As real estate owners and operators reposition and retrofit their properties, most are focusing on environmentally conscious upgrades including upgrades to the lighting and mechanical systems as well as the building envelope. Although the costs associated with the upgrades may be significant, the anticipated utility cost savings should reduce the “payback” period and, as a result, the investment or economic outlay will be recouped more quickly. At a time when returns on investments in savings accounts and other products are close to 0%, a “payback” period of less than five years, as an example, is certainly attractive. Additionally, the utility cost savings associated with the upgrades should result in an increase in net operating income with a corresponding positive impact on valuations. As an added bonus, the upgrades will also make the property more attractive to potential tenants.
The utility savings in connection with the upgrades could be significant from a sustainability point of view, but real estate owners and operators as well as tenants should not overlook the tax incentives provided by the Internal Revenue Code. The additional savings associated with tax credits and/or tax deductions could further reduce the “payback” period of such investments. The following is a brief discussion of certain Federal tax incentives that should be evaluated when embarking on any repositioning and retrofit project.
-Solar Energy and Combined Heat and Power
The Internal Revenue Code allows a 30% tax credit (i.e., dollar for dollar reduction in tax) related to certain investments in equipment using solar energy to generate electricity or to heat or cool a structure. There is also a 10% credit related to certain investments in geothermal property and combined heat and power property.
-Energy Tax Deduction
There is a 60 cents per square foot deduction (maximum deduction of $1.80 per square foot) associated with certain environmentally sound upgrades to the lighting system, HVAC system, or building envelope. For example, if the wattage usage per square foot associated with a lighting upgrade is 50% or less as compared with the ASHRAE 2001 standards, a taxpayer may be eligible for a 60 cents per square foot deduction. If all three components (lighting, HVAC and building envelope) are upgraded and certain energy usage benchmarks are met, a taxpayer may be eligible for a $1.80 per square foot deduction. Thus, larger facilities will yield larger tax deductions. The energy tax deduction is scheduled to expire for property placed into service after December 31, 2013.
-Historic Structures and Districts
There are also significant benefits associated with upgrades to pre-1936 structures or Certified Historic Structures or buildings located in a Registered Historic District that are “substantially rehabilitated.” A building is “substantially rehabilitated” if the real property expenditures incurred during either a 24-month or 60-month measurement period exceed the depreciable basis at the beginning of such measurement period. For pre-1936 buildings that meet the requirements, the tax credit is 10% of “qualified rehabilitation expenditures” and the credit increases to 20% for Certified Historic Structures or buildings located in a Registered Historic District that are “substantially rehabilitated.”
-Cost Segregation Studies
Not to be overlooked are cost segregation opportunities whereby the goal is to segregate tangible personal property (e.g., carpeting, VCT, wallcoverings, cabinetry, specialized HVAC, equipment related enhancements, secondary lighting, etc.) and land improvements (e.g., landscaping, site work including parking lots, concrete walkways, site lighting, drainage, underground utilities, etc.) from real property improvements. As a general rule, the result of segregating these types of improvements, which have shorter tax recovery periods, is more depreciation expense, less taxable income, less taxes, and more cash in the taxpayer’s hands. There could be permanent present value tax savings associated with a cost segregation study.
The first-year bonus depreciation provisions are also extremely generous. For “qualified” improvements placed in service prior to December 31, 2013, there is a 50% first-year bonus depreciation allowance (i.e., 50% write off). Additionally, certain taxpayers may be eligible to write off as much as $500,000 of “qualified” property improvements for 2012 and 2013 expenditures.
Taxpayers should also be aware of the state and local tax incentives, and it is highly recommended that taxpayers meet with their utility companies, including NYSERDA, before any project is started to determine what additional incentives and cash grants are available.
Although there is a movement to “green” properties, the overriding principle while retrofitting and repositioning buildings is that it must make economic sense. The main financial economic objective of making environmentally sound investments is to reduce expenses and increase net operating income with a resulting increase in valuations of real estate holdings. To further alleviate the cost of such expenditures and reduce the “payback” period, the Internal Revenue Code has provided many tax incentives that should not be overlooked.
For more information, please contact Scott O’Sullivan.