Since its passage barely over two years ago, the Inflation Reduction Act of 2022 (IRA) has made significant steps forward in promoting energy efficiency within the construction industry. Incentives under the IRA include tax credits for the installation of clean energy solutions such as solar panels, battery storage, heat pumps, and more efficient exterior doors and windows. While these incentives are specific to individual improvements, the IRA also provides several whole-building incentives, including those found in Sections 45L and 179D of the Internal Revenue Code (IRC). These incentives stand out as being key to encouraging sustainable, more efficient, and more resilient building practices throughout the country.
Since their introduction, the 45L tax credit and 179D deduction have surpassed expectations in terms of popularity. As developers increasingly seek to align their projects with sustainable practices, these incentives have gained widespread traction. This surge in adoption has led to more states making these programs available, further broadening their reach and impact.
Section 45L Tax Credits
Section 45L is designed to provide tax incentives to developers who construct or substantially reconstruct residential properties – single-family and multifamily – that meet specific energy efficiency standards, thereby offsetting some of the costs associated with building energy-efficient homes and promoting greener residential development.
To qualify for the Section 45L tax credits, projects must meet certain energy efficiency criteria set by the Energy Star (ES) program or the Zero Energy Ready Home (ZERH) program – each of which being jointly administered by the Environmental Protection Agency and Department of Energy (DOE).
Under Section 45L, projects must meet the required energy efficiency standards by securing certification that the project complies with the necessary criteria, typically through third-party verification. Developers must also maintain thorough documentation to support their claims and submit Form 8908 when filing their taxes.
The Section 45L tax credits can be substantial, with eligible developers able to claim up to $5,000 per dwelling unit. The exact amount depends on the level of energy savings achieved and compliance with prevailing wage requirements. Prevailing wages under 45L and the IRA are generally dictated by the Davis-Bacon Act, as indicated here. ZERH-compliant projects are eligible for significantly more than ES-compliant projects; however, multifamily projects can achieve even greater incentives by complying with locally prevailing wages. The table below details available incentive amounts under Section 45L based on the ES or ZERH requirements, and prevailing wage requirements, satisfied.
ES Compliant, No Prevailing Wage | ZERH Compliant, No Prevailing Wage | ES Compliant, Prevailing Wage | ZERH Compliant, Prevailing Wage | |
Multifamily | $500 per unit | $1,000 per unit | $2,500 per unit | $5,000 per unit |
Single-Family | $2,500 per home | $5,000 per home | $2,500 per home | $5,000 per home |
Both the ES program and the ZERH program offer three paths to compliance for developers of multifamily properties. These paths are outlined in ES’s “Multifamily New Construction National Requirements, Version 1.1.” For example, under the “prescriptive path,” multifamily units must satisfy specific energy efficiency metrics in a detailed checklist specific to the program and receive certification by a third-party multi-family review organization (MROs). ES has listed approved MROs on the U.S. EPA website, and ZERH lists MROs considered ZERH Certification Organizations through the DOE website. Under the “ASHRAE path,” ZERH program partners must generally achieve 20% source energy savings over applicable referenced standards promulgated set by the American Society of Refrigeration and Air-conditioning Engineers in 2019 (ASHRAE 90.1-2019). The ES program requires 15% source energy savings over a previous ASHRAE standard (either 90.1-2010, or 90.1-2016 in the case of states that have adopted as the commercial code the 2021 IECC or ASHRAE 90.1-2019). Under the “ERI Path,” an approved software rating tool recommends the required efficiency targets, and a Home Certification Organization (HCO) must certify that each unit complies with the applicable reference standards.
In general, overlap exists both between qualified software options used to obtain 45L credits under the ASHRAE path and the ERI Path, as well as between the 45L Credit and other Inflation Reduction Act incentives such as 179D, but qualified software products must be determined individually rather than uniformly across Inflation Reduction Act incentives.
Summary of Section 179D Tax Deductions
Section 179D offers tax deductions from federal income tax to developers who implement energy-efficient improvements in commercial buildings. These deductions are designed to encourage the adoption of energy-saving technologies in lighting systems, heating, ventilation, cooling systems (HVAC), and building envelope installations.
Who Can Take Advantage of Section 179D?
The Section 179D tax deductions are available to commercial developers, property owners, and designers of government-owned buildings who make energy-efficient improvements to their properties This includes new constructions as well as retrofits.
Qualifying Projects for Section 179D
Eligible projects under Section 179D include those that result in a 25% or greater reduction in total annual energy and power costs compared to a reference building. (eligible energy savings are capped at 50%). Qualifying improvements can be made to interior lighting, HVAC systems, and building envelope. The effects of qualified installations are tested through qualified software approved by DOE and efficiency improvements are tested on a whole-of-building basis.
Steps to Become Eligible for Section 179D
To qualify for the Section 179D deductions, developers must ensure that their projects meet the relevant energy efficiency standards, as specified by ASHRAE. Certification from a qualified third party is often required to substantiate the energy savings. Proper documentation is essential to support the deduction claim.
Potential Amounts Under Section 179D
In general, the 179D deduction increases with higher levels of building efficiency, according to the sliding scale below. The amounts shown are the IRA statutory amounts for projects placed in service for 2023 and after, before indexing for inflation as determined by the consumer price index referenced in IRC Section 179D(g).
Efficiency Gain Over the applicable ASHRAE Baseline | Deduction Amount “Base Rate” | Labor Standards “Bonus Rate” |
25% (Minimum) | $.50 per square foot | $2.50 per square foot |
30% | $.60 per square foot | $3.00 per square foot |
35% | $.70 per square foot | $3.50 per square foot |
40% | $.80 per square foot | $4.00 per square foot |
50% (Maximum) | $1.00 per square foot | $5.00 per square foot |
The deduction amount increases five times if the building meets labor standards that: (1) pay prevailing wages to laborers that install equipment and (2) satisfy apprenticeship hiring requirements. Projects can achieve efficiency gains through the installation of interior lighting, HVAC, hot water systems, and building envelope (e.g., roof, windows, and insulation). Any building within the scope of ASHRAE 90.1 standard for commercial and larger multifamily buildings is eligible. For new construction, the building must be at least 25% more efficient than the applicable AHRAE 90.1 baseline. As detailed here, ASHRAE 90.1-2007 generally applies for new construction projects placed in service up through 12/31/2026 (or for buildings that began construction prior to January 1, 2023); ASHRAE 90.1-2019 applies for projects placed in service on or after 1/1/2027.
A building must be five years or older to qualify and set forth in a qualified retrofit plan certified by a professional engineer or architect.
Conclusion
The Inflation Reduction Act’s Sections 45L and 179D provide powerful incentives for developers focused on energy efficiency. As these programs continue to gain popularity and more states adopt them, they offer substantial financial benefits while advancing the broader goals of sustainability. Developers looking to capitalize on these opportunities should carefully navigate the eligibility requirements to maximize the potential tax savings for their projects.