Authored by RSM US LLP
Executive summary: The real estate industry and the Inflation Reduction Act
In August of 2022, President Biden signed Public Law 117–169, 136 Stat. 1818, 2003, commonly referred to as the Inflation Reduction Act of 2022 (the Act) The Act provides for an array of tax credits intending to spur significant project development in the renewable energy space. These tax credits will affect businesses across various sectors. This article is part of a series on the effect of the Inflation Reduction Act on certain industries. This article will focus on the credits that affect the real estate industry. Prior articles include the Act’s impact on the clean fuels industry, manufacturers and excise taxes, automotive industry and the tax-exempt sector. While many questions remain on the implementation of these new incentives, Treasury is busy drafting additional guidance and has requested comments from affected stakeholders.
Renewable energy and real estate
Clean energy incentives – Overview
The Act includes many clean energy incentives affecting both developers and investors in the real estate industry. The Act extends and expands the energy investment tax credit which applies to those placing in service certain energy property – including solar, geothermal, energy storage/batteries, microgrid controllers and combined heat and power cogeneration systems. There have also been significant incentives to facilitate the purchase of passenger and commercial electric vehicles and refueling equipment.? The Act also provides for new opportunities for monetization of the credits by making them essentially refundable through the “direct pay” provisions for certain “applicable entities.”? In other situations, credits can be sold for cash under “transferability” provisions.?
Base and bonus rates – Apprenticeship and prevailing wage requirements
The Act makes significant changes by replacing the existing credit regime with a two-tiered system that provides a minimum “base” credit amount and an enhanced bonus credit (bonus credit) amount that is five times the base amount. In addition to the bonus credit, there may be opportunities to add additional bonuses for certain project locations or the use of domestic content. These amounts will vary depending on the relevant project. The bonus credit amount will be available only if certain prevailing wage and apprenticeship requirements are satisfied in connection with the relevant project.
To qualify for the bonus credit rates for many of the incentives, the taxpayer must meet certain apprenticeship and prevailing wage requirements. In general, for the apprenticeship requirements, the taxpayer must generally have a minimum ratio of hours worked and number workers that are in an apprenticeship program. Additionally, in order to satisfy the prevailing wage requirements, the taxpayer must pay at least the prevailing wages to its laborers, mechanics, contractors and subcontracts for a renewable energy project (as determined by the Secretary of Labor) during the construction of such project and with respect to subsequent alterations or repairs of the project following its placement in service.
Projects that began construction prior to Jan. 29, 2023, are deemed to meet the prevailing wage and apprenticeship requirements in order to claim the bonus credit o. For further coverage on the labor requirements see this article.
Developers can expect pressure from their customers to satisfy and substantiate the prevailing wage and apprenticeship rules in order for their customers to qualify for the bonus credit rate. Developers should be evaluating contract language and terms to consider these provisions.
Credit “adders” – Domestic content requirements; energy communities
The Act also provides for incremental tax credits for certain renewable projects that are placed in service after 2022 and meet certain “domestic content” requirements and/or are located in specified “energy communities.”
Domestic Content. An increased tax credit rate for certain renewable energy projects may apply for projects that meet certain domestic content requirements. To meet this requirement, taxpayers must ensure that the steel, iron or other manufactured products that comprise the project are produced in the United States. Generally, a manufactured product will be considered manufactured in the United States if a specified percentage of the total cost of the components is attributable to components that are mined, produced, or manufactured in the United States. Treasury released Notice 2023-38 with a portion of what to expect in the forthcoming proposed regulations. The specified percentage generally starts at 40% and increases to 55% in later years.
Energy communities. An increased credit rate may apply for certain projects located in an “energy community.” An energy community is either (1) a brownfield site; (2) a statistical area category that is, an area that has employment or local tax revenue related to extraction, processing, transport or storage of coal, oil or natural gas and an unemployment rate at or above the national average; or (3) a “coal closure community;” that is, census tract where a coal mine has closed or a coal-fired electric generating unit has been retired, or a census tract directly adjoining the mine or unit. An interactive map has been released to identify some (but not all) locations that qualify as an energy community. For further coverage, see this article.
Monetization
Important to project development and financing, the Act provides alternative ways to monetize renewable tax credits by allowing certain entities or projects to sell tax credits to third parties under section 6418. The provision allows for a one time only transfer all or any portion of an eligible credit to a third party for cash if the taxpayer elects to do so before the credit year’s tax return is due. The cash, however, would not be included in taxpayer income, nor be deducted on the third party’s income tax return. However, taxpayers would still have to reduce basis in the asset and would still be subject to the recapture rules.
