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Legislation accelerates deductions, improving your cash position

What if there was a piece of legislation that could improve your cash flow through tax savings? There is — the energy efficient commercial building deduction. By making your building more energy efficient, you could see significant cash flow benefits. By having this increased cash flow, your company can reinvest or meet current needs.

If your company owns or leases commercial buildings — which includes most types of buildings, such as residential buildings with four or more stories above grade — and you have installed or retrofitted the property to be more energy efficient, you may be eligible for a deduction for part or all of the costs associated with the installation or retrofit. This opportunity allows for the potential immediate expensing of costs that would otherwise be capitalized and recovered through depreciation over 27.5 or 39 years.

Enacted in 2005, The Energy Tax Incentives Act was designed to combat the growing energy crisis and reward conservation by providing $14.5 billion in incentives and subsidies for projects or actions, such as the purchase of hybrid vehicles, clean coal development, use of wind and alternative energy sources and projects that avoid production of greenhouse gases, among others. As part of The Act, IRC §179D provides a deduction with respect to energy efficient commercial buildings. It allows for the deduction for part or all of the cost of an energy efficient commercial building or certain qualifying commercial building property that is placed in service in 2006 and 2007 (and recently extended to include 2008, Tax Relief and Health Care Act of 2006).

Does your building qualify?
To qualify for a full or partial deduction, the energy efficient commercial building property must satisfy the following conditions:

• Building must be located in the United States
• Installation as part of interior lighting systems, HVAC and hot water systems or the building envelope (insulation, exterior doors, exterior windows, certain roofing material)
• Certified that installation will reduce total annual energy and power costs by 50 percent or more as compared to Std. 90.1-2001 American Society of Heating, Refrigerating and Air-Conditioning Engineers (ASHRAE) Reference Building
• Energy and power consumption calculation using IRS approved software programs that compare subject facility to the ASHRAE Reference Building
• Certification of the property by a qualified individual, such as an engineer or contractor licensed in the same jurisdiction as the proposed building
• Energy reduction isn’t simply generated from a change in use, function or utility of the building

What about cash flow?
When using a reference building as the barometer, the maximum deduction is $1.80 per square foot of building floor area that qualifies under IRC §179D. The deduction is allowed for prior tax years, including 2006 and 2007, and can include multiple taxpayers. The multiple taxpayers are limited to allocating the $1.80 among the parties. Also, if your building does not qualify for the full deduction, it could qualify for a partial deduction. Specifically, if your building does not meet the 50 percent energy savings, it could still qualify for 60 cents per square foot deduction if certified to reduce energy costs by at least 16.66 percent.

An example of tax savings derived from IRC §179D would be the construction of a new four story 120,000 square foot office building that has design parameters exceeding that of the ASHRAE reference building in all areas, including interior lighting systems, HVAC and hot water systems, and the building envelope. This type of building would allow a first year benefit of immediately expensing $216,000 rather than capitalizing and deducting over 39 years. The cash value of this upfront deduction using a combined tax rate of 40 percent would be approximately $85,000 in year one, with an overall net present value benefit of approximately $55,000 over the life of the building at a 7 percent discount rate.

An example of an allowed partial IRC §179D deduction ($.60 per square foot) would be the retrofitting of an existing building, using the same building criteria above, by replacing existing lighting systems with high efficiency lights combined with bi-level switching, which could yield an approximate first year benefit of immediately expensing $72,000. This immediate deduction would result in a cash benefit of approximately $28,000. The overall net present value over the life of the building would be approximately $18,000.

The government wants to encourage serious consideration of energy conservation when buildings are being designed and constructed, which is why they enacted The Energy Tax Incentives Act. If you believe you qualify for this deduction and want to increase your cash flow, get in contact with a professional today who can help you reap the benefits of your energy efficient commercial building.

This article originally appeared in Minnesota Real Estate Journal in February 2007.

John W. Dorn is a director with RSM McGladrey. For more information, contact him at john.dorn@rsmi.com.

Kevin P. Johnson is a director with RSM McGladrey Consulting. For more information, contact him at kevin.johnson@rsmi.com.