Building owners and operators have been incentivized to include energy-saving designs in their buildings for decades, and now design and construction firms can receive extra financial benefits for their part in a project through Section 179D.
Before claiming the deduction, however, architecture and engineering (A&E) firms should note some key rules and regulations.
Section 179D Tax Deduction for Architects & Engineers: The Basics
Originally, the Energy Policy Act of 2005 created the Section 179D Energy Efficient Commercial Building Deduction (Section 179D) tax incentive (Notice 2008-40). Then, on December 28, 2020, the Section 179D tax deduction was made a permanent part of the U.S. tax code in the Consolidated Appropriations Act of 2021. Section 179D was again changed by the Inflation Reduction Act (IRA) of 2022.
Currently, this deduction provides tax benefits for qualifying commercial building owners and designers — architecture, engineering and construction companies — on certain designed projects for government and other tax-exempt buildings achieving energy-efficiency targets after construction is complete.
How Much Is the Section 179D Tax Credit Worth to A&E Firms?
Through claiming a Section 179D deduction, companies can receive more than $5.00 per square foot when making energy efficient improvements to commercial buildings placed in service in 2023 and after. The building must reduce energy consumption by 25% or more as compared to an American Society of Heating, Refrigerating and Air-Conditioning Engineers (ASHRAE) 90.1-2007 reference building.
Section 179D Requirements for Architects, Engineers and Contractors
The Section 179D deduction can be allocated to engineering, architecture and construction entities that are responsible for the design components of government-owned and other tax exempt, energy-efficient buildings.
Because the owners of these public buildings are nontaxable entities, the deduction is then passed on to the primary designers of the buildings — in this case, engineering, architecture, construction entities and energy service providers that qualify as designers. The purpose of the deduction is to incentivize designers of commercial buildings to utilize energy efficient systems and components within the construction projects.
Designer Qualifications
An entity is considered responsible for the building’s design components if it creates the technical specifications for a building. Any entity that merely installs, repairs or maintains a property does not meet the definition of a designer for the purposes of this deduction.
That means architecture and engineering firms must have primary responsibility for the design of energy efficient properties and technical specifications in order to qualify for the Section 179D deduction. Qualifying improvements can be made to any of the following categories:
- Building Envelope
- Heating, Ventilation, and Air Conditioning (HVAC) System
- Lighting System
- Fully Replaced Domestic Hot Water Heaters
In some instances, the construction contractor may qualify for the Section 179D deduction if they have input in the design or are obligated to participate in the design based on their contract terms. For example, contractors engaged on a design-build contract with a government entity are more likely to qualify for the Section 179D deduction than if they are only operating as a general contractor.
Building Eligibility
The Inflation Reduction Act extended the coverage of Section 179D, making buildings owned by tax-exempt organizations applicable for this tax incentive. Eligible not-for-profit buildings include:
- Schools and Other Higher Education Buildings
- Airports
- Libraries
- Courthouses
- Religious Institutions
- Tribal or Native American Owned Buildings
Claiming the Section 179D Deduction
The Section 179D deduction is claimed using Form 7205. However, a Section 179D study must be completed first to ensure eligibility and to help calculate the full amount of the tax credit.
Complete a Study
To claim this tax incentive, the applicant must complete a Section 179D study, in which a qualified third party — separate from the designer taking the Section 179D deduction — uses IRS-approved energy software to model the energy performance of the building and improvements.
The energy model then compares the building’s performance with a reference building that meets relevant energy and power cost requirements, according to standards set by the American Society of Heating, Refrigerating, and Air-Conditioning Engineers. The third-party also completes a physical site visit of the facility.
The qualified third party must be a contractor or professional engineer (PE) licensed in the state where the building is located. They must also sign a certification document for the Section 179D deduction stating they have examined the energy model and support the allocation of the deduction to its respective designer.
Apply for the Deduction
A company claims the Section 179D deduction in the same tax year as when the building is placed in service. If the entity meets the requirements of the Section 179D study, it can report the deduction on its current-year tax return.
If the deduction was not applied on a timely-filed tax return, there are avenues to claim the deduction retroactively. Designers can look back three open tax years to claim the deduction on amended tax returns. Building owners can reach back to apply Section 179D results as far back as the 2006 tax year through an accounting method change.
Will Claiming Section 179D Deductions Trigger an IRS Audit?
Claiming the deduction as a designer of tax-exempt buildings will not automatically trigger an audit from the IRS, but it is important to follow the appropriate steps to determine qualification for the deduction. The IRS Large Business and International division (LB&I) has included Section 179D in its list of so-called practice units, which provides a framework for designers that might be eligible to take the deduction.
On May 26, 2022, the Section 179D IRS Practice Unit released a knowledge-based document or the ATG that outlines the steps the IRS would take when auditing Section 179D studies, so it is important for designers to carefully review those guidelines. Please refer to our podcast to learn more.
Section 179D Deduction Benefits for A&E Firms
While this incentive might require additional steps, such as completing a study and securing the certification document, a growing number of leading A&E firms are taking advantage of the deduction to reduce their tax burden and promote sustainability. Here are some of the benefits of Section 179D for A&E firms:
- Increased Revenue: Section 179D can increase revenue for A&E firms by making them more competitive in the marketplace. By designing energy-efficient buildings that qualify for the incentive, A&E firms can attract more clients and win more business, leading to increased revenue and profitability.
- Cost Savings for Clients: Designing energy-efficient buildings can also provide cost savings for clients. Energy-efficient buildings require less energy to operate, which can result in lower utility bills and operational costs. This can make these buildings more attractive to clients and can lead to increased demand for A&E firms that specialize in energy-efficient design.
- Increased Competitiveness: Taking advantage of the Section 179D tax incentive can help A&E firms differentiate themselves from other firms and attract more clients. Additionally, designing energy-efficient buildings can help A&E firms stay ahead of regulatory requirements and market trends.
- Tax Savings: The Section 179D tax incentive provides A&E firms with significant tax savings. The incentive allows firms to deduct $5.00+ per square foot of energy-efficient commercial building property.
- Improved Environmental Impact: Designing energy-efficient buildings can also positively impact the environment. Energy-efficient buildings emit fewer greenhouse gases, use less energy and can reduce the built environment’s carbon footprint. By designing energy-efficient buildings, A&E firms can contribute to a more sustainable future.
By taking advantage of this incentive, A&E firms can position themselves for long-term success in a rapidly changing business landscape.
Your Guide Forward
The Section 179D deduction can provide a significant cash-flow opportunity for architecture, engineering and construction entities. Companies pursuing the 179D deduction should consult with Cherry Bekaert’s Tax Credits and Incentives advisory practice to ensure they are maximizing the energy efficient deduction.
The Professional Services Industry team is also comprised of accounting and tax advisors and business strategists, technologists and analysts who have extensive A&E firm industry experience and keen business acumen. Reach out to our team of advisors to learn more about their innovative ideas, industry trends, regulatory compliance and best practices for A&E firms.
