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June 26, 2020 - Roofing
By Daniel King
Building owners can spend money to save money by making timely, qualifying improvements to your properties to take advantage of the federal tax code and making sure your accounting department understands your intent. The best part? Many of the qualifying categories do not necessitate major changes to your use case, risk profile, or building. Basic systems such as security and fire systems, HVAC systems, new roofs, and simple energy efficiency improvements can qualify and save you significant cash while positioning your asset for long term performance. Let’s examine roofing and energy improvements.
Two recent changes to tax law offer building owners — and in some cases tenants — the opportunity to qualify for tax deductions for expenditures on qualifying projects. The first is contained in the U.S. tax law passed in 2018, specifically Section 179, which changes qualifying deductions to make capital expenditure improvement investments more attractive. The second involved Section 179D, which has been in effect since Jan. 1, 2006, but has now been retroactively extended to Dec. 31, 2020.
We will discuss the section 179 changes first, then the 179D details and extension requirements.
Changes to Section 179 allow most short-term capital expenditures to be considered for a full tax write-off for the same tax year that the investments were made. The previous tax codes required large capital outputs to be depreciated per IRS timetables, typically over the course of 39 years. Given that roofs typically deliver 15 to 25 year service lives, that 39 year timetable has historically hurt the building owner’s ability to fully deduct the roof asset.
In addition to removing the depreciation timetable limitations, the revisions to Section 179 expanded the maximum deduction and list of qualifying approved goods rather dramatically. The list of approved goods for this deduction now includes capital and building improvements with a usable lifespan of 20 years or less. The maximum annual deduction is set at $1,040,000 for 2020, and the benefit phases out if improvements exceed $2,590,000 in the tax year. The deduction begins to phase out on a dollar-for-dollar basis after $2,590,000 is spent by a given business. In other words, the entire deduction goes away once $3,630,000 in purchases is reached, so this is a true small and medium-sized business deduction. Nevertheless, given that many building owners own individual assets under a separate entity, it is worth exploring with a tax professional whether even a large business can benefit from this deduction.
Commercial building improvements can now be written off in lump-sum entirety in the same tax year; that is, 100 percent of the asset cost can be written off in year one. This means, for instance, that the entire expenditure on a new roof could be deducted from this year's earnings, provided that income meets the requirements to support the investment and write-off.
These Section 179 changes expire in 2025 and could change before then. Because of this risk and benefit, building owners should consider front loading improvements and investing in their assets. It is certainly worth a chat with your tax professional to assess how this current code could be relevant to your business.
Section 179D provides up to a $1.80 per square foot tax deduction for installations that reduce building energy costs by at least 50 percent in the aggregate, as well as smaller deductions for lower percentage reductions.
Late in 2019, Congress approved and President Trump signed a $1.4 trillion dollar spending package that includes retroactive extensions of Section 179D tax deduction for projects put in service from Jan. 1, 2018 to Dec. 31, 2020. (Yes, it expires this year. And yes, you can apply for Section 179D deductions retroactively.)
Section 179D allows building owners to claim a tax deduction of up to $1.80 per square foot for installing qualifying energy saving systems in buildings. Tenants may also claim eligibility for deductions if they take on construction expenses. Qualifying installations include interior lighting; building envelope, including roofing; and heating, cooling, ventilation, and hot water systems. To qualify for the maximum $1.80 per square foot deduction, installations must achieve a 50 percent reduction in building energy and power costs, in comparison to buildings meeting minimum requirements set by ASHRAE standards. The breakdown of those percentages achieved by improvements is as follows: 10 percent energy savings for envelope improvements, 20 percent for lighting improvements, and 20 percent for HVAC improvements. For projects that do not achieve 50 percent savings, the tax code also allows for a partial benefit: $0.60 per square foot deduction for HVAC systems achieving 15 percent savings, $0.60 per square foot deduction for lighting systems achieving 25 percent savings, and $0.60 per square foot deduction for building envelope systems achieving 10 percent savings. The Office of Energy Efficiency and Renewable Energy has specific software to be used to calculate these savings in order to have them qualify, plus more information on Section 179D. There are also tax firms that specialize in guidance on obtaining Section 179D deductions.
There are time-limited, low-hanging fruits in the current tax code that can significantly impact a building owner’s bottom line and the future performance of a facility. While this article is not intended offer tax advice, a look at some rough numbers illustrates how both of the codes function and the possible savings they offer.
Here’s an example of how Section 179 works:
• Assume a $250,000 initial improvement investment. That qualifies for a $220,000 first year write-off plus a $30,000 bonus first year depreciation, for a total first year deduction of $250,000, provided that income meets the requirements to support the investment and write-off.
• Assume a 35 percent tax rate. That means the $250,000 tax deduction equals $87,500 in cash savings.
• The total improvement costs after deductions is $162,500.
Here is an example of how 179D works:
• Assume a $250,000 initial investment for a roof replacement or recover project, assuming $6 per square foot for a 41,500 square foot roof area.
• Also assume that the roofing upgrade achieves a 10 percent savings in energy costs and therefore qualifies for $.60 per square foot tax deduction. That provides a $24,900 tax deduction.
• The bottom line is a $225,100 investment after the tax deduction.
It is important to note that 179D does not provide for additional deductions on top of the Section 179 write off if your project is below the maximum deductions for Section 179. However, if you are investing in multiple systems or a large system that exceeds the limits of Section 179, you can accrue additional tax benefits for qualifying projects under Section 179D.
The takeaway? Now is a great time to consider upgrading your roof or other building components to optimize energy efficiency
Daniel King is president of Integrative Roofing and Energy. He holds an MBA in finance from Atkinson Graduate School of Management. The firm provides full service owner roof representation in the commercial and industrial real estate market. This article is not intended to provide tax guidance. For more information, contact email@example.com.
Energy.gov. Office of Energy Efficiency and Renewable Energy, www.energy.gov/eere/buildings/179d-commercial-buildings-energy-efficiency-tax-deduction. Accessed 15 Feb. 2020.
Cornell Law School Legal Information Institute. Cornell Law School, https://www.law.cornell.edu/uscode/text/26/179D. Accessed 20 Feb. 2020.
Cornell Law School Legal Information Institute. Cornell Law School, https://www.law.cornell.edu/uscode/text/26/179. Accessed 20 Feb. 2020.
Walker Reid Strategies. “Energy Tax Incentives 179 D and 45 L are back!” https://mailchi.mp/5210bb53a297/energy-tax-incentives-179d-and-45l-are-back?e=1975ad32a9. Accessed 20 Feb. 2020.