By Chris Heuer, Kevin Pearson, and Adam Kobos

Until recently, cost has been one of the biggest obstacles to “green building,” which is the application of sustainable development principles to the construction of buildings. Although the costs of developing green buildings are beginning to approach those of traditional buildings, new tax credit and financial incentive programs also are helping to make green-building projects more attractive. Federal, state, and local governments are discovering that high-performance buildings, including both new construction and retrofits of existing buildings, are good for the environment and generate economic benefits by reducing building operations and maintenance costs. Reflecting this new understanding, a variety of state and federal legislation has been passed that provides a mixture of tax incentives, rebates and other financial assistance to encourage additional growth in the rapidly developing green building industry.

This article provides a general overview of three significant federal tax incentives for green building: the energy efficient commercial building deduction, the energy efficient home tax credit for builders, and the investment-based energy income tax credit. Although these tax incentives are set to expire December 31, 2008 and it is not certain that the sunset dates will be extended, a variety of proposed legislation that would extend these incentives is pending. Even where it is not possible to meet the December 31, 2008 deadlines applicable under current law, it is important to plan for the likelihood that some or all of these federal tax incentives may be renewed.

The energy efficient commercial building deduction
Section 179D of the Internal Revenue Code of 1986, as amended (the “Code”), allows a commercial building owner to deduct part or all of the cost of certain “energy efficient commercial building property” placed in service after December 31, 2005 and before January 1, 2009. The amount of the deduction generally is equal to the cost of qualifying property placed in service during the taxable year, subject to a lifetime cap per building of $1.80 per square foot. The tax basis of the property for purposes of calculating depreciation deductions and gain or loss on a disposition is reduced by the amount of the Section 179D deduction.

“Energy efficient commercial building property” generally means property that meets all of the following requirements:

• The property must be depreciable or amortizable (i.e., buildings and equipment, but not land);
• The property must be installed on or in a building located in the United States that is within the scope of Standard 90.1–2001 of the American Society of Heating, Refrigerating, and Air Conditioning Engineers and the Illuminating Engineering Society of North America as in effect on April 2, 2003 (“Standard 90.1–2001”);
• The property must be installed as part of (1) the interior lighting systems of a building; (2) the heating, cooling, ventilation and hot water systems of a building; or (3) the building envelope; and
• The property must meet certain certification requirements, described below.

To qualify as energy efficient commercial building property, property must be certified as being installed as part of a plan designed to reduce the total annual energy costs with respect to the interior lighting systems and the heating, cooling, ventilation and hot water systems of a building by 50 percent or more in comparison to a reference building that meets the minimum requirements of Standard 90.1–2001.

This standard is intended to be fuel neutral—in other words, the same energy efficiency features qualify for the deduction regardless of whether the heating source is a gas furnace or an electric heat pump. The required 50-percent reduction must be met solely through energy cost reductions for the interior lighting systems and the heating, cooling, ventilation, hot water systems.

Reductions in any other energy uses are not taken into account in determining whether the 50-percent reduction is achieved. However, the calculation methods for the 50-percent reduction are intended to take into account savings for alternative design methods and technologies not otherwise credited in Standard 90.1-2001—for example, natural ventilation, evaporative cooling, automatic lighting controls, and daylighting. The required certification must be completed by a qualified individual using qualified software and must include inspection and testing to ensure compliance with energy-savings plans and targets.

Even if a building does not meet the 50-percent requirement described above, a Section 179D deduction may be available if property comprising one of the qualifying systems (i.e., the interior lighting systems; the heating, cooling, ventilation and hot-water systems; or the building envelope) reduces the total annual energy costs with respect to the combined usage of the building’s interior lighting systems and heating, cooling, ventilation, hot water systems by a certain percentage as compared to a reference building. Taxpayers currently may choose between two sets of energy-savings targets.

Under the first option, a partial deduction requires a 10-percent reduction in energy costs for the interior lighting systems, a 20-percent reduction in energy costs for the heating, cooling, ventilation and hot water systems, or a 20-percent reduction in energy costs for the building envelope. Under the second option, a partial deduction requires a 16.67-percent reduction in energy costs for one or more of the qualifying systems. For partially qualifying property, the lifetime cap on the deduction for each qualifying system in any building is $0.60 per square foot.

Special interim rules apply to property installed as part of the interior lighting system of a building before the publication of final regulations under Section 179D. A partial deduction may be available if the interior lighting systems incorporated into the building achieve a reduction in lighting power density of at least 25 percent (50 percent in the case of a warehouse) of certain minimum requirements specified in Standard 90.1-2001 and certain other requirements are met.

