Going Green With Recent Legislation: Does It Make Business Cents?

Congress and the White House have been busy since October 2008 attempting to provide business owners with tax and other incentives to build in a more energy efficient manner and to produce energy using renewable methods.

The Energy Improvement and Extension Act of 2008 (EIEA) and the American Recovery and Reinvestment Act (ARRA), passed in February 2009, have extended and expanded many green incentives. EIEA and ARRA provide opportunities for business owners to reduce the cost of going green through accelerated tax deductions, tax credits, grants and loan guarantees.

Five (although there are numerous others) notable incentives were extended and/or expanded by the two acts:

• Commercial Building Tax Deduction

• Business Energy Investment Tax Credit

• U.S. Department of Treasury — Renewable Energy Grants

• U.S. Department of Energy — Loan Guarantee Program

• Renewable Electricity Production Tax Credit

Details, details

In order to provide a framework for determining whether it makes sense to build and/or invest “green,” it is important to understand the general details behind some of the major incentives.

Commercial Building Tax Deduction

EIEA extended the Commercial Building Tax Deduction from December 31, 2007, to December 31, 2013. The incentive allows a taxpayer who is an owner or lessee of a commercial building to take a one-time accelerated deduction (as opposed to capitalizing and depreciating over a much longer useful life) for the cost or a portion of the cost of energy efficient property installed to the commercial building’s interior lighting systems, heating, cooling, ventilation, hot water systems and building envelope.

The amount of the deduction is based on the square footage of the building floor area (not to exceed the actual cost of the improvement). Accelerated deductions of $1.80 per square foot are given for buildings that achieve a 50 percent or greater reduction in energy and power costs.

Smaller accelerated deductions of $.60 per square foot are allowed at lower energy saving percentages depending on the type of property installed. The three primary systems eligible for the smaller deduction are interior lighting systems, HVAC systems and the building envelope. In order to receive this accelerated deduction, a certification must be obtained to verify the property installed satisfies the energy efficiency requirements. The certification is generally performed by a certified engineer using commercially available software. 

Business Energy Investment Tax Credit

EIEA and ARRA both expanded the Business Energy Investment Tax credit. A taxpayer who constructs or acquires (if the original use of the property begins with the taxpayer) depreciable and/or amortizable energy property is eligible for a credit of up to 30 percent of the basis of the energy property placed into service. The credit is received in the year in which the property is placed into service.

The amount (percentage) of the credit is based on the type of energy property placed into service. For example, energy property that produces solar energy used to generate electricity, heat or cool a structure, provide solar process heat, or illuminate the inside of a structure using fiber-optic distributed sunlight, is eligible for a 30 percent credit. However, other energy property like qualified fuel cells, micro-turbines and qualified small wind is eligible for a 10 percent credit. If the credit is claimed on the energy property placed into service, the basis of that property must be reduced by half of the credit claimed.  

U.S. Department of Treasury — Renewable Energy Grants

ARRA allows taxpayers eligible for either the Business Energy Investment Tax Credit (ITC) or the Renewable Electricity Production Tax Credit (PTC) to receive a grant in lieu of the credits from the U.S. Department of Treasury. The grant is equal to 10 percent or 30 percent of the basis of the property, depending on the type of property.

To be eligible for the grant, property must generally be placed into service between January 1, 2009, and December 31, 2010. Grant applications, by and large, must be submitted no later than October 1, 2011. Payment of the grant will be made within 60 days of the application date or the date property is placed into service, whichever is later.

It is very important to note that only tax-paying entities are usually eligible for this grant, but there are several specific exclusions in Treasury guidance. In addition, the basis of the energy property placed into service must be reduced by 50 percent of the grant payment received. 

U.S. Department of Energy — Loan Guarantee Program

The incentive was originally offered under the Energy Policy Act of 2005, which authorized the U.S. Department of Energy (DOE) to issue loan guarantees for projects that “avoid, reduce, or sequester air pollutants or anthropogenic emissions of greenhouse gases” and “employ new or significantly improved technologies as compared to technologies in service in the United States at the time the guarantee is issued.” The 2005 act was authorized to offer more than $10 billion in loan guarantees, but was set to expire in September 2009.

ARRA extended the authority of the DOE to continue to issue loan guarantees until September 30, 2011, and allocated an additional $6 billion to the initiative. ARRA expanded the types of projects that were eligible for the loan guarantee to include:

• Renewable energy systems

• Electric power transmission systems

• Leading edge biofuel projects

Renewable Electricity Production Tax Credit

The credit is a per kilowatt-hour tax credit for electricity generated (from qualified energy resources at a qualified facility) and sold by a taxpayer. Qualified energy resources include wind, closed-loop biomass, open-loop biomass, geothermal, solar, small irrigation power, municipal solid waste, qualified hydropower production and marine and hydrokinetic renewable energy.

