Internal Revenue Code: Section 179D. Energy Efficient Commercial Buildings Deduction.

May 5, 2011

Eighty companies and groups associated with the commercial real estate industry (including 3M, Empire State Building Company, Jones Lang LaSalle and U.S. Green Building Council)  have sent a letter that asks congress to support the Obama administration's Better Buildings Initiative and modify the Energy Efficient Commercial Buildings Deduction, also known as Section 179D of the Internal Revenue Code, to increase and encourage energy retrofits of existing buildings.

The letter recommends adding an additional tax incentive provision that is targeted toward existing building energy retrofits, which should include the following key elements:

Measure energy savings compared to the existing building baseline.

Currently Section 179D rewards buildings that reduce the energy consumption of the whole building to 50 percent of the amount the building would use if it were built to a particular code. This is an arbitrary baseline for buildings that were constructed decades ago. Additionally, the current savings threshold of 50 percent better than this code is very aggressive for existing buildings. For instance, the project at the Empire State Building—a leading and internationally recognized example of whole-building commercial retrofits that makes a $106 million investment in efficiency upgrades—would not meet this target, despite the fact that the retrofit is guaranteed to reduce the building’s energy consumption by about 38 percent.

Link the amount of the incentive to energy savings achieved.

This would calibrate the tax benefit to the value created. We recommend that the minimum amount of the incentive should correspond to 20 percent total energy savings compared to the building’s baseline energy consumption, and the maximum incentive should correspond to 50 percent savings. The amount of the incentive would increase for every 5 percent increase in energy savings within this range.

Tie a portion of the tax incentive to implementation of efficiency measures and a portion to demonstrated energy savings.

There are good reasons to reward a building owner for implementing energy savings measures, and good reasons to reward energy savings actually realized at the meter level. We recommend doing both by allowing the building owner to claim 60 percent of the incentive at the time measures designed to save a certain percentage of energy (as certified by a Professional Engineer) are put in to service. The remaining 40 percent of the incentive would be available 2 years later, based on demonstrated energy savings (as measured using the ENERGY STAR Portfolio Manager tool or other tools designated by the Secretary).

Allow owners or tenants to claim some incentive for improving a substantial space within a building.

There is significant opportunity and appetite for building owners and tenants to improve energy efficiency during tenant build-out of office space, but current landlord-tenant arrangements seldom seize that opportunity. Similarly, there is also appetite and opportunity for building owners to improve the efficiency of a large space within a building, but where they do not necessarily have access to all tenant space. To encourage these objectives, the Department of Energy should be directed to develop guidance for how the tax incentive can be used for efficiency improvements for large defined spaces within an existing building.

Make the tax incentive useable for a broad range of building efficiency stakeholders and building types, including REITS and multifamily buildings.

Commercial buildings are owned by a variety of organizations, some of which do not have appetite for conventional tax incentives. To gear a tax incentive for optimal benefit by Real Estate Investment Trusts (REITS), the full amount of the incentive that considers such entities’ special tax requirements should be available for REITS.3 Furthermore, we believe it is important to enable a range of building efficiency stakeholders to realize the value of the tax incentive when making investments in energy savings. Hence, we suggest clarifying language that the building owner be permitted to allocate the incentive to other parties related to the transaction, such as the contractor, a tenant, engineer, architect, or source of financing. Additionally, multifamily buildings should remain eligible for any commercial building incentive given their similarity to commercial buildings with respect to ownership, structure, and application of energy codes. To capture a larger set of multifamily buildings within the scope of the incentive, it will also be critical to ensure that the incentive complements the rules of the existing low-income housing tax credit to encourage energy efficiency upgrades in the affordable housing stock.

Supplemental incentives should be considered for retrofits that multiply energy efficiency benefits.

Some retrofit projects and technologies can achieve important policy objectives beyond energy efficiency, are not normally implemented as part of comprehensive retrofits, and thus may not be effectively incentivized by the base provision. Congress should consider additional incentives for certain improvements that multiply energy efficiency benefits -- such as renovating historic buildings, installing energy-efficient ?cool roofs? to mitigate urban heat island effects, and replacing chillers that use ozone-depleting refrigerants.