The Inflation Reduction Act (IRA), a truncated version of the original Build Back Better legislation, is an unprecedented federal investment in mitigating the effects of climate change. According to the Congressional Budget Office’s estimate, the bill will provide $391 billion for energy efficiency upgrades, controls on greenhouse gas (GHG) emissions, and clean energy manufacturing, production, and transmission. However, several analysts believe that this figure undercounts the actual cost of the bill, with independent estimates varying from $500 billion (McKinsey) to $1.2 trillion (Goldman Sachs).

This federal spending will help reduce US GHG emissions to roughly 40% of 2005 levels by 2030, according to several independent analyses. Despite its name, the IRA is therefore actually a climate bill that uses subsidies and tax credits — that is, carrots rather than sticks — to promote clean energy and reduce anthropogenic GHG emissions.

To achieve that reduction, the IRA has put in place numerous incentives for most sectors of the economy. Four of the most important provisions for commercial real estate are the revised and expanded Commercial Buildings Energy Efficiency Tax Deduction (Section 179D), the DOE Zero Energy Ready Home (ZERH) Tax Credit (Section 45L), the Investment Tax Credit (ITC) (Section 48), and the Alternative Fuel Vehicle Refueling Property Credit (Section 30C) for installation of electric vehicle charging stations.

Section 179D: A Well-Intentioned Energy-Efficiency Incentive That Fell Short of its Goals

Congress established the Section 179D tax deduction in the Energy Policy Act of 2005 as an incentive for developers and building owners to implement energy-saving measures. Any building that implemented at least a 50% reduction in energy consumption (compared to buildings that met basic standards set by the American Society of Heating, Refrigerating and Air-conditioning Engineers (ASHRAE)) qualified for a $1.80 per square foot tax deduction.

While ASHRAE’s codes are reasonable for newer buildings, they are somewhat stringent for many older buildings. 75% of buildings in the U.S. have been built prior to 2000. Though they could easily have been retrofitted to reduce energy consumption, they didn’t qualify for deductions large enough to make retrofitting profitable under ASHRAE’s standards. Therefore, the main shortcoming of Section 179D was that these energy-saving measures were not well incentivized - the cost of making the improvements often outweighed the tax benefit.

Additionally, real estate investment trusts (REITs) — which are required by law to disburse most of their profits to shareholders — had limited access to Section 179D deductions from their taxable income.

The IRA Addresses the Shortcomings of Section 179D

To a large extent, the IRA addresses these issues.

1. The bill increases the Section 179D deduction from $1.80 per sq. ft. to a sliding scale ranging from $2.50 to $5.00 per sq. ft., depending on the efficiency gains relative to ASHRAE standards.

2. Existing older buildings are measured against themselves so that efficiency gains from retrofitting are now more likely to qualify for the Section 179D tax benefit. This is a crucial change for owners and developers pursuing value-add opportunities.

3. The bill also contains a provision that enables REITs to reduce their taxable earnings and profits by the Section 179D deduction amount in the year energy improvements are made. This will provide an immediate financial benefit to shareholders of any REIT associated with such improvements.

The IRA Offers a Fair Wage Bonus

One important caveat: the increased Section 179D benefits are only available to developers and owners who pay workers at prevailing-wage rates or higher. Otherwise, the maximum benefit is only $1.00 per sq. ft. as opposed to the standard $1.80 under prior law. This type of two-tiered benefit structure that rewards developers and property owners for having a positive socio-economic impact as well as facilitating energy improvements is characteristic of the IRA.

Incentivizing Energy-Efficiency Upgrades

HEEHRA: High-Efficiency Electric Home Rebate Program

The IRA provides $4.275 billion in grants to State Energy Offices and $224 million to Indian tribes for home electrification rebate programs. The High-Efficiency Electric Home Rebate (HEEHRA) Program is designed to offer rebates for qualified electrification projects, including point-of-sale consumer rebates and developer rebates for multifamily buildings. It provides up to $14,000 per unit for multifamily properties meeting specified income criteria, which lowers costs for developers and incentivizes them to make energy efficiency upgrades.

According to analysis from electrification nonprofit Rewiring America, installing modern, electrified furnaces and water heaters would enable 85% of U.S. households - 103 million - to reduce their energy bills, with a large majority - nearly 65 million households - saving an average of $496 annually.

Section 45L Tax Credit: Zero Energy Ready Home Program

The Section 45L tax credit was created alongside the Section 179D deduction under the Energy Policy Act of 2005. Like the Section 179D deduction, the Section 45L tax credit encourages developers and property owners to make energy-efficiency upgrades to their buildings. It can be availed of in addition to the Section 179D deduction.

Section 48: Offsetting the Cost of Energy Assets

The IRA has also increased the Section 48 Investment Tax Credit (ITC) from 26% to 30%, which it extends through 2033 followed by a phase-out period. Specifically, the Section 48 ITC enables developers and property owners to offset their annual taxable income by 30% of the “fair market value” (determined by an eligible appraiser) of certain energy assets (like solar systems and heat pumps), if these assets are installed for energy efficiency upgrades. The IRA also covers expenses connected to improved energy storage — for example, thermal energy storage and dynamic glass, biogas, and other investments that ultimately enhance energy efficiency. 

The Low-Income Communities Bonus

Like the two-tiered structure of the 179D and 45L clauses, the 48 ITC clause offers significant bonuses to promote other goals besides energy efficiency, such as development in low-income communities. The Low-Income Communities Bonus Credit program increases the 48 ITC by 20%, which means a 30% solar credit can become an annually recurring 50% credit for multifamily buildings in low-income communities through 2033. These provisions make value-add projects — already exceptionally lucrative propositions in the currently distressed commercial market — even more profitable when undertaken in low-income communities.

Since the steep upfront costs of making energy improvements often outweigh the long-run savings of these improvements, the substantial credit offsets under Section 48 — potentially 70% of the value of qualifying energy assets — will increase the feasibility of these upgrades for otherwise underfunded developers and property owners.

Section 30C: Incentivizing Installation of EV Charging Stations

The Section 30C tax credit for building electric vehicle (EV) charging stations is particularly useful for developers, as many local jurisdictions now require the addition of EV charging in commercial buildings.

The 30C credit, which extends through 2032, is capped at $100,000 per charge station and is transferable to third parties by developers whose tax liability is too low to benefit from the credit. While this transferability will expand its use, the IRA restricts the maximum available benefit only to EV charging stations in rural and low-income census tracts.

The IRA Brings Momentum to CRE’s Ongoing Clean Energy Efforts

The commercial real estate sector has already made significant improvements in energy efficiency and clean energy production since the passage of the Energy Policy Act of 2005. The IRA will accelerate these changes by providing significant subsidies for major energy improvements and upgrades.

The IRA’s generous provisions, coupled with California’s new pro-housing legislation, incentivize many developers and property owners to capitalize on the rising number of value-add opportunities around the state.