The IRS released temporary and proposed regulations for section 6418. The temporary regulations require taxpayers to complete the mandatory pre-filing registration. After the IRS reviews the pre-filing registration submission, the IRS will then issue a registration number. A registration number is necessary to transfer credits under section 6418. The pre-filing registration must be completed electronically through an IRS electronic portal which is expected to be available by Fall 2023. Registration numbers are only valid for one year and for the taxable year for which it is obtained.
As an alternative to the transfer of credits, elective payment or direct pay is available to applicable entities. An applicable entity includes state or local governments, tax-exempt entities and tribal governments. To learn more regarding tax exempt entities, you can read additional information in a previous article
Production of electricity from renewable resources
Developers of utility-scale electricity generation projects, including once again solar energy projects, are interested in the Act’s revisions to the section 45 production tax credit. Further, tax equity investment in these projects continues to be of interest while the market for monetization of credits is in its infancy.
Under the Act, the renewable electricity production credit (section 45) was extended and a new technology neutral production tax credit (PTC) was added effective for facilities place in service after Dec. 31, 2024. For facilities that begin construction before Jan. 1, 2025, the PTC provides a tax credit for each kilowatt of electricity produced from qualifying facilities and sold to an unrelated party.
Of particular interest for developers, the provision also revives the PTC for solar energy (previously sunset in 2006) for certain facilities. The expanded provision generally provides a credit of 2.5 cents per kilowatt hour (0.5 cents per kilowatt hour and if new apprenticeship and prevailing wage requirements are not met). In order to claim the credit at the higher credit rate, taxpayers must satisfy the prevailing wage requirements for the entire duration of the construction of the project and for each year during the 10-year credit period, and apprenticeship requirements during the construction of the project.
In addition, if a facility meets certain domestic content requirements, the credit rate is increased by 10%. The section 45 credit is eligible direct pay for applicable entities and transferability for others.
Energy investment tax credit
The new and modified provisions of the Act will incentivize the use of certain clean energy technologies that may previously have not been financially viable in the past. We are seeing more interest in the use of technologies in construction projects such as solar panels, geothermal systems, energy storage and microgrid controllers and dynamic glass. These technologies are being added to many types of projects from manufacturing facilities to office buildings and universities, to residential communities. With an increased focus from customers on sustainable and carbon-neutral technologies, it is expected that more developers will be incorporating these technologies into projects.
The Act extends and expands the section 48 Investment Tax Credit (ITC) through 2024 and creates a technology neutral ITC for property placed in service beginning in 2025. The provision generally provides a credit rate of 30% of the basis of energy property (6% if labor requirements are not met). To claim the ITC at the bonus credit rate, taxpayers must generally satisfy the prevailing wage and apprenticeship requirements.
The Act expanded the ITC to include energy storage technology, biogas property, microgrid controllers, dynamic glass, interconnection property, and linear generators placed in service beginning January 1, 2023. These technologies are also eligible for a 30% credit rate (6 % if the taxpayer does not meet the labor and apprenticeship requirements).
In addition, credit adders of 10 percentage points for domestic content and an additional 10% points for locations in an energy community may apply. An additional credit adder may apply for wind or solar projects located in low-income communities. For further information, see a previous tax alert.
This credit is eligible direct pay for applicable entities and transferability for others.
Alternative fuel refueling property; EV chargers
The addition of EV chargers is becoming standard practice at most new real estate construction projects as customer demand increases. The alternative fuel vehicle refueling property credit is a credit for the installation of alternative fuel vehicle property used in a trade or business or installed at the taxpayer’s residence. Real estate investors may be particularly interested in charging stations for use by employees, customers and residents.
The new provision provides a 30% credit (6% if labor requirements not met) for taxpayers who place in service certain qualified alternative fuel refueling property.
The total is limited to $100,000 for each qualified property that is subject to depreciation and $1,000 for any other property. Developers and investors should pay particular attention to the location of the property as this credit now only applies to alternative fuel vehicle property located in non-urban areas or areas that are eligible for new market tax credits.
