Table of Contents
In August, Congress passed the Inflation Reduction Act with little fanfare. Unless you were paying close attention. You might have assumed that this piece of legislation was to target both combating inflation and advancing climate change initiatives.
However, the legislation of $738 billion contains a large amount of funding for programs that will specifically affect commercial real estate. Specifically, the owners and operators of multifamily properties are going to benefit from this.
In this article, we look at how the IRA will have far-reaching impacts on the multifamily industry.
Background
The Inflation Reduction Act (H.R. 5376) was signed into law by President Biden in the August of 2022. The legislation will raise $738 billion and earmark $391 billion to fund various energy and climate change programs. Many of these programs are directly related to energy-saving property improvements, and therefore, are of interest to multifamily owners.
With energy costs hitting all-time highs in 2022. The focus on energy savings has become front and center for apartment communities.
- Annual Deficit Reduction (With Interest)
- Cumulative Deficit Reduction
- Cumulative Deficit Reduction (Assuming ACA Extiontion Without Offsets)
The IRA includes a variety of tax credits. These measures will likely encourage building owners and developers to make energy-efficient improvements. Those that speed the decarbonization of commercial real estate.
Specific Incentives for Multifamily Owners
The Inflation Reduction Act has a number of specific incentives and programs that multifamily owners can utilize. These include:
45L Tax Credit for Energy Efficient Homes
IRC Section 45L currently provides a $2,000 tax credit (per unit). This credit is provided for homes and apartments that meet certain energy efficient design criteria. The tax credit was set to expire at the end of this year. However, the IRA extended the deadline to include homes sold or placed into service through December 2032. It also increases the tax credit to $2,500 in 2023.
Additionally it ramps up the value of the credit to $5,000 per unit for both single family and multifamily homes. In order to be eligible for the full $5,000 tax credit, properties must be certified as “Zero Net Energy Ready” units. Therefore, this tax credit is especially valuable to multifamily owners pursuing new development or heavy value-add strategies. Especially those that entail LEED certification and/or Passive House designation.
Importantly, the legislation was tweaked. Ensuring that multifamily developers can take advantage of both 45L tax credits AND 179D deductions (outlined below).
The Inflation Reduction Act has
a number of specific incentives and programs
that multifamily owners can utilize.
The Residential Clean Energy Credit
The IRA established the Residential Clean Energy Credit. This provides a 30% tax credit applied to the cost of installing any residential systems that use solar, wind, geothermal, or battery storage technology to produce electricity, heat water, or regulate temperature.
Over a 200+ unit apartment building, this 30% savings can translate into tens of thousands of dollars. An additional 10% credit may be applied to projects located in low-income communities. There can be further incentives offered if the projects use equipment that is manufactured in the U.S.
179D Energy Efficient Buildings Tax Deduction
179D tax deductions were expanded as part of the IRA. The existing incentive allows multifamily owners and developers to claim a tax deduction on energy-efficient buildings and installations. Currently, the 179D deduction is worth $1.88/SF.
Starting in 2023, the IRA will increase the value of this deduction to $5.00/SF. For an eligible 250,000-square-foot apartment building. A deduction that was worth $470,000 in 2022 will now potentially increase to $1.25 million in 2023.
Any multifamily building that is four or more stories qualifies. To be eligible, buildings have to reduce the energy and power costs. Any costs associated with their interior lighting, HVAC systems, and hot water systems by 50% or more. Both existing buildings pursuing retrofits and new development qualify.
Another big change is that now, under the IRA, tax-exempt buildings are now eligible to receive the expanded 179D deduction. This will benefit anyone who owns or partners with affordable housing developers. REITs are also eligible now. Experts expect this specific legislation to trigger significant private sector investment in building envelope improvements and HVAC upgrades.
It may also usher in the more widespread use of “proptech” that can monitor energy consumption. Building owners will need this data certified by an independent engineer to confirm they have met certain energy reduction targets.
Tax Credits for Electric Vehicle Charging Equipment
Electric vehicles are becoming more popular—and will become increasingly more so as states adopt “Zero Emission Vehicle” programs. In which there are 13 states that have already done so.
