By Mark E. Battersby
Looking for a way to make your company—and your bottom line—“greener”? Uncle Sam wants to reward mattress manufacturers and sleep products companies that improve the energy efficiency of the buildings that house their operations.
In fact, all so-called “commercial buildings” may qualify for these tax deductions. Even those that only partially improve energy efficiency may qualify, albeit receiving a smaller deduction. Recently revised guidelines from the U.S. Internal Revenue Service make the process easier than ever.
Commercial property is generally defined as property intended for use by retail, wholesale, office, hotel or service users, or for manufacturing or other industrial purposes.
It’s no secret that U.S. tax laws have long treated commercial property less favorably than residential property. Today, however, tax breaks create significant incentives for making commercial buildings more energy efficient—and reward many commercial building owners and tenants.
U.S. tax laws allow a deduction for a portion of the costs of installing energy-efficient systems in a depreciable commercial property as part of a certified plan to reduce the total annual energy and power costs to a building that meets specified minimum standards. Under the Energy Efficient Commercial Building Deduction, a company can claim tax deductions for new or renovated buildings that save 50% or more of projected annual energy costs for heating and cooling systems compared with model national standards. The maximum deduction is generally $1.80 per square foot, less the total amount of any deductions claimed in earlier years.
Partial deductions of $0.60 per square foot are available for efficiency improvements to lighting, heating and cooling systems, or the building’s envelope—the area that separates conditioned space from outdoors, such as walls, roofs and foundations.
The deadline for filing deductions is Dec. 31, 2013.
The person or company that makes the expenditure for construction is generally the recipient of the allowed tax deductions. This is usually the building’s owner, but for some HVAC or lighting-efficiency projects, it could be the tenant. For government-owned buildings, the deduction can be taken by the designer of the building or system.
Tax-break mechanics
Before any company can claim the EECBD for energy-efficient systems installed in a commercial building, it must obtain certification. A licensed contractor or engineer must verify that the building or portion of the building that’s being submitted is better than the American Society of Heating, Refrigeration and Air Conditioning Engineers’ Standard 90.1-2001.
According to EECBD standards, percentage reductions are determined by comparing energy use to a “reference building,” which is a building located in the same climate zone as the company’s building and is otherwise comparable to it except that its interior lighting systems, HVAC, hot water systems and building envelope meet the minimum requirements of the ASHRAE 90.1-2001 standards. Remember, the improvement must save at least 50% of the HVAC, water heating and interior lighting energy costs.
The U.S. Department of Energy maintains a list of the software that must be used to calculate power consumption and energy costs for purposes of certifying the required energy savings necessary to claim the deduction. Only buildings covered by the scope of the ASHRAE Standard 90.1-2001 are eligible. And professional assistance is almost mandatory.
Amending the rules
The IRS originally provided guidelines for achieving a partial deduction for interior lighting systems, HVAC and hot water systems, and the building envelope. Under an amended “permanent rule,” property that would be energy-efficient commercial property except for a failure to achieve the targeted 50% reduction in energy and power costs is considered a partially qualified commercial building property if it is installed as part of a system that satisfies the applicable energy-savings percentage.
In other words, if a building doesn’t meet the whole building requirement of a 50% energy savings, it still qualifies for a partial deduction for each separate building system. Thus, deductions of $0.60 per square foot are available to owners of buildings in which individual lighting, building envelope, or heating and cooling systems meet target levels that would reasonably contribute to an overall building savings of 50%, if additional systems were installed.
The methods for calculating energy efficiency usually take into account the extent that the current systems exceed “typical” performance. The intent of the rules is for any calculation to be fuel neutral: The same energy efficiency features will qualify a building for the deduction, regardless of whether the heating source is a gas or oil furnace, boiler, or an electric heat pump.
The newly revised energy savings percentages required by the IRS are now 15% for HVAC and hot water systems; 25% for interior lighting systems; and 10% for the building’s envelope.
Owners versus tenants
Would a mattress manufacturer that is a tenant in a commercial building and performs a retrofit meeting the energy-savings requirements qualify for the deduction? Can a tenant in a leased space take advantage of the deduction, or is the deduction for privately owned buildings restricted to the owner?
Unfortunately, as in many matters of tax law, the answer is not necessarily clear. The company that is entitled to the energy-efficient commercial buildings deduction is the one who “owns” the property for tax purposes. Although in many, if not most instances, a tenant improvement will revert to the landlord at the end of a lease, the property is not necessarily owned by the landlord for tax purposes.
But the determination of the deduction depends on the arrangement between the parties. If the tenant pays for the improvement, constructs it according to its own specifications and there are no concessions in the lease or from the landlord, it is likely that the tenant will be the “owner” of the improvements for tax purposes and eligible to claim the deduction.
Fortunately, this is a question that arose under the tax law before the enactment of the energy-efficient commercial buildings deduction. In the case of tenant improvements, the tenant and landlord would have to determine the tax “owner” for purposes of claiming depreciation deductions. The energy-efficient commercial buildings deduction doesn’t change that determination. The energy-efficient commercial buildings deduction simply provides a more beneficial deduction than is normally provided by depreciation.
A company that owns—or is a tenant in—a commercial building in which energy efficient property or systems qualifies for a partial deduction for each system that meets the IRS requirements. Because the deduction for each system, however, is limited to $0.60 per square foot, the sum of all partial Section 179D EECBD deductions claimed can’t exceed the amount allowed for the full $1.80 per square foot of the entire building claimed in prior years.
Ever-increasing energy costs and an interest in “going green” are forcing more and more companies to think about the environment when planning renovations or constructing new facilities. With lawmakers pondering the big picture and future legislation centering on funding energy efficiency, it’s important to remember that current tax laws already help companies reduce the out-of-pocket, upfront expenditures that are essential to long-term energy savings.