Energy efficient commercial building deduction
The addition of property such as LED lighting and energy efficient HVAC systems is becoming standard for many new commercial buildings. Section 179D or the energy efficient commercial building deduction was originally enacted by the Energy Policy Act of 2005 to encourage building owners to install energy efficient property. Energy efficient property includes interior lighting, HVAC and hot water systems, as well as building envelopes.
In order to incentivize green building projects further, the Act considerably increased the section 179D energy efficient commercial building deduction. For buildings placed in service after Dec. 31, 2022, the Act provides a sliding scale tax deduction base of $.50 cents/sqft up to $5/sqft on a sliding scale for taxpayers who qualify. Qualifications for the accelerated deduction include meeting specific prevailing wage and apprenticeship requirements for all contractors and subcontractors involved during construction.
Qualifying taxpayers under 179D are those taxpayers that are entitled to depreciate the property. This can include the owner of the building or a lessee that installs and pays for the property as well as real estate investment trusts (REITs).
For existing buildings, the “retrofit” deduction requires a building’s energy cost to be reduced by a minimum of 25% of the building’s own specific level of pre-retrofit site energy usage intensity (EUI). The deduction increases for each percentage point of reduced energy use thereafter up to $5/sqft as a bonus rate when labor standards are met. Some things to consider; in addition to the labor standards requirement to qualify for the bonus rate, the building must be five years or older to qualify for the “retrofit” 179D deduction, must have a qualified retrofit plan certified by a professional engineer or registered architect, and the deduction is capped at the plan’s cost. In addition, the retrofit deduction can only be claimed by the taxpayer after the equipment is in service for one year and the project results in anticipated site EUI reductions.
Prior, section 179D was a single use only tax deduction for the lifetime of the building, however, the updated legislation provides for additional 179D deductions to be claimed every three years by the taxpayer if subsequent energy cost reductions are made. For tax exempt organizations the 179D deduction can be claimed every four years.
Incentives for home builders
For the construction of new homes, the Act made significant changes to the section 45L or new energy efficient home credit that went into effect after Dec. 31, 2022. To qualify, the taxpayer must proactively take steps to meet certain requirements during the entire construction process.
The new efficiency targets require eligible contractors meet the conditions of certain Energy Star Programs or the Department of Energy’s Net Zero standards. The Energy Star standards contain requirements to satisfy both national and local standards, although separate standards apply for manufactured homes. The new law distinguishes multifamily from single family construction.
The IRA adds a special enhanced credit for qualifying multifamily residences that meet prevailing wage requirements. If builders do not meet the zero energy ready home requirements, but do meet the prevailing wage requirements, the credit equals $2,500 per residence. If builders meet the zero energy ready home requirements in addition to prevailing wage requirements, the credit is $5,000 per residence.
It is important to note that the process to obtain Energy Star or DOE Net Zero certification requires a proactive approach and that the credit only applies to homes sold or leased before Jan. 1, 2033.
Washington National Tax Takeaways
The Act has provided the real estate industry with expanded incentives for construction and investment in clean energy projects a. The addition of clean energy components to a project will not only provide energy security but will also meet consumer demand and attract ESG-focused investors, buyers and tenants.
The provisions outlined above are a major expansion of existing clean energy incentives. Developers and investors should evaluate all potential credit opportunities and modeling the financial impacts on adding clean energy property to their projects. However, new labor requirements must be followed and documented to maximize the potential incentives.
As mentioned above, the Act now allows for the transferability of some credits that creates new opportunities for taxpayers who may not have been able to take advantage of credits due to a lack of taxable income. There are still many unknowns with respect to the marketability on these credits including appropriate valuation for risk, penalties on excessive claims, contract clauses to protect buyers from undue risk, and the potential need for tax insurance to mitigate tax risk.
As the Act’s impact on the real estate and construction industry continues to settle, it is important to take advantage of the opportunities, document compliance with the requirements and mitigate the potential risks. Documentation, recordkeeping and substantiation requirements for prevailing wage and apprenticeship requirements could be critical to maximizing the incentives. While the incentives in the Act as well as the ability to transfer credits in exchange for cash could provide a significant boost to real estate projects, it is critical to anticipate the risks and requirements that may be required to take advantage of the incentives. Taxpayers should work with their tax advisors to assist with the energy credit planning to ensure the proper credit rates are applied and available bonus rates and other adders are substantiated.
This article was written by Deborah Gordon, Christian Wood, Brent Sabot, Heather Rosas and originally appeared on Jun 29, 2023.
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