Significant tax savings exist for companies seeking to “go green” via the EPAct’s Section 179D deduction. Bruce Johnson, founding partner with Capstan Tax Strategies in Jenkintown, Pa., and himself an engineer, discusses how this deduction – passed through the federal Energy Policy Act of 2005 – allows companies to save money while helping the environment.
By: Jim DeLuccia, PICPA Communications Manager
Going green helps companies burnish their public image and potentially attract new customers, but significant tax savings can be achieved as well thanks to the EPAct Section 179D. Bruce Johnson, Founding Partner with Capstan Tax Strategies in Jenkintown, joins me to further explain the advantages of this deduction for corporate CPAs.
What is the EPAct Section 179d deduction?
[Johnson] It's a program that was set up as part of the 2005 Energy Policy Act, and the purpose of it is really to incentivize owners and operators of commercial real estate to improve the energy performance of their buildings. Again, this was part of the Energy Policy Act of 2005 which was really all about putting a program together for the federal government to reduce their energy consumption of all their commercial real estate. And they had a threshold target of 30 percent. EPAct 179d was created through that and what it really focuses on are three areas of construction for commercial real estate. This could be for new construction or renovations, and those are interior lighting, HVAC (otherwise heating, ventilation, air conditioning), and building envelope. The program as it currently constituted it would focus on those new construction or renovation projects that occurred in 2006 through 2017.
You and I spoke briefly offline about this before we started our discussion: that you have some news about the timing of this deduction. And I want to remind listeners that we're recording this on Nov. 29, 2018, but what's going on with the timing of this deduction?
[Johnson] We have a changing landscape here potentially. First of all, EPAct 179d has typically been part of annual tax extenders bills, and as we all have seen, particularly over the last three, four years, those extenders have been happening later and later in the year. And particular to 179d the last time it was extended was through the 2017 calendar period. As you just mentioned, we do have effective Monday (Nov. 26, 2018) a tax extenders bill has been floated from the desk of Kevin Brady and the House, and it does include extending section 179d through 2018. It'll be retroactive essentially for this calendar year, and as we understand it, it would be continuing under the current or the most-current rules. So that's what we hear and by the time we probably will be publishing this we'll know whether or not this gets passed. But I think there is a strong level of support for it, it's just a matter of ... obviously it's bundled with a number of other things. Is there enough support to pass it before the end of the year?
It'd be interesting to see how that goes, and actually considering the expiration are there any look back opportunities?
[Johnson] It's an interesting program. It has evolved over the years. The way the current program is constituted does allow for that look-back effect. If you or you as a building business owner, building operator, or a CPA, and you've done or you know of a project that was done back in 2010, you absolutely can do a look back. The way that would occur is that you wouldn't have to amend the return. Once you find the results you would use a form 3115 to execute that. You definitely can do this. Now there is a little bit of a nuance. 179d does have an attribute related to the design profession, so that's design professionals, architects, engineers. If they're working in the environment doing a design for a government entity, then the actual design professional might be able to claim this deduction. It's a very unique aspect of 179d but I would say that 90 percent of the use of 179d is for the commercial building environment.
What are a few key benefits of this deduction that may be overlooked?
[Johnson] It's a federal deduction derived benefit, and the way the calculation is put together is that it looks at your building, your design, in relation to a benchmark facility and you have to achieve a 50 percent or greater energy performance over that benchmark facility. And the benchmarks for today are using Ashrae 2007 standards. The building code has evolved significantly since then. For example, lighting retrofits, most people are putting in LED lighting systems. Well those in and of themselves, without too much effort, are going to help achieve that 50 percent energy savings threshold.
The benefit, again, is a depreciation-derived incentive and it's up to a $1.80 of affected square footage. What that means is that if I built a brand new facility, the entire facility square footage would be in play for calculating up to that $1.80 a square foot. By the way, that $1.80, it depends on how many of those three areas of construction – remember, interior lighting, HVAC, or building envelope. All of those factors come into play whether you can get up to the full $1.80. If it's a new construction building the full $1.80 could be in play. If it's just a lighting retrofit for an existing building, you may not be able to achieve 60, maybe at most a $1.20 a square foot. It depends on the factors of your specific project, whether it's a new construction or renovation, and then the type of scopes that are involved.
I think your explanation there segues pretty nicely into my next question. What are the eligibility requirements to take this deduction then?
[Johnson] We talked about the timing: the project has to be placed into service any time between 2006 and 2017. You then have to look at the scope of work. Did it include any one of those three items that I mentioned: interior lighting, HVAC, or building envelope? And then you really look at the actual performance. You look at the type of facility, where it is, and how it's actually constructed. You use those metrics and evaluate it against the benchmark that, again, it's Ashrae 2007 standards. In those standards, if you are talking office building you would look for an office building in the region where your property is, and then that's how you would evaluate against that.
I think you mentioned this briefly, but how are the benefits actually calculated?
