The 179D Deduction: How to Claim It

The 179D deduction is a tax incentive designed to encourage the construction and renovation of energy-efficient commercial buildings. It allows eligible taxpayers to claim a deduction for the cost of installing qualifying energy-efficient property. This provision aims to promote sustainable building practices and reduce energy consumption across the commercial real estate sector, making energy-saving investments more attractive for businesses and building owners.

Eligible Taxpayers and Properties

The 179D deduction is available to various taxpayers who invest in energy-efficient commercial building property. Building owners who place qualifying energy-efficient systems into service in their commercial properties can claim the deduction. Tenants may also be eligible if they make construction expenditures for qualifying leasehold improvements within a commercial building.

Designers of government-owned buildings can also claim the deduction. This includes architects, engineers, contractors, and energy service providers primarily responsible for designing energy-efficient systems in public properties. Since government entities do not pay federal taxes, they can allocate the deduction to the private entities that designed the improvements. This allocation encourages energy-saving designs in public infrastructure projects.

Qualifying properties include new construction, renovations, and existing buildings undergoing energy-efficient upgrades. Eligible buildings include commercial structures such as office buildings, retail stores, warehouses, and hotels. Residential rental properties four stories or more above grade can also qualify.

The placed-in-service date of the property determines the applicable rules and deduction rates. The Inflation Reduction Act (IRA) of 2022 enhanced the 179D deduction for properties placed in service after December 31, 2022. This legislation expanded eligibility to include tax-exempt entities, allowing them to allocate the deduction to designers.

Energy Efficiency and Certification Requirements

To qualify for the 179D deduction, a building must meet specific energy efficiency performance standards. The property’s energy consumption is compared to a baseline standard established by the American Society of Heating, Refrigerating, and Air-Conditioning Engineers (ASHRAE) Standard 90.1. For properties placed in service after 2022, the energy savings threshold was lowered to 25% or more compared to a reference building.

The energy-efficient property must be installed as part of a plan designed to reduce total annual energy and power costs. This includes improvements to interior lighting systems, heating, ventilating, and air conditioning (HVAC) systems, hot water systems, and the building envelope (e.g., walls, roof, windows). These are the primary systems evaluated for energy savings.

A “qualified individual” must certify the energy efficiency of the property. This individual is a licensed engineer or contractor who possesses the expertise to attest to the energy savings. Their responsibilities include performing a site inspection and using IRS-approved software for energy modeling. The energy modeling simulates the building’s energy performance with the installed improvements compared to the baseline.

After the energy-efficient property is placed in service, a qualified individual conducts a field inspection. This inspection verifies that the installed systems match the design specifications. The energy modeling analysis then quantifies the energy and power cost savings. Finally, the qualified individual issues a signed certification statement, confirming that the property meets the energy efficiency requirements.

Documentation and Data Collection

Before calculating and reporting the 179D deduction, specific information and documentation must be gathered. The signed certification statement from the qualified individual is a foundational document. This statement must identify the property, detail the basis for the deduction, specify the energy savings achieved, and list the particular energy-efficient components installed.

Detailed cost breakdowns of the energy-efficient property components are essential. This includes expenses related to HVAC systems, lighting upgrades, and building envelope improvements. Taxpayers should retain invoices, contracts, and other financial records that substantiate these costs.

The energy modeling reports and supporting data generated by the qualified individual’s software must be retained. These reports provide the technical basis for the claimed energy savings and are crucial for substantiating the deduction in case of an IRS inquiry. The software used for modeling must be approved by the Department of Energy.

Other necessary property details include the building’s square footage, its placed-in-service date, and complete owner or designer information. This collection of documents ensures that all aspects of the energy efficiency project are well-documented. Proper recordkeeping is vital for demonstrating compliance with the deduction’s requirements and supporting the claimed amount.

Calculating the Deduction Amount

The 179D deduction amount is calculated on a per-square-foot basis, and these amounts are adjusted annually for inflation. For properties placed in service after December 31, 2022, the deduction framework was enhanced by the Inflation Reduction Act. The base deduction begins at $0.50 per square foot for a 25% energy efficiency improvement over the baseline.

The deduction amount increases incrementally for each percentage point of energy savings above 25%. For projects that do not meet prevailing wage and apprenticeship requirements, the deduction can increase by $0.02 per square foot for each percentage point of energy savings above 25%, up to a maximum of $1.00 per square foot. If prevailing wage and apprenticeship requirements are met, the deduction increases.

For projects meeting prevailing wage and apprenticeship standards, the deduction starts at $2.50 per square foot for a 25% energy savings. It then increases by $0.10 per square foot for each percentage point of energy savings above 25%, up to a maximum of $5.00 per square foot. For tax year 2025, these maximums are adjusted to $1.16 per square foot without prevailing wage and $5.81 per square foot with prevailing wage, reflecting inflation. The total deduction cannot exceed the cost of the qualifying energy-efficient property.

When claiming the 179D deduction, its interaction with the depreciable basis of the property should be understood. The amount of the 179D deduction reduces the depreciable basis of the building. This means that while an upfront deduction is realized, the amount of depreciation that can be claimed in future years will be lower. Taxpayers can reclaim the deduction on the same building every three years for commercial buildings or every four years for buildings owned by tax-exempt entities, provided new improvements meet the requirements.

Reporting the Deduction on Tax Returns

Reporting the 179D deduction on tax returns involves specific forms and procedures, depending on the taxpayer’s entity type and whether the deduction is being claimed for a current or prior year. Building owners claiming the deduction, especially for prior years or when changing accounting methods, may need to file IRS Form 3115, Application for Change in Accounting Method. This form adjusts the building’s basis to reflect the 179D deduction.

The 179D deduction is reported on various tax forms depending on the taxpayer. For individuals, the deduction may be reported on Schedule C (Form 1040) for sole proprietors, Schedule E (Form 1040) for rental income, or Schedule F (Form 1040) for farm income, if applicable to the energy-efficient property. Corporations report the deduction on Form 1120, U.S. Corporation Income Tax Return, on the appropriate line item for deductions. Partnerships report the deduction on Form 1065, U.S. Return of Partnership Income, and the deduction flows through to the partners via Schedule K-1 (Form 1065).

Designers of government-owned property must receive an allocation letter from the government entity that owns the building, authorizing them to claim the benefit. This letter formally transfers the deduction to the designer, as the government entity is not a taxpayer. Designers typically amend prior year tax returns within the statute of limitations to claim missed deductions.

Maintaining thorough recordkeeping is important for audit purposes. All supporting documentation, including the certification statement, detailed cost data, energy modeling reports, and any allocation letters, should be retained. These records provide the evidence to substantiate the eligibility and amount of the 179D deduction claimed on the tax return.