New Opportunities in the Inflation Reduction Act

In late August, President Biden signed the Inflation Reduction Act into law. As the name suggests, the legislation is designed to help counter the ill effects of inflation while creating new jobs, lowering healthcare costs, revitalizing manufacturing, and promoting clean energy investment. Key priorities in the legislation include the reduction of carbon emissions and the investment in domestic clean energy manufacturing. To facilitate the changes, several tax updates have been introduced including a 15% corporate minimum tax, a 1% stock buyback fee, and bolstered IRS tax enforcement efforts. There are also new and expanded tax incentives to promote clean energy investments. These incentives create a unique opportunity for real estate and construction companies to obtain significant tax savings. To help clients, prospects, and others, Klatzkin has provided a summary of the key incentives below.

Benefits of Renewable Energy in Real Estate

Energy efficiency and sustainability have been hot topics for years. Factors driving the movement include an increased sense of corporate social responsibility, investor and tenant demands, and changes to building codes. Going green has advantages for real estate investors, owners, and customers in terms of higher value and cost savings. Green-certified buildings can attract higher demand and rent premiums.

One recent JLL survey noted that most real estate investors associate green certification with higher occupancy, rents, tenant retention, and overall value. It can also be easier and less expensive to secure financing, producing enhanced returns on investment.

Budgeting for energy costs becomes more stable when long-term energy contracts and/or renewable energy rates remain predictably more constant for several years. Utility costs are among the most volatile of building expenses. With the right mix of renewable energy power sources, they don’t have to be.

A powerful example of this is the potential for significant cost savings over a several-year period simply by making a widespread investment in LED lighting systems.

Another place where investors and building owners look for energy efficiency and cost savings is the installation of solar systems. Buildings can be equipped solar-ready, complete with reinforced roofing, space for equipment, and conduits should the installations be on rooftops. Off-site green power is another energy-saving measure that can be obtained through power purchase agreements. This can be a viable option for owners, tenants, and investors by entering into contracts with wind farms.

Typically, projects like these are capital-intensive and thus off limits for all but the largest real estate investors and owners. Large renewable energy projects can also be risky. The goals and objectives appear to offer savings opportunities on face. However, implementing and transitioning energy thought and policy on such a large scale also includes abiding by ever-changing regulations, changing overall consumer behavior, the economy, and various other external factors. Most real estate investors will take a more balanced approach to risk, and that might deter or slow the movement toward large renewable energy investments.

The hope is that tax incentives to install solar and other renewable energy systems will make projects like these less risky and ever more accessible to the industry.

Deduction for Energy Efficient Building Design

The Inflation Reduction Act contains a mix of extended and expanded pre-existing tax incentives as well as new tax credits designed to spur investment in and production of clean power.

One of the more notable tax provisions is the revamped Internal Revenue Code Section 179 deduction for energy-efficient building systems. This applies to buildings with four or more stories placed in service in 2023 and after. To qualify for at least a partial deduction, the project must attain at least a 25 percent energy efficiency rating compared to applicable American Society of Heating, Refrigeration and Air-Conditioning Engineers (ASHRAE) standards. The partial and full deduction is worth $0.50 and $1.00 per square foot, respectively.

This is considerably lower than the current deduction of $1.80 per square foot. However, there are opportunities for substantial Internal Revenue Code Section 168 bonus depreciation deductions as well. Projects that meet prevailing wage and apprenticeship requirements can qualify for up to $2.50 or $5.00 per square foot.

Also new in the Inflation Reduction Act is a partial Section 179 deduction for energy-efficient upgrades to building retrofits. At a minimum, the project must meet 25 percent energy efficiency compared to the building’s baseline energy usage. The retrofit deduction is $0.50 to $1.00 per square foot, and bonus amounts are available for projects meeting prevailing wage requirements just like the deduction for new construction.

There is good news for investors in real estate investment trusts (REITs). REITs can now qualify for the Section 179 deduction as well.

A similar but unrelated provision called the Home Owner Managing Energy Savings (HOMES) rebate could help owners of multi-family properties who retrofit their buildings for energy efficiency.

The rebates are worth $2,000 or $4,000 per unit if the retrofit achieves at least 20 percent or 35 percent energy savings compared to previous energy usage. Buildings in low- to moderate-income areas can qualify for higher rebates of $4,000 or $8,000 per unit, respectively.

Both single- and multi-family property owners can also qualify for other rebates related to upgrades of inefficient and non-electric water heaters, HVAC systems, appliances, dryers, electric panels, and more.

Internal Revenue Code Section 45L Energy Efficient Home Credit

Homebuilders and multi-family property developers can benefit from an extension of the Code Section 45L tax credit, which provides a credit for selling or leasing energy-efficient homes. It expired at the end of 2021. This credit applies to single-family homes, manufactured homes, and multi-family units. For properties placed in service or acquired between 2023 and 2032, the base credits are as follows:

• Single-family homes: $2,500 (Energy Star requirements), $5,000 (Zero Energy Ready)
• Manufactured homes: $2,500 (Energy Star requirements), $5,000 (Zero Energy Ready)
• Multi-family: $500 per unit (Energy Star requirements), $1,000 per unit (Zero Energy Ready)
• Multi-family with prevailing wage: $2,500 per unit (Energy Star requirements), $5,000 per unit (Zero Energy Ready)

Affordable Housing

There are also opportunities for real estate investors and owners of affordable housing. To qualify, projects must address one or more of the following:

• Energy efficiency or storage
• Water efficiency
• Indoor air quality or sustainability
• Building electrification
• Climate resilience

Thinking Ahead

The Inflation Reduction Act has the power to bring renewable energy to the forefront and push innovations into the real estate sector, both from embodied carbon in building materials and operational carbon in building maintenance. Various tax incentives like Section 179D, production and investment tax credits, can and should help the real estate industry adapt to changing demands and pivot to a more sustainable future.

Contact Us

There are saving opportunities abound for eligible real estate and construction companies. It is essential to carefully review the tax changes to determine how your company can benefit. If you have questions about the information outlined above or need assistance with a tax or accounting issue, Klatzkin can help. For additional information call 609-890-9189 or click here to contact us. We look forward to speaking with you soon.