Disconnects between building managers and accountants result in millions of dollars in lost tax credits. I meet thousands of professionals each year and few seem to know/remember the benefits of the Federal Tax Extenders Act, which can transform four-year payback projects into two-year projects.
Signed into law in December 2015, the legislation enabled a significant $1.80 per square foot deduction for energy-saving equipment. Note that this deduction is in addition to the standard deduction for capital investment. Also, this special deduction is not tied to the equipment’s capital value. For example, if you right-sized your lighting last year, your deduction is based on the square feet of the corresponding area, not the cost of equipment.
Below are two case studies about the benefits of the special tax deductions for energy efficiency projects completed during 2016. If these tax deductions apply to you, file an extension if you have not claimed them. If the federal government allows these deductions in 2017 and future years, you will reognize the potential savings to your organization.
Case Study 1: A For-Profit Company
Consider a small 8,000-square-foot building with standard fluorescent lighting and a 16-year-old, 20-ton, split-system HVAC. In 2016, $20,000 was invested to upgrade to LED lighting and new HVAC coils/condensers, which improved energy efficiency and reliability. The LEDs were the “snap in” style that I have mentioned in a previous BUILDINGS article. Four new 5-ton condensers were installed (requiring new refrigerants and interior coils). Exterior lighting was also upgraded, and most of the retrofit qualified for utility rebates.
Let’s take a look at the numbers from an after-tax standpoint. Assuming a conservative 30% tax rate, a $100 tax deduction would be worth about $33 in cash value to the taxpayer.
Project Total Cost = $20,000
Utility Rebate = $ 1,760
Standard Tax Benefit (Retrofit is a Deductible Maintenance Expense) = ($20,000)*(.3) = $ 6,600
Special Tax Benefit= ($1.8/ft2)*(8,000)*(.3) = $4,320
Net after-tax cost = $7,320
Note: If your retrofit is comprehensive enough, you may not be able to claim it as “maintenance.” Your accountant may want to capitalize the new assets and depreciate them over a longer period. However, you may also use the 179d tax deduction to immediately depreciate up to $500,000 of new assets, so make sure your accountant knows about IRS Publication 179d.
If you consider that this project yields about $5,000 per year in savings, the rate of return on this investment is approximately 68%. Without considering the special tax benefit, the return would have been only 43%. These economic projections incorporate the energy savings alone, but there would be other benefits, such as reliability and comfort.
Case Study 2: A Nonprofit Organization
If you are an architect, consultant, contractor or designer and were involved in an energy upgrade at a nonprofit organization, you can claim the deduction on your return because the nonprofit cannot do so. There are some conditions, but they are easily satisfied by the documentation that most energy engineers would generate anyway. The requirements are listed in this IRS publication, which the 2015 legislation extended for the 2015 and 2016 tax years.
If you do apply for a tax deduction for a nonprofit’s project, you can offer to share the cash savings with the nonprofit, a benefit that can help to sell a project to a client.
In this example, a 50,000-square-foot building with outdated fluorescent lighting upgraded to LEDs at a cost of $32,000. Because only the lighting and not the HVAC was upgraded, the deduction was limited to $0.60/square foot deduction. To be conservative, let’s assume a 30% tax rate for the designer and thus $33 in cash value for a $100 tax deduction.
Therefore, the additional tax benefit that was available:
= (50,000 square feet) * ($0.60/square foot)
= $30,000 in extra tax deductions that are not linked to any assets so no need for additional depreciation calculations
The cash value of the deductions on this project:
= ($30,000) * (.3)
If you shared 50%, you would pocket $5,000 in cash value and so would your nonprofit client. With a number of such projects, the accumulated deductions might put you into a lower tax bracket or drop your taxes to zero!