The deduction for energy efficient commercial building property installed in a building owned by a federal, state, or local government may be allocated to the designer of the building. For this purpose, the designer is the person who created the technical specifications for the installation of energy efficient property (e.g., an architect, engineer, contractor, environmental consultant or energy services provider). A person who merely installs, repairs, or maintains the property is not a designer. If there is more than one designer, the building owner may allocate the deduction either to the designer who is primarily responsible or among several designers. The allocation of the deduction must be in writing and must meet other specified requirements.

The energy efficient home tax credit for builders
Section 45L of the Code allows a tax credit of up to $2,000 for builders of “qualified new energy efficient homes,” including manufactured homes constructed in accordance with the Federal Manufactured Home Construction and Safety Standards.

A home is a “qualified new energy efficient home” if:

• • it is located in the United States;
• • its construction is substantially completed after August 8, 2005;
• • it meets certain energy savings requirements;
• • it is acquired from an eligible builder after December 31, 2005 and before January 1, 2009 for use as a residence.

A home qualifies for the full $2,000 credit if:

• • the building is certified as reducing energy consumption by 50 percent compared to a home that was constructed in accordance with certain national and international standards;
• • building-envelope improvements account for at least one-fifth of the 50-percent reduction.

A manufactured home qualifies for a $1,000 credit if:

• • it is certified as reducing energy consumption by at least 30 percent and building envelope improvements account for at least one-third of the 30-percent reduction;
• • it complies with requirements under the Energy Star Labeled Homes program.

To meet the certification requirements, a home must be certified by a person who is accredited or authorized by the Residential Energy Services Network, or an equivalent rating network that performs such certifications, using software approved by the Internal Revenue Service. The tax basis of the property for purposes of calculating depreciation deductions and gain or loss on any disposition is reduced by the amount of any credit taken.

Energy credit for solar energy property
A third set of incentives applies to solar energy equipment. Section 48 of the Code provides a nonrefundable income tax credit equal to 30 percent of the tax basis of any “energy property,” including certain solar energy equipment that is placed in service during a tax year. To qualify for the 30-percent credit, energy property must be placed in service before January 1, 2009.

“Energy property” includes depreciable equipment that uses solar energy to generate electricity, heat or cool a structure, provide hot water to a structure, provide solar process heat, or illuminate the inside of a structure using fiber-optic distributed sunlight, but does not include solar equipment used to heat a swimming pool. The tax basis of the solar energy equipment for purposes of calculating depreciation deductions and gain or loss on any disposition is reduced by 50 percent of the amount of any credit taken. If the taxpayer financed the project in whole or in part with subsidized energy financing or tax-exempt private activity bonds, the basis on which the credit is calculated is reduced.

Under current law, beginning January 1, 2009, the amount of the credit will decrease to 10 percent of the tax basis of energy property, and equipment that uses solar energy to illuminate the inside of a structure using fiber-optic distributed sunlight will no longer qualify for the energy credit.

In addition to the investment-based energy tax credit, solar energy property may qualify for greatly accelerated depreciation deductions. Solar property that qualifies for the tax credit generally also qualifies for depreciation deductions over five years using the double-declining balance method, which can generate significant tax savings.

A developer that has little or no ability to use tax credits (e.g., because it has little or no taxable income) may nevertheless be able to obtain the benefit of the energy credit and the accelerated depreciation deductions by entering into an arrangement with an investor that is able to utilize the credits. For example, a developer could enter into a partnership with an investor that is willing to contribute cash to help finance the solar facility. The partnership could then operate the facility and, within certain limits, the energy credit could be allocated to the partner able to utilize the credits. This and other potential techniques for “monetizing” the energy credit require careful tax planning.

Conclusion
The federal tax incentives for green building can make a significant impact on a project’s bottom line. Congress’s reluctance to make the incentives permanent is unfortunate, but many experts expect that Congress will renew these tax incentives before they expire at the end of 2008. In the meantime, developers would be well served to analyze the impact these tax incentives would have if property is placed in service before the relevant sunset date or if the sunset dates are extended. Finally, while federal tax incentives can be a significant part of financing a green building project, it is important to investigate the full array of financial incentives, both public and private, that are available for green buildings. SLDT

About the authors: Chris Heuer (503-294-9206; This e-mail address is being protected from spam bots, you need JavaScript enabled to view it ), evin Pearson (503-294-9622; This e-mail address is being protected from spam bots, you need JavaScript enabled to view it ), and Adam Kobos (503-294-9246; This e-mail address is being protected from spam bots, you need JavaScript enabled to view it ), are ttorneys at Stoel Rives LLP, a leading provider of legal services to developers of and investors in sustainable projects.