Multifamily developments included in Section 45L tax credit
Prior to 2023, only smaller projects, like single-family homes and low-rise residential developments of three stories or less, could take advantage of the Section 45L New Energy Efficient Home Credit. This tax credit has been a boon for home builders since its inception in 2006. It allowed developers of qualified energy efficient homes to claim a tax credit of $2,000 per unit. But unfortunately, larger multifamily projects were not eligible to claim these tax credits.
Inflation Reduction Act of 2022 expands Energy Efficient Home Credit
With the passage of the Inflation Reduction Act of 2022 (IRA), the Section 45L tax credit was substantially expanded and extended starting with the 2023 tax year. IRC Sec. 45L tax credits are available for eligible contractors for the construction or rehabilitation of energy-efficient residential units or dwellings that are leased or sold. The eligible contractor – typically the developer, builder, or homeowner – is the only person who can claim the IRC Sec. 45L tax credit, and they must own the unit at the time of construction or improvement. A “person” can also be a corporation, estate, trust, partnership, or association.
The building standards necessary to qualify for the credit are governed by the Environmental Protection Agency through the Energy Stary Program and the Department of Energy Zero Energy Ready Home Program.
The Internal Revenue Code has been modified to include a prevailing wage requirement. These wage requirements ensure that laborers, mechanics, contractors, or subcontractors are paid wages not less than the prevailing rates for work of a similar character in the locality, as determined by the Secretary of Labor. Adherence to the prevailing wage requirements increases the available tax credit. The IRA expanded the credit to be as much as $5,000 per unit depending on what qualifications the property and developer meet upon completion. The IRA also made larger multifamily developments eligible for the credit by removing the “three stories or less above grade” requirement. The Act also extended the tax credit through the end of 2032, which eliminates the annual concerns of whether it will be extended.
In addition to the framework changes mentioned above, the IRA also modified how the credit is determined. Previously, only a property’s energy-efficient qualifications dictated how much credit could be claimed. The IRA now adds a few additional components to consider that can boost how much credit can be claimed. The original Energy Star qualification is still the main standard, but that is now the base level for the credit. The IRA now adds the Zero Energy Ready, and the Prevailing Wage qualifications, for consideration when attempting to maximize the credit claimed. Here’s a look at how those additional factors can boost the credit claimed.
Tax credit per unit
|Section 45L Credit Eligibility
2023 – 2032
|Energy Star Plus
|Zero Energy Ready||Zero Energy Ready Plus Prevailing Wage|
To qualify as a zero energy ready unit, the unit must be certified as such under the Zero Energy Ready home program of the Department of Energy as in effect on January 1, 2023. Generally, a zero-energy-ready home is a high-performance home that is so energy efficient that a renewable energy system could offset most or all of the home’s annual energy use.
To qualify under the prevailing wage standard, the developer must ensure that any laborers and mechanics employed by the developer, or any contractor or subcontractor involved in the construction of a said property, are paid wages at rates not less than the prevailing rates for construction, alteration, or repair of a similar character in the locality in which that property is located.
To put that in perspective, a multifamily developer checking all the boxes here could qualify for a $5,000 per unit tax credit. On a 100-unit project, that’s $500,000 of federal tax credits generated. Assuming the highest tax bracket, that’s equivalent to a federal deduction of more than $1,300,000.
The changes brought to Section 45L by the Inflation Reduction Act are a welcome benefit for the real estate industry, especially now that larger multifamily developments can take advantage of these credits.
Single-Family Home Requirements – the standards to qualify for the credit vary by state and/or region and are expected to be updated every two years.
- The criteria have been time-segmented, and the maximum available credit has increased up to $5,000.
- The program requirements are expected to be updated every two years beginning January 2023 and have been set through December 31, 2026. The requirements may differ by state and/or region.
- Zero Energy Ready Home Program – credit available, $5,000
- Energy Star Single-Family New Homes National Program – credit available, $2,500
Multi-Family Home Requirements – the standards to qualify for the credit vary by state and/or region. Like single-family home requirements, the criteria will be time-segmented and are expected to be updated every three years. The maximum credit available for multi-family units is generally $1,000 and can be taken in addition to IRC Sec. 179D deductions.
- Residential buildings are no longer limited to three stories.
- Basis adjustments are not required for low-income housing.
- Zero Energy Ready Multi-Family Home Program – credit available, $1,000
- Energy Star Multifamily New Construction – credit available, $500
Claiming an IRC Sec. 45L tax credit involves complex calculations. For example, there are several methods for obtaining the tax credit depending on the energy-efficiency levels of each project. It is also important to understand certain limitations as part of the effort to meet all the requirements and get full credit for the past two years.
With many other tax benefits now fading away or other changes working against the real estate industry in 2023, such as bonus depreciation beginning to sunset and the business interest limitations under Section 163(j) getting tighter, developers may want to look towards these tax credits to help maximize cash flow.
Please be advised that, based on current IRS rules and standards, the advice contained herein is not intended or written by the practitioner to be used and cannot be used by the taxpayer for the purpose of avoiding penalties.
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