the tax code.  For example, in order to allocate the deduction, the government-owner and the design firm must sign the following statement:

"Under penalties of perjury, I declare that I have examined this allocation, including accompanying documents, and to the best of my knowledge and belief, the facts presented in support of this allocation are true, correct, and complete."(6)

Accordingly, a consulting firm with tax and energy specialists may assist the government-owner with the technical components of the statute, the potential value from the provision, and provide a level of support regarding the government-owner’s diligence and documentation to sign off on the allocations authorizing the deductions. 

Qualifying energy efficient improvements

Many government-owners require newly constructed or renovated buildings to meet minimum energy efficient standards.  For example, all new General Services Administration buildings and those undergoing substantial renovations must achieve the Leadership in Energy and Environmental Design (LEED) Gold certification.   Similarly, the city of Scottsdale, Arizona requires new commercial publicly funded buildings and renovations to achieve a LEED Gold certification.

While achieving a LEED certification is an indicator that the building may qualify for the deduction, it is not required nor does it guarantee the project will qualify under Section 179D. In order for the building to be eligible for the deduction, the building must meet certain energy reduction requirements (see Table 1) and be certified by a third party licensed engineer or contractor.

Table 1 Permanent rule energy reduction requirements:

Generally, a Section 179D deduction may be claimed for all or part of energy efficient property costs under either the "Permanent Rule" or the "Interim Lighting Rule," discussed below.

The Permanent Rule deduction appears available for newly constructed properties or renovations made with energy efficiency in mind. To qualify for the full $1.80 per square foot deduction available under the Permanent Rule, a taxpayer must demonstrably reduce building annual energy costs by 50 percent or more when compared to the baseline standard established by American Society of Heating, Refrigerating and Air-Conditioning Engineers (ASHRAE) Standard 90.1-2001. Partial deductions of $0.60 per square foot may be available for improvements made to one or more building subsystems including:  (1) HVAC/hot water heating, (2) interior lighting, and (3) the building envelope.  In order to calculate the energy deduction under the Permanent Rule, qualified software must be used.  A current list of the approved software may be found at http://www1.eere.energy.gov/buildings/qualified_software.html.

If the energy efficient improvements to a building are limited to the lighting systems, then the Interim Lighting Rule should be considered. The Interim Lighting Rule provides taxpayers with a simple method for determining a partial deduction for building lighting systems.  This method does not involve using qualified software which can be more involved under the Permanent Rule. The deduction under the Interim Lighting Rule is available on a sliding scale based on an energy reduction from 25 percent to 40 percent, with a maximum deduction of $0.60 per square foot.

Given these the technical requirements, the government-owner may need to evaluate a minimum building size and number of projects in order for Section 179D to be cost effective for all stakeholders. Table 2 illustrates the potential value of the deduction to eligible designers based on various assumptions:

Table 2 Comparison of values for Interim Rule and Permanent Rule deductions:

Concluding remarks

Section 179D provides a unique opportunity that may allow a government-owner to encourage designers to incorporate significant energy efficient enhancements. There is considerable flexibility regarding the criteria used to award an allocation.  A starting point may be to evaluate the potentially allocable deductions related to prior and future projects to understand the potential value of the deduction from the perspective of the designer.

*Footnotes