The Inflation Reduction Act, signed into law by President Biden on August 16, 2022, includes provisions for a range of new government initiatives. Notably for nonprofit organizations, among the new programs included in the Act is a dramatic increase in eligibility for the energy-efficient commercial building deduction, otherwise known as Internal Revenue Code (IRC) Section 179D.
The new legislation included in the Inflation Reduction Act increases the amount eligible to be deducted while also extending eligibility to tax-exempt entities. This marks an exciting opportunity for nonprofit organizations planning to engage in construction projects.
In this briefing, we will provide an overview of the changes to Section 179D and explore the benefits these changes offer to tax-exempt organizations including schools, arts and culture organizations, and more.
Originally enacted as a temporary tax deduction in 2005 and later made permanent in 2020, Section 179D provides tax deductions to encourage the construction of energy-efficient buildings. Developers were previously able to claim a tax deduction that enabled them to save money while increasing the energy efficiency of their properties. The deduction also applied to retrofit projects that upgraded an existing building’s energy efficiency.
Previously, Section 179D only applied to for-profit entities and government-owned buildings. The deduction was primarily taken by commercial building owners, including commercial and multi-family real estate developers. While these groups can still avail themselves of this deduction, the qualification criteria have now been expanded to include tax-exempt organizations.
Until the passage of the Inflation Reduction Act, the deduction was set at $1.88 per square foot. This has now been increased to a maximum of $5 per square foot. It’s important to note that this is not a flat $5 per square foot deduction––deductions are calculated on a sliding scale based on the energy-saving performance criteria.
In addition to the increased value of the deduction, the Inflation Reduction Act also expanded eligibility for IRC Section 179D to include buildings owned by tax-exempt organizations.
This applies to property placed in service after December 31, 2022, and includes nonprofit organizations such as private schools, universities, museums, art galleries, performing arts venues, and more. This represents a major opportunity for nonprofit organizations in the midst of planning or negotiating new construction projects.
Section 179D previously only allowed these deductions to be taken by commercial building owners or designers of buildings owned by government entities (such as public schools). Now, these deductions can be allocated toward designers of buildings owned by nonprofit organizations.
For nonprofits, this represents a powerful new negotiation tool. Instead of claiming the deduction on their own tax return, nonprofits can choose to allocate the tax deduction to any architect, designer, engineer, or other qualified entity that contributed to the design or construction of the building.
This allows nonprofit leaders to propose allocating this tax deduction to construction partners in exchange for certain concessions, such as a reduction in the contract value or waived change order fees.
If you’re a nonprofit leader currently in the process of planning or negotiating a new construction project, these changes offer major benefits. Here is a brief example:
A tax-exempt museum is planning to construct a new wing covering 50,000 square feet to house a series of new collections. They plan to complete construction to the highest-possible energy efficiency standards.
Previously, as a tax-exempt organization, the museum would not have been able to claim any deductions under IRC Section 179D. With the passage of the Inflation Reduction Act, the museum is now able to claim a $250,000 tax deduction (50,000 sq. ft. x $5/sq. ft deduction).
This deduction could be claimed directly by the museum; however, if the museum does not report significant taxable income, there is little to no benefit to the museum in claiming this deduction. Alternatively, the museum may allocate the deduction to a tax-paying architect, designer, or engineer who contributed to the project in return for some form of contractual concession.
While these changes clearly offer significant benefits, the process to report or allocate the deduction is being developed. The IRS is aiming to standardize the process of claiming this deduction through Form 7205 and is currently accepting comments. Against this backdrop of uncertainty, for nonprofits to successfully claim or allocate this deduction for their construction projects, it’s important they have the support of an experienced nonprofit accounting firm.
The accounting and tax needs of nonprofit organizations are markedly different from those of for-profit organizations. For nonprofits to build a robust financial infrastructure and maximize their performance, a partnership with an experienced nonprofit accounting firm can be invaluable.
At Smith and Howard, our specially trained nonprofit accountants are honored to work with leading tax-exempt organizations all across the nation, providing a wide range of services including accounting, assurance, and tax services.
Our dedicated professionals diligently track new developments that affect the organizations we work with and closely study new legislation such as the Inflation Reduction Act to discover opportunities such as the eligibility expansion of IRC Section 179D.
To learn more about Smith and Howard’s nonprofit accounting services and discover how your organization can benefit from recent changes to the tax code, contact an advisor today.
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