The Inflation Reduction Act Targets Energy Efficiency Improvements
The Inflation Reduction Act (IRA) was signed into law on August 16, 2022. The provisions included in this law address a wide range of financial efforts targeted at reducing the deficit while providing some tax reductions and incentives.
Contractors and building designers for both individuals and businesses can benefit from the additional energy efficiency incentives found in the IRA. While the new law primarily helps businesses adopt more eco-friendly measures and jump-start clean energy production, there are incentives for ordinary Americans to go green and save some green, too. For example, homeowners can cut their tax bill even more if they install new energy-efficient windows, doors, water heaters, furnaces, air conditioners, and the like. That’s because the legislation extends and enhances two tax credits that reward ‘green’ upgrades to your home.
When 2021 came to an end, so did the Nonbusiness Energy Property Credit which many homeowners are familiar with. But, with the passing of the Inflation Reduction Act, it has been revived, improved, and is now known as the Energy-Efficient Home Improvement Credit. Under the Nonbusiness Energy Property Credit, you could only attain a 10% credit on the installation of certain energy-efficient installations and improvements to your home, such as your windows and doors. And the lifetime limit was up to $500 for the credit and a $200 lifetime limit for new windows which was quite restricting.
Per the Inflation Reduction Act, beginning in 2023, the credit will now be equivalent to 30% of the costs for qualifying home improvements made throughout the year. The $500 lifetime limit has also been increased to a $1,200 annual limit on the credit amount.
Keep in mind that some of the energy-efficient standards have been updated and the annual limits for qualifying improvements have also been modified for 2023 including $250 for an exterior door and $600 for exterior windows, skylights, $2,000 for electric or natural gas heat pump water heaters, electric or natural gas heat pumps, and biomass stoves and boilers (for this one category, the $1,200 annual limit may be exceeded, $150 for home energy audits, and more.
For Business Properties: The Energy-Efficient Building Deduction
Section 179D provides a deduction for certain energy-efficient buildings. Specifically, prior to enactment of the IRA, this provision allowed a deduction based on the square footage of certain buildings that meet energy efficiency requirements. The deduction could be up to $1.80 per square foot if the building meets the highest energy efficiency standards.
Partial deductions might have also been available if the building had efficiencies in some areas but not others. Each system provides an additional deduction per square foot of space. These systems included:
- Heating, Cooling, and Ventilation (HVAC)
- Hot water systems
- Building envelope construction
- Interior lighting systems
Both building owners and designers can benefit from these deductions. Even government contractors might be able to deduct some of these costs (because the government does not need a deduction).
If the entity owns the building, the deduction must be used in conjunction with a reduction in the basis of the building property equal to the amount of the deduction.
Changes in the Section 179D Deduction from the IRA
The Section 179D deduction became a permanent part of the Internal Revenue Code in 2021, when the Consolidated Appropriation Act, 2021 was passed. However, the IRA added some new features and limitations that commercial businesses should be aware of.
First, the “most recent” standards must be used, which is still ASHRAE 90.1-2007, at least until new standards are developed. Second, the IRA did away with partial deductions for some systems. Instead, the energy efficiency improvements must increase efficiencies relative to a reference standard by 25% (down from the prior 50% requirement).
The amount of the deduction has also changed. The deduction is set at $0.50 per square foot, but it can increase by $0.02 for each percentage point reduction in energy usage. The maximum is $1.00/foot, which is a significant reduction from $1.80 per square foot. However, if the project also meets certain apprenticeship requirements (to encourage job creation), then the base amount increases to $2.50/square foot, with a $0.10 increase per each percentage point. The maximum, under those circumstances, is $5.00/square foot.
The deduction has also been expanded to apply to designers of tax-exempt entities in addition to government entities.
For Residential Properties: The Energy-Efficient Home Credit
Section 45L provided an energy-efficient home credit for individuals that permitted a $2,000 tax credit for certain “eligible contractors” and those who constructed, reconstructed or rehabilitated the energy-efficient home. It also provided the same credit for “producers” of an energy-efficient manufactured home. The home must have also been acquired by someone who used the property as a home in the same tax year that the credit is taken.
It is important to note that although this credit targets individual homes, it is actually the contractor who takes the credit. The credit ended on December 31, 2021. However, the IRA reinstated the program with new requirements. For now, it extends the credit through December 2022.
Before the IRA, the home was required to be 50% more efficient than standard dwelling units, as defined by the 2006 International Energy Conservation Code standards. There was no partial credit if the 50% standard was not met.
Changes to Section 45L from the IRA
The credit itself has been extended (at $2,000 per unit) through December 2022. After 2023, the credit will increase to $2,500 per unit, but it will decrease by $500 for multiple-family homes. Instead of the prior standard, the IRA requires that the homes follow standards set out by the Energy Star New Construction program or the Energy Star Manufactured Homes program—these are both stricter standards compared to the standards used before the IRA.
The IRA also created a higher value credit ($5,000) for homes that meet the Zero Energy Ready home standards that are set out by the Department of Energy (as in effect on January 1, 2023). Multiple-family homes that meet these standards will also get an increased credit of $1,000.
Finally, if the contractor confirms that employees of the contractors and subcontractors are paid prevailing wages, then the credit for a multifamily dwelling increases to $2,500 (or $5,000 for Zero Energy Ready homes).
Get Help with New Energy Credits
Talk to a tax professional if you need more information about the new energy credits. Ensuring you meet these qualifications now will help you take full advantage of these deductions and credits at tax time.
If you have any questions or would like additional information, please contact DMJPS.