Although there are many intricacies, generally a credit of 1.5 cents (adjusted for inflation) per kilowatt-hour produced and sold is allowed for the first 10 years after a qualified facility is originally placed in service. Currently, the “adjusted for inflation” credit amount is 2.1 cents per kilowatt-hour. Most electricity generating facilities must be placed into service prior to January 1, 2014. The only two exceptions are wind facilities, which must be placed into service prior to January 1, 2013, and solar facilities, which needed to have been placed into service prior to January 1, 2006.

In addition to the credit, most solar and wind facilities placed into service would also be eligible for the tax benefit of accelerated depreciation deductions (five years) under the Modified Accelerated Cost-Recovery System (MACRS). ARRA also allows facilities that qualify for this credit to elect to receive the ITC or the U.S. Department of Treasury Renewable Energy Grant in lieu of this credit. The ITC or grant for PTC-eligible technologies is generally equal to 30 percent of eligible costs.

Decision Time: Invest “Green” or Not?

Armed with a general understanding of notable federal tax, grant and loan guarantee incentive programs as extended and expanded by EIEA and ARRA, it is time to decide or advise clients whether it would be a good financial business decision to build green.

Some considerations include:

• What is the cost of the energy efficient property versus the non-energy efficient property?

• What type of tax incentives would be granted with the installation of energy efficient property (credit, accelerated deduction, grant or loan guarantee)?

• What energy savings will be recognized through the installation of energy efficient property compared to the alternative, over the life of each type of property?

• Do the useful lives and/or salvage value of each type of property vary?

• Are there any qualitative benefits to owning and running energy efficient property (marketing, advertising, etc.)?

• Are there any state tax incentives in addition to the federal incentives that would make it more lucrative to place energy efficient property into service rather than traditional (non-energy efficient) property?

• Will there be future mandates to increase the energy efficiency of business property?

For example, assume that a business owner is considering whether to replace the HVAC system in a commercial building with either a new HVAC system that is not energy efficient (i.e., a traditional system) or one that is energy efficient. Pertinent assumptions are as follows:

• The size of the building is 111,111 square feet.

• The energy efficient system would reduce energy and power usage by 50 percent and therefore would be eligible for the commercial building tax deduction of $200,000 ($1.80 times 111,111 square feet).

• The cost associated with obtaining a certification to be eligible for the commercial building tax deduction is included as part of the total cost of the energy efficient system.

• The cost of the traditional HVAC system is $1 million with a 39-year useful life and no salvage value.

• The cost of the energy efficient system is $1.2 million with a 39-year useful life and no salvage value.

• The average annual energy cost of a traditional system is $100,000 ($20,000 of which are base costs and $80,000 of which are based on consumption of energy).

• The energy efficient property would not reduce the $20,000 of energy base costs.

• The business owner has an average federal/state combined tax rate of 40 percent. 

Table 1. Calculating the Green Cost Breakeven Point: A Basic Framework

		Green	Traditional
Original Cost		$1,200,000	$1,000,000
Excess Cost of Green Property		$200,000	-
Year 1
	Tax benefit of commercial building deduction	(80,000.00)	-
	Energy Savings, net of tax	(24,000.00)	-
Year 2
	Energy Savings, net of tax	(24,000.00)	-
Year 3
	Energy Savings, net of tax	(24,000.00)	-
Year 4
	Energy Savings, net of tax	(24,000.00)	-
Year 5
	Energy Savings, net of tax	(24,000.00)	-
	Total	-	-

Using the assumptions in Table 1, the “breakeven point” is five years. In addition, the green system would produce many more years of energy savings over the useful life of the property. It is important to note that the above example ignores state tax incentives that could make the result (payback) even shorter. Although the example is very simplified, it sets forth the framework for which business owners and client advisors can analyze whether to “invest” in energy efficient property for future capital improvements. 

Stay tuned

With both parties in Congress focused on energy independence and efficiency, it seems reasonable to assume that additional incentives and/or mandates will come “online” in the near future.

Ryan N. Rhed, CPA, is a senior accountant with Baker Tilly (formerly Beers + Cutler) in Vienna. The firm has been providing tax, assurance and consulting services for more than 30 years and recently expanded its practice to focus on the analysis of renewable energy investments. Ryan can be reached at ryan.rhed@bakertilly.com or (703) 923-8503.

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