Economics and Sustainability in Commercial Buildings
Energy Policy Act of 2005 (Section 179D)
ACREL ANNUAL MEETING
OCTOBER 2012
1. Background. Economic development incentives are forms of federal, state or local governmental assistance that help an employer develop or continue business activity at a given location. Most economic development incentives take the forms of tax credits, grants, reduced rate or deferred loans, or real or personal property tax abatements. In the commercial green building markets, the economic incentive first brought to mind is a tax credit or a tax deduction against a company’s federal or state tax burden, based on funds spent on energy savings or sustainable improvement, or based upon the actual energy savings of a building compared to a set baseline.
The primary federal economic incentive is known as “EPACT”, Section 1331 of the Energy Policy Act of 2005, Pub. L. No. 109-58, 119 Stat. 594 (2005), enacting Section 179D of the Internal Revenue Code, and is popularly known as “Section 179D.” This paper will outline economic development structures for businesses that own real estate, summarize the requirements and benefits of Section 179D, and briefly touch upon other sustainability incentives.
2. Green teams. Economic development agencies seek to influence private sector businesses in a variety of decisions. Is a project economically feasible? Should we relocate an existing program or site? Do a program’s economic projections support workforce deployment plans? If a business is allocated tax credits or awarded other incentives, that economic development support enables the business to bring or retain much needed employment to an area and, with that, increased “trickle down” economic activity. From the agency’s perspective, if the business is provided money up front, that money will be reinvested in the area of the agency’s jurisdiction. From the business’s perspective, having that economic development incentive enables the business to use more freed capital in the future. From the societal perspective, retained or new jobs within an area can maintain or increase the standard of living and the tax base, and reduced energy usage can lower current and future demands on coal or other resources.
A business’s internal economic development team interacts with economic development agencies in a variety of fashions, depending on the business’s programs that require the assistance and the types of incentives that might be available. If the incentive is targeted towards meeting the business’s sustainability goals, then that team must balance the business’s environmental sensitivity to both the business’s and the market’s economic
July 31, 2012
Theresa B. Shea
Research and assistance provided by Michael L. Weiland, University of Baltimore School of Law
realities. This is more easily done, however, when the economic incentive is driven by the
business or governmental push for new jobs. When the driver is the government’s or business’s desire to create a more environmentally conscious environment for business, both the political and financial externalities change. It is always hoped that one’s sustainability efforts would lead to more jobs, either through direct installation or maintenance of new technologies. Decisions are still driven, though, by freed capital that may be reinvested. Since sustainability-focused incentives tend to be smaller amounts than incentives based upon capital investment or job creation, the green piece tends to be a small part of an otherwise focused transaction or program.
This author believes in the benefits of a business empowering a team of internal decision makers that looks specifically at the green incentives – at incentives that specifically focus on environmentally sensitive ideas to encourage more environmentally sensitive behavior. Most businesses that own a significant real estate portfolio already dedicate internal departments to facilities and utilities management. These informed personnel should lead a green team along with finance or accounting staff, as most upper management does not have the necessary intimate knowledge of utilities generation to dictate decision making. Interdepartmental green teams provide opportunity for employees across divisions to build cross-department relationships that identify and complete sustainability projects that should be better geared to produce deep and continuing savings in both energy and finance. Investing in variable frequency devices, changing out interior lighting standards, or standardizing sourcing are three examples of small changes that might be driven by the building engineers as opposed to accountants, but that if implemented could produce long term financial and environmental benefits.
One must be cautious in establishing green teams, however, to ensure that the team and the team’s charter fits one’s business needs, geographical realities, and political forces. Any team must first conduct an analysis to understand the product, its work flows, production line process, etc. Also, local issues vary; thus, multiple or decentralized teams may be needed for larger companies that own real estate in multiple or diverse states. A particular geographical difference may not be related to the business at all: a jurisdiction may not offer as many green incentives as others, thus discouraging activity in that location, but the business may require that location for other reasons. Ultimately, how a business dedicates both time and resources to a green team can only be based upon a full consideration of its needs, its talents, and its locations.
3. Section 179D. Section 179D relates to the design and construction of commercial buildings. It states “[t]here shall be allowed as a deduction an amount equal to the cost of energy efficient commercial building property placed into service during the taxable year.” It applies to property in the United States only, and only for property for which depreciation, or amortization in lieu of depreciation, is allowable. To be considered an energy efficient commercial building property, the building must be new construction or a retrofit that affects interior lighting, the HVAC or hot water systems, or the building envelope, and the work must be certified as “being installed as part of a plan designed to reduce the total annual energy and power costs … by 50 percent or more” in comparison to buildings that meet the minimum requirements of ASHREA 90.1. The law also identifies how the energy savings must be calculated.
ASHRAE 90.1 is a standard established by the American Society of Heating, Refrigeration, and Air Conditioning Engineers in 1975 to provide the minimum acceptable requirements for energy efficient designs for buildings other than low rise buildings. This standard is a key component of the International Energy Conservation Code, and represents about 60 possible points in the LEED Certification Program. Section 179D refers to savings exceeding 50% of the minimum established by ASHRAE in 2001; the ASHRAE standards are routinely updated.
The Section 179D tax deduction originally expired December 31, 2008. The commercial property sections of the law were extended by TARP, and apply to buildings placed in service between January 1, 2006 and December 31, 2013. The guidelines issued by the Internal Revenue Service in support of Section 179D, Notice 2006-52 and Notice 2008-40, each refine the requirements further, including that special rules for government-owned buildings. Unfortunately, that guidance is also in some instances inconsistent with the statute, which has led to some difficulties in implementation and use.
