IRS Issues Guidance for Implementing the Commercial Buildings Deduction
By Craig DiLouie, Lighting Controls Association
Published early August 2006; updated August 21, 2006
The Energy Policy Act of 2005 (EPAct 2005) created a special tax deduction provision encouraging building owners to adopt energy-efficient building systems.
The Commercial Buildings Deduction allows owners to deduct the full cost of energy-efficient building systems in the year they are placed in service rather than depreciating their cost over time.
Regarding lighting, this Deduction can be implemented using available technologies and good lighting practice aimed at exceeding the national energy standard.
EPAct 2005 was signed into law about nine months ago and left writing parts of the Commercial Buildings Deduction provision up to regulators at the Departments of Energy and Treasury. They finally did in June, issuing a set of guidelines (Notice 2006-52; PDF; updated version) defining the process through which owners can claim the Deduction. While these are intended to be the final regulations, they may not be the final word from Treasury.
The Lighting Controls Association covered the Commercial Buildings Deduction last year when EPAct 2005 became law; this whitepaper builds on the material in this previous whitepaper. Click here to see this other whitepaper in case you need it for reference (opens in new window).
There are now three options for lighting that can result in the owner achieving additional financial benefits from adoption of lowest-lifecycle-cost lighting.
Options
The Commercial Buildings Deduction is effective until December 31, 2007, and has three options regarding lighting. In all cases, the building must be located in the United States or its territories, and the project must be in the scope of ASHRAE/IES Standard 90.1-2001 model energy code, which serves as the reference for the upgrade.
Complete Deduction: Lighting can be upgraded in efficiency as part of a building solution involving lighting, HVAC/hot water and building envelope. If the building upgrade achieves a 50% savings in total annual energy and power costs (lighting + HVAC/hot water systems) compared to a Reference Building meeting the minimum requirements of Standard 90.1-2001, then the owner can deduct the full cost of the more efficient systems, capped at $1.80/sq.ft.
Partial Deduction: The partial deduction allows the owner to upgrade either lighting OR HVAC/hot water OR building envelope. If this results in a 16-2/3 percent savings in total annual energy and power costs (lighting + HVAC/hot water systems) compared to a Reference Building, the owner can deduct the full cost of the more efficient system the year it’s placed in service, capped at $0.60/sq.ft.
Figure 1. Process map for completing qualification for Commercial Buildings Deduction (opens in new window) (updated 8/21).
Interim Lighting Rules: The Interim Lighting Rules were originally designed to be in effect until the partial deduction rules went into effect, but appear likely to stay in effect until the end of 2007, when the Deduction expires. (The final IRS regulations, however, state that they will expire when the Partial Deduction rules enter the IRS tax code, but this would mean they could expire before they could even be implemented.)
Under the Interim Lighting Rules, if the owner reduces interior lighting power density (LPD) (W/sq.ft.) by at least 25-40% of the minimum requirements in Table 9.3.1.1 or Table 9.3.1.2 of Standard 90.1-2001, the owner can deduct the full cost of the new lighting, capped at $0.30-$0.60 on a sliding scale.
Warehouses are the exception: The owner must achieve a reduction in lighting power by 50% to qualify for a maximum tax deduction of $0.60/sq.ft.
In addition, the Interim Lighting Rules require bi-level switching in all occupancies except hotel and motel guest rooms, store rooms, restrooms and public lobbies; require controls and circuiting that complies with Standard 90.1-2001; and require that light levels meet the minimum levels as published in the Ninth Edition of the IES Lighting Handbook. Note that the Partial Deduction rules do not require any of these items.
A possible glitch occurred in the final IRS rules. The IRS regulations include a formula that shows a different sliding scale than what’s in the original law. The IRS sliding scale is $0.00-$0.60/sq.ft. based on reducing LPD by 25-40%, while EPAct 2005 says it’s $0.30-$0.60/sq.ft. based on 25-40% savings. According to NEMA, the IRS version is in error and is expected to be corrected in the near future.
Figure 2. Process map for the Interim Lighting Rules (opens in new window).
What’s the Best Choice? Professionals involved in new construction can take any of the three choices, while professionals who provide lighting retrofit services will likely take the Partial Deduction or Interim Lighting Rules routes. Let’s compare these two routes in detail, including pluses and minuses.
Partial Deduction Rules:
Upgrade a lighting system and achieve total building energy and power cost savings of 16-2/3% compared to a Standard 90.1-2001 Reference Building. The maximum tax deduction is $0.60/sq.ft.
Pluses: You don’t have to do bi-level switching or mandatory lighting controls (unless it's a new construction or renovation project and local code requires it), and lighting controls count toward the energy reduction.
Tradeoff: You have to do a design certification, or total building energy analysis (lighting + HVAC/hot water).
Interim Lighting Rules:
Upgrade a lighting system and achieve LPD savings of 25-40% (all buildings covered by Standard 90.1-2001 except warehouses) or 50% (warehouses) compared to the applicable tables in Standard 90.1-2001. The maximum tax deduction is $0.30-$0.60/sq.ft. (all buildings except warehouses) or $0.60/sq.ft. (warehouses).
Pluses: You don’t have to do the building energy analysis/modeling (lighting + HVAC/hot water).
