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. 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 Prevailing Wage
Zero Energy Ready
Zero Energy Ready Plus Prevailing Wage
How homebuilders can qualify for the credit
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 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 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. 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.
Interested in learning how your business can leverage the Section 45L New Energy Efficient Home Credit? Contact your Keiter Opportunity Advisor for further assistance.
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The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.