Case Study 2 OF 8 Qualifying as a designer of energy-efficient commercial building properties
Developers and owners of commercial buildings have been qualifying for IRC §179D, a section of the IRS code that provides a deduction for integrating energy efficiencies in buildings, either through new construction or retrofits. Recent changes to §179D are included in 2022’s Inflation Reduction Act, including a significant increase in the maximum deduction amount.
This deduction applies explicitly to those commercial buildings that notably reduce their interior lighting energy costs, as well as heating, cooling, and building envelope. The tax provision also provides a partial deduction for those systems that partially qualify.
A special provision of §179D allows government building owners to allocate this deduction to their building designers if the required energy requirements are met. However, this is an area to tread carefully, as the IRS is fully aware that this allocation, in some cases, has been incorrectly claimed.
“The IRS now has $45 billion for tax law enforcement and taking the §179D deduction without actually qualifying for it is really low-hanging fruit for auditors,” says David Diaz, a partner at Walker Reid Strategies. “We know that contractors that work in the government sector, in particular, are getting audited for this.”
Fortunately, the IRS has released several factual case studies that help clarify this issue. In particular, IRS Memorandum AM 2018-005 addresses two specific questions using these case studies: whether the taxpayer indeed does qualify as a designer of energy-efficient commercial building properties, and if the maximum deduction can be taken if the designer has only designed one system in an energy-efficient building. Walker Reid is releasing a series of blog posts to further explain these case studies. This is the second in the series.
The second IRS case study involves an architect that was contracted to design the exterior building shell for a government building contractor. Numerous contracts comprised this design project, which was coordinated by a Construction Manager, but the architect’s responsibility was limited to this sole task, with no involvement in the design of any other building systems that made up the qualification for §179D. The building qualified for the maximum $1.80/ sq. ft. deduction, which was allocated upon request to the architect. Though other building system designers also requested an allocation, the government building owner declined to allocate the deduction to them, and the entire deduction was given to the architect whose sole responsibility was the exterior shell design.
In this situation, the IRS agreed that the government building owner has the right to allocate the entire deduction to the designer of the exterior building shell, even though the designers of other systems also qualified and could request an allocation of the deduction amount. Government building owners do have the discretion to allocate the deduction amount to qualified designers on a project, though any allocation cannot exceed the total qualifying amount. As the maximum was allocated to the architect as the designer, any additional allocation would exceed this amount and would not be allowed.
The key takeaway is that the architect did design one of the building systems, which qualified as Energy Efficient Commercial Building Property (EECBP). Therefore, the architect did qualify as a “Designer” for §179D purposes. If the building owner was not a government entity and instead was a private building owner/taxpayer, that taxpayer would have been able to claim the entire §179D on the building in question. For this reason, once allocated to the “Designer,” that designer may claim the entire §179D tax deduction allocated to them even when they only designed one of the §179D qualifying subsystems.
David Diaz is a partner at Walker Reid Strategies, a licensed professional engineering firm specializing in performing §179D studies and §45L certifications. Mr. Diaz is an expert in energy efficiency and specialty tax services who shares his insights at www.walkerreid.com and online through webinars. For more information, contact him at firstname.lastname@example.org.