Tradeoff: You must install bi-level switching (or dimming) in most occupancies and also install lighting controls that are mandatory in Standard 90.1-2001, which are not counted in reducing LPD.
Bi-Level Switching
There has been a little confusion about what constitutes bi-level switching. Generally, bi-level switching is manual or automatic control (or a combination of the two) that provides at least two levels of lighting power in a space (not including OFF). NEMA has stated that bi-level switching typically produces 10-15 percent energy savings.
Dimming or switching can be used. It can be as simple as a split-ballasting system with the lighting assigned to two circuits, each controllable from a separate wall switch that is accessible to occupants (unless remote access is required for safety or security). The A/B switching can be based on alternate ballasts switching or alternate fixtures. From this basic scheme, other options become available. For example, the control can be a photosensor, occupancy sensor or input from a schedule instead of a wall switch, or alternatively dimming ballasts can be used that respond to a range of control inputs.
Design Certification
If one applies for the Complete Deduction or Partial Deduction, the design must be certified, meaning there must be energy modeling that demonstrates the required reductions in a proposed design compared to a reference design (that meets minimum Standard 90.1 requirements).
The IRS guidelines state that the Performance Rating Method (PRM) must be used when calculating the total building energy and power costs and comparing it to a Reference Building. The total power energy and power costs are the sum of the building’s interior lighting and HVAC/hot water. You subtract the costs of the proposed building from the Reference Building, and the difference is the savings. See LightingTaxDeduction.org in the near future for more information if you would like to take this route, as there are requirements that must be followed to calculate the Reference and Proposed Buildings.
Project Certification
If one applies for any of the three routes in the Commercial Buildings Deduction, the project must be certified to demonstrate that it meets all requirements of the law and therefore qualifies for the tax deduction.
The IRS recognizes “qualified individuals” as those who can perform the certification. These qualified individuals include engineers or contractors who are properly licensed as such in the jurisdiction where the building is located, and who demonstrate in writing to the taxpayer that they have qualifications to do the certification. According to NEMA, this individual cannot be an employee of the asset owner.
The certification must include:
- Contact information for the certifying individual;
- Address of the certified building;
- A statement that the new installed equipment meets the requirements of either the Complete Deduction, Partial Deduction or Interim Lighting Rules;
- A statement that the amount of the reduction was determined under the rules of Notice 2006-52 (the final IRS guidelines document; PDF);
- A statement that 1) field inspections after the building was placed in service confirmed that the building has met, or will meet, the energy-savings targets, 2) the field inspections were performed in accordance with the Energy Savings Modeling and Inspection Guidelines for Commercial Building Tax Deductions as published by the National Renewable Energy Laboratory (NREL), and 3) these procedures are in effect when the certification is given.
- A statement that the building owner has received an explanation of the energy efficiency features of the building and its projected annual energy costs.
- A statement that qualified computer software was used to calculate energy and power consumption and costs, along with identification of the software used.
- A list identifying the components used in improving the efficiency of the building and their projected annual energy costs.
- A sworn declaration that the certification is true, correct and complete.
Basically, you have to be an engineer or contractor licensed in the state where the building is located. You have to complete a field inspection according to defined procedures, and provide documentation and a declaration indicating the certification is accurate. NREL will publish the Energy Savings and Inspection Guidelines on its website, NREL.gov.
In a letter to the U.S. Treasury Department commenting on the IRS guidelines, NEMA has taken the position: "The
requirement of the Notice that this field inspection be performed in accordance with NREL procedures is
unnecessary and inappropriate for the interim rule, which is independent of energy-saving targets.
Qualified individuals already exist that can inspect an installation to assure that a lighting design that is
consistent with the prescriptive requirements of the interim rule has been installed in the building. There
is no need for new NREL requirements."
As of August 21, Treasury has not responded to these comments in an actionable manner.
Computer Software
Computer software can be used to calculate energy and power consumption and costs, but it must be recognized by the government.
The Department of Energy will be creating and maintaining a public list of recognized software programs at this webpage:
http://www.eere.energy.gov/buildings/info/qualified_software/
As of August 21, there were two software programs listed. One of these is for HVAC systems.
For the Interim Lighting Rules, any software can be used as long as it demonstrates the LPD reduction. In fact, software is actually not needed. According to NEMA (letter addressed to U.S. Department of Treasury commenting on IRS guidelines): "Compliance with the prescriptive method of the interim rule is readily determinable without the use of softare. Thus, a taxpayer is eligible for a Section 179D deduction with respect to a lighting system under the interim rule without demonstrating the use of qualified software."
Public Projects
Many in the lighting industry were interested in an item in the Commercial Buildings Deduction, which states that if the building is owned by a Federal, State or local government, the primary designer of the energy-efficient system gets the deduction. The law instructed IRS to create regulations defining how this would work.
Unfortunately, the IRS ignored this instruction and issued no such guidelines, and at this point there is nothing to indicate they will, leaving the law vague on this point.
More Information
There is an update planned for LightingTaxDeduction.org, a website produced by NEMA Lighting Systems Division, which explains these rules in greater detail. For other questions, contact NEMA or seek the consultation of a tax expert.
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