While you’ve no doubt heard of the Inflation Reduction Act (IRA), it may have escaped your area of concern as it’s only relevant to those focused on tackling economic inflation or fighting climate change. However, you may want to take a second look as the bill contains important considerations for the commercial real estate (CRE) industry. Because the bill is broad and its implications are far-reaching, we focus only on the bill’s impact on CRE and exclude consequences related to domestic production, single-family homes, medical costs, etc. If you are a commercial or multi-family homeowner, property manager, developer or investor in CRE, this article will be of particular interest to you.
The IRA (HR 5376) was signed into law by President Biden last August and committed $369 billion to a variety of carbon reduction strategies, with a particular focus on supporting poorer communities.
It’s hard to ignore the steady rise in electricity prices, which hit an all-time high in the first half of 2022 on record-high fossil fuel costs and inflation. Those in the CRE industry know that operating expenses can make the difference in profit. The IRA aims to reduce this spending by subsidizing both energy efficiency retrofits (to reduce overall consumption) and renewable energy installations (to offset consumption costs). The bill does this primarily through tax deductions and credits.
179D tax deduction
IRC Section 179D is an existing incentive that allows property owners and developers to claim a tax deduction for energy efficient buildings and equipment. The IRA improved this tax deduction to include:
- Significant increase in deduction from $1.88/sqf to a maximum deduction of $5.00/sqf.
- Substantial reduction in minimum efficiency requirements for tax deduction from 50% to 25%.
This deduction applies to all commercial buildings and apartment buildings with 4 floors or more. Both existing buildings that are being retrofitted and new builds are eligible. Other updates to 179D include allowing REITs and tax-exempt building owners (such as nonprofits) to take advantage of these tax deductions, albeit to a limited extent.
179D also allows real estate investors to deduct a significant portion of the cost of a new energy efficient building or a retrofit to an existing building in the first year, rather than having to wait many years to realize those deductions as depreciation. Calculating the total amount of tax deduction for the first year can be complicated and requires an independent engineer to certify the energy savings target. An engineering firm can design the energy efficiency improvements for the maximum tax deduction and ensure compliance with Section 179D and ASHRAE standards. Without getting into the “exciting” details of tax law, we can confidently say that many energy efficiency projects that were not “crazy” in the past will now be commercially viable.
45L tax credit
IRC Section 45L is a federal tax credit that encourages multifamily developers to meet energy efficient design criteria by the time it expires in 2021. Developers received a $2,000 tax credit for each energy efficient dwelling in their buildings. The IRA improved the tax credit by:
- Extension of the 45 liter credit until 2032.
- Beginning in 2023, the IRA will increase the maximum tax credit from $2,000 to $5,000 per property for single-family and multi-family homes.
In addition, the energy efficiency criteria will be changed to align with Department of Energy (DOE) programs that apply to all housing developments (as opposed to just low-rise buildings). Apartment buildings 4 stories and above may qualify for the 45L credits in addition to the 179D deductions.
Renewable Energy Generators
The IRA is more than just a tool to incentivize energy reduction; It also promotes the implementation of renewable energy generators such as solar and the technologies that support them such as batteries and electric vehicles.
One of the biggest inclusions in the IRA is the extension of the Solar Investment Tax Credit (ITC) through 2034. This loan allows solar system owners and investors to save up to 30% in taxes on their project’s hard-cost budget.
Put simply, the state reimburses you for 30% of the cost of your solar project in the form of a tax credit. Without going too deep into the tax benefits of the legislation, we note that the Energy Act also allows for the depreciation of solar assets (under MACRS) using a 5 year recovery period and for the owner to write off the depreciable basis using the system with the bonus depreciation rules .
While a 30% tax credit already gives most CRE professionals the boost they need to get their solar project off the hook, the IRA also includes provisions to increase the tax credit even further. A 10% surcharge is applied to the tax credit for projects installed in low-income communities (20% for qualifying low-income residential buildings). Additional adders are available for projects using US-made equipment and for projects in an “energy community” (areas with significant coal and natural gas employment).
As with improving energy efficiency, tax-exempt property owners and investors (e.g. non-profit organizations and state/local governments) will be allowed to transfer their renewable energy tax credit to third parties starting in 2023. This change effectively allows these companies to sell their tax credits for cash.
If you have available roof space with a usable lifespan of 15 years or more and high energy costs, a solar PV system could be a reliable investment with great tax incentives. Experienced consultants can help you maximize any available discounts and incentives and ensure the project is solid from feasibility to execution.
The IRA now views energy storage or battery energy storage systems (BESS) as a standalone project, rather than being tied to a renewable energy project. This means energy storage systems can receive the same tax credit benefits and extensions as mentioned in the solar section above. This is great news for any property owner who currently owns or is considering installing an energy storage system, especially for homes with limited roof space. Prior to the IRA, energy storage systems had to be charged from at least 75% renewable resources for the first five years, which limited what an energy storage system could do and discouraged property owners who could not install solar from installing an energy storage system. With the IRA, energy storage systems are now able to offer a wider range of revenue streams than ever before. If a CRE property is located in one of the following states, an energy storage system is likely a reliable investment with great tax incentives. Working with renewable energy consultants can allow you to quickly analyze these projects and provide detailed economic metrics to CRE clients who may be interested in an energy storage project.
illustration 1: Large markets for solar plus storage (S+S) or standalone energy storage projects
Electric vehicle chargers
Property owners and investors interested in installing EV charging stations in their parking lots (or garages) in low-income or rural areas can now take advantage of the Enhanced and Modified Home Loan for Alternative Fuel Vehicle Refueling. From 2023 to 2032, this charging infrastructure will receive a 30% tax credit up to $100,000 per property.
All above project types starting in 2023 and above 1 MWAC, but must comply with applicable IRA wage and training requirements; otherwise the tax credits are reduced to 6%.
The direct financial benefits of the IRA discussed above are significant and will go a long way in motivating those in the CRE industry to integrate renewable energy and energy efficiency systems into their business models. However, there are a variety of indirect and/or operational aspects of the IRA that are beneficial to anyone whose business model requires tenant acquisition and retention. Lower electricity costs despite market volatility, on-site solar panel power, protection against grid outages and the ability to charge electric vehicles are all major selling points for those whose business depends on their buildings remaining occupied.
And with the government heavily subsidizing the cost of these improvements, now is a good time to take action.