Energy Policy Act
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You might want to retrofit your existing building with energy efficient lighting, HVAC or upgrades to the building envelope in order to save money on energy costs, but youve first got to come up with the funding for those improvements. Do you provide the required capital or continue to face increased operating costs? The ROI on new, energy-efficient systems may be longer, but the equipment will perform more reliably while providing better working conditions and lowering energy costs along the way. Most business owners will assume that funding for energy efficient upgrades has to come from dipping into their equity in the facility, or from an outside funding source such as a bank loan.
Fortunately, there are alternative strategies that can be put into place to pay for energy efficiency projects by significantly lowering your tax burden. A cost segregation analysis identifies and reclassifies personal property assets to shorten the depreciation time for taxation purposes, which reduces current income tax obligations. Personal property assets include a buildings non-structural elements, exterior land improvements and indirect construction costs. Depreciation expense is accelerated and tax payments are decreased when an assets life is shortened, which frees up cash for investment in energy efficiency projects.
The benefits of a cost segregation study are retroactive, including buildings that have been purchased, constructed, expanded or remodeled since 1987. This allows taxpayers to recapture previously unrecognized depreciation, which increases cash flow in the current year.
Another tax benefit that can be applied to energy efficient construction or improvements is found in section 179D of the Energy Policy Act of 2005. 179D includes full and partial tax deductions for investments in energy efficient commercial buildings that are designed to increase the efficiency of energy-consuming functions. The deduction available is up to $.60 per square foot for lighting, HVAC and building envelope, creating potential for $1.80 per square foot if all three components qualify. These deductions are applicable to buildings that were either built or retrofitted after December 31, 2005. In order to qualify for the deduction, the taxpayer must receive a third party energy efficiency certification.
In addition, the issuance of Revenue Procedure 2011-14 will allow some taxpayers to claim the 179D deduction all the way back to January 1, 2006 without filing one single amended income tax return. Taxpayers who wish to take the deduction without amending any returns will file a Form 3115 (Application for Change in Accounting Method) and will get to take the entire catch up deduction on the return that is being filed. This means that a taxpayer could potentially claim deductions from 2006-2010 (or 2011) all on one return and significantly reduce their tax burden, if not eliminate it altogether, which goes a long way toward funding energy efficiency.
Instead of looking to outside sources or reducing your valuable equity to fund energy efficiency, look to your own building for the answers. Putting the right strategy into place can result in surprisingly significant savings and painless way to pay for your project.
The 179D tax deduction came about as part of the Energy Policy Act of 2005 (EPAct). Congress wanted to incentivize the utilization of energy-efficiency components in a building to one of the following parties:
1.The owner of the building
3.The primary designer of an energy-efficient government building. (Architect, engineer, contractor etc.)
The deduction available is up to $.60 per sq./ft. for lighting, HVAC and building envelope, creating potential for $1.80 per sq./ft. if all three components qualify. These deductions are applicable to buildings that were either built or retrofitted after 12/31/2005.
Since EPAct came into effect, the IRS has provided interim guidance on EPAct deductions through several additional notices. IRS Notice 2006-52 describes in detail the rules and how to ensure a building qualifies if it was a new build or a retrofit. It requires the taxpayer to obtain certification that the property satisfies the energy efficiency requirements of 179D and specifies the software that must be used to calculate energy and power consumption. To further the cause, the IRS issued Notice 2008-40, which allowed a government building (non-taxpaying entity) to pass the deduction to the “primary designer” of the qualifying assets.
Until recently, taxpayers looking to claim the 179D deduction were limited by the three year statute of limitations for filing amended income tax returns for a particular tax year. That has changed with the issuance of Revenue Procedure 2011-14, which will allow some taxpayers to bypass this statute of limitations and claim this deduction all the way back to 1/1/2006 without filing one single amended income tax return. Taxpayers who wish to take the deduction without amending any returns will file a Form 3115 (Application for Change in Accounting Method) and will get to take the entire “catch up” deduction on the return that is being filed. This means that a taxpayer could potentially claim deductions from 2006-2010 (or 2011) all on one return and significantly reduce their tax burden, if not eliminate it altogether.
Deciding whether or not to amend returns or file for a Change in Accounting Method (Form 3115) is entirely dependent upon each taxpayers situation. If taxable income was higher in open years and therefore the taxpayer was in a higher tax bracket, it still may make sense to amend those returns. The impact of Revenue Procedure 2011-14 will also depend on whether or not any deductions have already been claimed or returns have been amended. A thorough analysis of each taxpayers scenario by an advisor experienced in 179D is advantageous to determining the best approach and claiming the maximum deduction allowed under the law.