Much of the Inflation Reduction Act signed into law in late 2022 contains provisions intended to combat climate change, largely through tax incentives. Such tax breaks aren’t usually relevant to the work of nonprofits. But if your organization is constructing new facilities or adding improvements, the Act’s changes to one tax deduction could benefit your organization.

Tax break becomes permanent

IRS Section 179D deduction for energy-efficient commercial buildings was made permanent by the Consolidated Appropriations Act of 2021. At that time, the deduction generally was available only to the owners of commercial properties and certain residential properties. Government entities with qualifying buildings could use the deduction by assigning it to qualified “designers.”

A qualified designer creates technical specifications for the installation of energy-efficient commercial building property. Installation, repair or maintenance of such property isn’t sufficient to qualify. Designers include architects, engineers, contractors, environmental consultants and energy services providers.

New rules

To qualify for the deduction before the Act, a taxpayer had to establish a 50% reduction in energy and power costs. The maximum deduction was $1.88 per square foot (adjusted for inflation). This meant it was worth as much as 63 cents per square foot for each of three eligible systems: HVAC and hot water, interior lighting, and building envelope. Taxpayers could claim the deduction once per property.

Under the Act and beginning in 2023, the qualification threshold drops to 25% energy savings. The base deduction amount is 50 cents per square foot, but a “bonus deduction” could substantially increase the deduction. To qualify for this bonus (up to $2.50 per square foot), projects must satisfy prevailing wage and apprenticeship requirements. The deduction amount also increases as energy savings exceed 25% — up to $5 per square foot for projects that also meet the labor requirements. And the credit can be taken on a specific building every three years.

Benefit for nonprofits

How do these changes help nonprofits? The Act now permits all tax-exempt entities, not just governmental entities, to allocate their deductions to qualified designers. This could reduce your organization’s costs on construction projects that incorporate sustainable materials. You may already have prioritized the use of such materials because it aligns with your mission and values or simply to cut future utility expenses.

Let’s say you plan to build a 40,000-square-foot, LEED-certified building and to meet the labor requirements. You’ll have $200,000 in tax deductions to allocate to qualified architects, engineers and other construction professionals. You can allocate the entire deduction to a single designer or make proportional allocations to multiple designers. That can help you negotiate a better overall price on the project than you would if you weren’t able to allocate. 

The exact deduction amount will be determined through a “Section 179D study” obtained by the designer. The study is performed by a qualified contractor or professional engineer. Among other things, this third party will have to make a site visit to your property to confirm that it has met or will meet energy savings requirements. You’ll also need to sign an allocation letter that includes the following:

• The cost of the energy-efficient property (including labor), 
• The date the property is placed in service, 
• The amount of the Sec. 179D deduction allocated to the designer, and
• A declaration that the information presented in the letter is true and complete to the best of your knowledge and belief.

Note that you can’t seek, accept or solicit payments from a designer in exchange for providing an allocation letter. Nor can you require a designer to pay you a portion of the deduction’s value. Both of these practices would constitute an illegal kickback.

Cover your bases

Your preferred architect, engineer or other type of qualified designer may not have experience working on a project involving the allocation of the Sec. 179D deduction. We can help ensure you jump through all of the necessary hoops and negotiate deals that reflect the value of the deduction.

Sidebar:  Do you qualify for cash refunds for tax credits?

In addition to expanding availability of the IRS Section 179D tax deduction (see main article), the Inflation Reduction Act makes another major change to energy-related tax incentives that could help nonprofits save money. It allows eligible organizations to receive certain tax credits — which otherwise would be of little use to nonprofits that pay no income tax — as direct payments from the IRS.

Nonprofits now may elect to receive a variety of credits as cash payments, including the following:

• Investment Tax Credit,
• Production Tax Credit,
• Credit for Qualified Commercial Clean Vehicles,
• Advanced Manufacturing Production Credit,
• Alternative Fuel Refueling Property Credit,
• Credit for Carbon Oxide Sequestration,
• Zero-Emission Nuclear Power Production Credit,
• Credit for Production of Clean Hydrogen,
• Clean Fuel Production Credit, and
• Advanced Energy Project Credit.

The IRS will make the credit payments after an eligible nonprofit files its return for the applicable year.