The IRA extended and modified the Alternative Fuel Vehicle Refueling Property Credit. That is a 30% tax credit that can be applied to EV charging infrastructure. The tax credit is worth up to $100,000 per item pf property.
This is particularly beneficial for forward-thinking multifamily owners who see EV charging stations as a necessity. Today’s consumers (particularly Millennials and Gen Z renters) tend to show loyalty to environmentally conscious brands. Property owners who want to attract this demographic will have no choice but to integrate EV chargers onto their properties.
Developers will need to capture at least
12,500 metric tonnes to qualify for the tax credits
(down from 25,000 MT previously).
45Q Tax Credits for CCUS Projects
The IRA also increased the value of the tax credits. Those that can be used for carbon capture, utilization, and sequestration (CCUS) projects. This significantly benefits new multifamily construction. IRA stipulates that carbon capture projects that begin construction in the next 10 years are eligible for 45Q tax credits.
Previously, CCUS projects could receive tax credits worth $50/tonne of CO2 captured. The IRA has increased that to between $85/tonne to $180/tonne. Developers will need to capture at least 12,500 metric tonnes to qualify for the tax credits (down from 25,000 MT previously). This threshold can be met at the building level or aggregated across a portfolio.
For the first time, the IRS will allow 45Q credits to be transferred to a third party. This will allow real estate developers to monetize the credits if they so choose. 45Q tax credits may not have been on the radar of multifamily developers previously. This is because carbon capture is typically associated with utilities and other direct carbon producers.
However, new technology and advances in building materials have made carbon capture more relevant to both new and existing buildings. As more developers look to “go green,” incentives like these will prove valuable.
Accelerated and Bonus Depreciation
In addition to the IRA’s direct tax benefits outlined above, there are tangential benefits related to depreciation. Under federal legislation, an owner who purchases a new energy-efficient building or makes thorough energy modifications to existing buildings. Is able to depreciate the cost of those improvements in the first year of ownership.
Typically, one would need to spread out the depreciation of those capital expenses over a longer period of time. However, for now, owners can take “bonus” depreciation to offset the costs of making these investments.
Those who invest in apartments will certainly want to pursue accelerated depreciation for these sustainability-related property improvements.
Opportunities for Multifamily Owners and Investors
The average investor will often overlook the importance of these tax benefits. Many of the programs seem too cumbersome to navigate. However, experienced sponsors understand that when they save a dollar, it means they have another dollar to return to investors. The more they can save, the more profits they will generate, which they can distribute among the investors.
In other words, the IRA creates real, tangible benefits for multifamily owners and their investors. There is more than $9 billion allocated for consumer home energy rebates. As well as 10 years’ worth of tax savings for owners who make energy-efficient home improvements.
The benefits of this approach will be particularly significant in low-income areas. In an attempt to pursue environmental justice. With nearly $850 million set aside for multifamily owners making building improvements in underserved communities. There may be state and federal grants to pair with the tax credits and rebates offered through the IRA.
Sustainability: A Good Business Decision for Multifamily Owners
Multifamily owners are facing pressure to “green” their properties as it is. Anyone who is undertaking substantial renovations will certainly want to consider these improvements already.
The fact that the IRA makes it more affordable makes these investments a no-brainer for owners.
For example, some developers might already be installing solar panels and high-efficient HVAC systems. Others might be integrating EV charging stations at their properties.
Now they can be financially rewarded for being a first-mover on the sustainability front.
Not only will owners be saving money, they’ll be cutting back their carbon footprint. Owners will want to highlight these building features when advertising their properties. Especially given how important sustainability is to the next generation of younger renters.
The IRA provides financial incentives that allows owners to create more sustainable properties.
It creates a virtuous cycle: the IRA provides financial incentives that allows owners to create more sustainable properties. People want to live in sustainable properties, and are often willing to pay a premium to do so. In turn, owners lower their operational costs and boost revenue through higher rents. Talk about a win-win-win!
Conclusion
To be sure, the IRA has many nuances. Owners should familiarize themselves with the specific provisions relating to commercial property. They should use this guide when evaluating specific capital investments, particularly if they have already planned for a significant renovation.
Of course, it is important to always first consult with your tax advisor. Make sure you take all the necessary steps to ensure that you’ll qualify for the tax credits when they’re available.