[Johnson] Yeah, I did kind of allude to that before. You look at the number of the scope items, how many of those are in play for the particular project in question, and then you look at the performance versus the benchmark. And then to actually do the calculation to prove that out, if it's just lighting only, typically you're going to use a spread sheet that's going to show the number of light fixtures and the types and such, and then run it out the calculation for you and determine whether you meet that 50 percent or greater threshold of savings. When you start including those other two components, HVAC and building envelope, the program requires you to model the building in a simulation software.
I believe there's 12 or 13 pieces of software that are approved through the program, and essentially what you have to do is take your building that you physically have in the field, model it in the software, and that software will run the calculations to determine whether or not again you meet that 50 percent or greater savings threshold. When we look at this – as I have alluded to before – when we see lighting as one of the scope inclusions for a project that typically is a really good indicator that you're at least going to get the 60 cents a square foot. And again, I'd mentioned that a lot of people are gravitating to the LED lighting system which is very energy efficient, and that spends off so much excess savings. To kind of give the analogy, it pulls the other components along if they're involved.
Because if we think about it, step back and look at the technological advances in lighting over the last 10, 15 years, have been exponential. Not so much when you look at HVAC and building envelopes. Certainly, there are some technological advances there but lighting has exponentially increased in terms of their performance. The new lighting systems performance versus say a lighting system even from five years ago. We're seeing a lot of work in the warehouse distribution field, and what I've come to understand is the reason is that the owners of those buildings – energy is a very big part of their operating cost. Interior lighting is about 40 percent of every energy dollar spent. We're seeing people in the distribution warehouse environment maybe replacing their lighting systems every 24 months because the technology's advancing that rapidly.
That's really interesting that you mention that there, though yet even a year from our discussion right now there could be so many more advancements too. I guess it's always evolving right?
[Johnson] It's an interesting field. The program does work, it does. When people see this and they build it into their proforma for a project, it really helps them to achieve a greater energy savings, but also free up cashflow to pay for those maybe increased or incremental costs to get that more energy efficient equipment.
With all that said, can you briefly describe the application or certification process?
[Johnson] The way the program works is that you need to validate that – you look at a set of construction drawings. You need to validate that – say those lighting fixtures, or that HVAC equipment, or that type of insulation was installed. You actually have to have someone visit the property and validate that “yes, the drawings are accurate.” That can typically be done by the engineer performing the calculations for the EPAct 179d study, or you could have the contractor perhaps do the field work to validate. Say I put in a hundred of this type of light fixtures, and they have to sign. Typically, we should be signing an affidavit saying, I visited the property and I validate that this type of asset was indeed installed.
The next thing is that you have to go through, and I talked about this before, the actual calculation. If it's lighting only, you can use a spread sheet to calculate that. If you include any one of the other two you have to actually use one of the approved software tools to calculate the savings. Obviously if you're having to model the building that's a little bit more involved in terms of time to do the actual calculation, but at the end of either path, whether it's lighting with a spread sheet only or one that has software modeling, you have a report essentially that would be put together to substantiate that you get: “here's the amount of affected square footage times the achieved.” Is it up to the $1.80 a square foot? And you essentially use that document to substantiate your tax filing.
And in your tax filing it typically shows up as a standard business deduction. A lot of people I see will put standard business deduction 179d, and you would essentially – say if you got a $100,000 deduction – that would be typically taken off your 39 year assets in your depreciation schedule.
I understand this is primarily a federal tax issue, but does this benefit affect Pennsylvania in any way?
[Johnson] It does. It can roll up through to ... ultimately it’s going to roll up to a person's personal returns, so there could be some impact of some savings from the Pennsylvania tax perspective. Maybe a little bit different spin on your question, is that, remember when we were talking about how is this calculated. You have to look at a benchmark building in the region where your property is. Well when we look at Pennsylvania, particularly the northern parts of the state, say up around Lake Erie, you are going to have benchmark buildings that are going to be more heavily weighted to energy performance on your heating systems. So what that means is that if you're looking at a project in one of those regions, the effect of Pennsylvania, in terms of geography, is going to weight how much of the heating system you put in, say that property up in the Lake Erie area, is going to have more impact on your ability to achieve that 50 percent or greater energy savings. So that's an interesting kind of take in terms of how the calculation is affected by where the property is in the state of Pennsylvania. It's interesting. I guess the point is that obviously we have a higher heating load here than say Texas or Florida, where they're going to be more weighted on the air conditioning side of things.
You can start to see your choice of equipment, if you're focused on trying to achieve the maximum results in a 179d study, is going to be very important when you're looking at a heating system if you're in one of those say northern Pennsylvania climate areas.
I was wondering if you could provide any information on where our members can turn to get more information about the EPAct 179d deduction.
[Johnson] There definitely is some information up on the Department of Energy's website. Certainly, can go and search the code section for 179 cap D on the IRS site, and certainly there's going to be a host of private organizations throughout the country with a lot of great information that's available. But I think definitely when you're looking at from the government perspective, I'd be looking at the Department of Energy's site, and also the IRS, which will have the specific code section in terms of 179d.