Integrate these tax strategies into your construction sales proposals for a competitive advantage.
Many construction companies that build commercial buildings need a competitive advantage to sell more buildings. Two different tax strategies may be available to your customers that you can integrate into your sales proposals at a relatively low cost to create a proposal with a much greater perceived value.
If you own a 10,000 square-foot (or larger) commercial building or a building that costs more than $750,000, you may be able to use these two often overlooked, yet very profitable tax deduction strategies—the energy efficiency tax deduction certification (Section 179D) and cost segregation studies. Both of these strategies reduce taxable income, decrease tax burdens, increase cash flow and reduce the need for outside funding sources.
My company recently performed a cost segregation study for a general contractor on a $6 million 50,000 square-foot manufacturing plant. After completing the study, the plant CFO told us that when she combined the mortgage interest for the building with the accelerated depreciation generated by the cost segregation study, they will generate an after-tax value of $31,500 for the building owner.
After we perform the energy efficiency tax deduction certification for the plant, the study will generate an additional $90,000 deduction from income or an after-tax value of $31,500 for the building owner.
Energy Efficiency Tax Deduction
Congress passed the Energy Policy Act of 2005 (EPAct 2005) to provide an incentive for commercial building owners to improve three types of energy conservation systems: the building envelope, lighting and HVAC.
The EPAct 2005 includes a tax deduction (provided under IRS Section 179 Deduction) up to $1.80 per square foot for investments in energy-efficient commercial building property designed to significantly reduce heating, cooling, water heating and interior lighting of newer or existing commercial buildings. To be eligible, the energy-efficient commercial building property must be built or remodeled appropriately between January 1, 2006 and December 31, 2013.
This energy efficiency tax deduction certification provides a one-time reduction of taxable income in the form of a Section 179 Deduction.
New buildings constructed today will qualify for the deduction if the building meets current codes that exceed the law’s energy efficiency requirements. Older buildings remodeled after January 1, 2006, will qualify for these benefits if they have been built appropriately to reduce energy costs.
For example, an owner would be entitled to a $180,000 deduction from his taxable income for a qualifying 100,000 square-foot building that meets the IRS criteria (because it would generate a maximum $1.80 square-foot deduction x 100,000 square feet).
To qualify for the full deduction, a building owner or building tenant must make investments designed to reduce total energy costs by 50 percent or more. A partial deduction of $0.60 per square foot is available for investments in one of three systems—lighting, heating and cooling, or building envelope—to reduce energy costs by one-third of the 50 percent requirement.
Lighting may receive up to a $0.30 to $0.60 deduction for reductions in lighting power density from the American Society of Heating, Refrigeration and Air Conditioning Engineers (ASHRAE) 90.1-2001 baseline (effective April 2, 2003)—a widely used industry standard.
Since most state building codes are based on the developed ASHRAE 90.1-2004 or later versions, almost all buildings in these states will qualify for some or all of the deductions even if they have been built to minimum standards. The tax deduction components include:
- Building Envelope $0.60 SF
- Lighting $0.30 to $0.60 SF
- HVAC $0.60 SF
- Total Maximum Deduction $1.80 SF
To claim the deduction, the taxpayer must obtain certification from an outside entity by an independent licensed engineering firm using modeling guidelines determined by the U.S. Department of Energy.
Many building owners who have improved their lighting systems assume they have already received their share of incentives from their local utility company, but this is not the case. While utility companies in many states provide rebates for each high-efficiency lighting fixture and sensor, the EPAct of 2005 is a legally separate federal government incentive that utility companies do not have to provide.
The EPAct of 2005 lighting system tax deduction is between $0.30 and $0.60 per square foot. It is certified by an outside firm, reduces taxable income and decreases the building owner’s tax burden.
One construction company owner we worked with discovered that the lighting systems he recently upgraded qualified him for over $85,000 in Section 179 deductions. The law allows owners to certify one, two or all three components as qualifying for the tax deduction, and now this construction company will be able to reduce their tax bill by almost $30,000.
But many wonder if the cost of the engineering certification study justifies chasing these tax deductions. The answer is yes. While most Americans have to settle for about 2.5 percent on a five-year CD, qualifying building owners can achieve an ROI greater than 100 percent on energy efficiency certifications.
A cost segregation study allows building owners to write off their building in the shortest amount of time permissible under the law. By reallocating costs to either real property or personal property, depreciation can legally be accelerated. Depreciation acceleration minimizes tax liability and increases cash flow in the early years of a building’s life when cash is typically short.
Personal property assets include a building’s non-structural elements, such as a wall covering, process equipment and related components (electrical service, process piping, air conditioning for machining equipment, etc.), overhead cranes, carpet, accent lighting, data-dedicated electrical components and exterior site improvements, such as sidewalks and landscaping. These assets can often be depreciated over three, five, seven or 15 years, rather than 27.5 or 39 years.
Often, for every $1 invested in a cost segregation study, the building owner will receive $10 back from the federal government.
Tax Burden Examples
To understand the value of these strategies, consider these two examples:
Tax burden without tax strategies:
- Gross Income$1,100
- Standard Depreciation-$100
- Net Taxable Income$1,000
- Federal Taxx34% = $340
Tax burden with energy efficiency tax deduction and cost segregation savings:
- Gross Income$1,100
- Cost Segregation Depreciation-$400
- Taxable Income$700
- Section 179D-$150
- Net Taxable Income$550
- Federal Tax x34%= $187
The net reduction in tax expenses equals $153 or a 45 percent reduction in tax payments.
The Energy Policy Act establishes a deduction for expenses incurred for energy-efficient commercial building property. This document describes the tax deduction provision in general: www.nema.org/gov/energy/upload/commbldgtaxdeduction.pdf