The tax deduction is a one-time accelerated depreciation deduction taken in the year in which the building is placed into service, and applies to commercial, multifamily, and publicly owned facilities. Consistent with the ASHRAE focus away from low rise buildings, multifamily buildings must be 4 stories or more. The entity that expends the funds for construction would take the benefit of the deduction, which entity could be a tenant but in most instances would be the building owner. If the building is publicly owned, then the deduction would be allocated to the “designer.” The designer is defined in Notice 2008-40 as the “person primarily responsible for designing the property …. that creates the technical specifications for installation of energy efficient commercial property” and may include “an architect, engineer, contractor, environmental consultant or energy services provider”, among others. The designer deduction may be allocated among more than one entity proportional to each entity’s contributions to the project, and that allocation (or choice of a single award) is made by the public agency that owns the affected building. If the deduction is allocated to a designer of a publicly owned building, then the basis in that publicly owned building must be reduced by the amount of the allocation allowed.
The deduction is allowed in an amount up to $1.80 per square foot of the building, if the building saves 50% or more of the projected annual energy costs across all three system components. It is divided among the three potential subsystem deductions: 0.60/sf each for HVAC or hot water, interior lighting, and building envelope. If the building design or retrofit results in a reduction in energy and power costs of only one or two of the systems, or of less than 50% of the lighting power density, then a partial deduction can still be taken. If either or both of HVAC/hot water or building envelope still meet the 50% or more reduction threshold, then the taxpayer may still claim a partial deduction of $0.60/square foot. If the lighting power density provides a 25% or great savings (50% for warehouses), then the taxpayer may still claim a partial deduction of $0.60/square foot. The interior lighting is the most often used energy savings design.
One requirement that sets Section 179D apart from many other economic development incentive programs is that taxpayers must have their energy savings certified by governmentally recognized qualified persons, and using statutorily specified methods of calculations and statutorily specified computer software.
4. Implementation of Section 179D. When originally enacted, Section 179D was directed towards only the highest levels of energy efficient buildings. Rachel Gold and Stephen Nadel discuss the reasoning for the initial statutory intent, and the success and concerns with the implementation and use of this incentive in commercial buildings, in their June 2011 white paper, “Energy Efficiency Tax Incentives, 2005-2011: How Have They Performed?”, American Council for an Energy Efficient Economy (ACEEE). The initial target by the EPACT was towards technologies and equipment that then had less than a 5% market share, and intended to target those participants who would not have made those investments “but for” the incentive. Gold and Nadel believe that the focus of Section 179D was “on increasing the market share of the most energy efficient equipment” (Gold and Nadel, p.1).
Section 179D was extremely useful at increasing market share in the internal lighting arena. Reasons for this include the interim lighting provision in the guidelines that allowed for deductions while the audit software was produced, and the sliding scale of deductions permitted for less that 50% savings in lighting power density. The increased demand for advanced lighting efficiency helped drive both the rate of improved technology and the availability of those lighting systems improvements to most building owners.
Section 179D was less successful in stimulating use of whole building and HVAC retrofits. Gold and Nadel cite as reasons for this that larger savings must be realized by these systems (at least 50%, and not starting at 25%), and that neither the Department of Energy nor the IRS implemented the necessary regulations to simplify the certification and claiming of those incentives for those systems. The guidance released by the IRS and the other implementing regulations were slow to be issued, and very complex in application process. This process resulted in certification requirements that did not fit the software available for ASHRAE 90.1 standards. Since the statute required that applicants only use approved software and qualified certificators, and neither was made available in the initial rounds of published guidance for these two systems, the numbers of participants was low. Building envelope savings also are generally not generated at a level high enough to meet the 50% threshold. See also Hayes et al., September 2011 for ACEEE, “What Have We Learned From Energy Efficient Financing Programs?”.
5. Other Sustainability Incentives. State and local governments and private entities also provide various incentives for real-estate owning business to increase sustainable design, operations and maintenance of their buildings. These incentives fall most often in the areas of energy – electrical, gas, solar, wind. Most localities have minimum requirements for new building design and retrofit; many have implemented LEEDs or similar requirements for new construction. In addition, the federal government has through various executive orders and law directed its own agencies to meet renewable energy, energy intensity, waste reduction, and energy efficiency standards. While beyond the scope of this paper, those requirements are considered instrumental in driving continued energy focus within the private sector. Additional building minimum requirements and new or updated incentive programs are added at a rate that makes tracking the existence and scope of those programs nearly impossible. A comprehensive database used by this author is the Database of State Incentives For Renewables and Efficiency, through North Carolina State University, www.dsireusa.org. A few such programs will be summarized, to provide a general overview of what might be available is some active jurisdictions.
Utility – General reduction
Most major regional utilities provide incentives for technical assistance, retrofitting inefficient equipment, starting a new construction project, launching a major renovation, purchasing new equipment, or replacing equipment at the end of its lifespan. These incentives vary from utility to utility, and may apply to both residential and commercial customers. Those utilities that are regulated may be subject to having incentive program cut by state governing bodies when those governing are implementing ‘austerity’ programs, see, e.g., Pacific Gas and Electric recent funding issues.
Maryland – Baltimore Gas and Electric Company
BGE incentives typically cover up to 50% of the total cost for retrofit projects and up to 75% of the incremental cost for new construction projects. Small business owners can upgrade existing lighting and equipment under additional incentive plans. Small businesses must use 60kW or less electricity per month to qualify.
§ Maximum Incentive: $1M/Corporate Tax ID/Year
§ Examples include:
§ New Construction Green Building Incentive: $0.25 - $0.40/kWh saved first year