Over the past few years, decarbonization has become a global imperative as governments and industry seek to mitigate the effects of global climate change, many with a goal of becoming net zero by 2050.

In many cases, the intent is more ambitious than the practice, as numerous challenges continue to confront business leaders, from converting a strategy to executing on the plan, to navigating tax credits, to developing KPIs and metrics to track sustainability investments. Decarbonization is a journey with different roadmaps for different sectors and industries.

Nevertheless, progress is being made, especially since the 2022 passage of the Inflation Reduction Act (IRA), which extended existing and introduced new federal tax credits and incentives to offset decarbonization investments. At the same time, companies are becoming more aware of the need for planning these investments, taking a more holistic, longer-term view as they determine their potential returns from decarbonization levers.

How can tax credits be factored into real estate companies’ business plans, whether building new or retrofitting? And how are they being utilized so far? Read on for insights and considerations.

Participants in a recent panel discussion at a CohnReznick-sponsored event hosted by Companies for Net Zero shared how they have been approaching these decarbonization options. Contact our team to learn more.

The Inflation Reduction Act: A boon, though still evolving

The IRA stands poised to be an important driver for decarbonization efforts, providing tax credits and incentives for clean energy investment and installation. Enhanced credits are available for meeting certain prevailing wage and apprenticeship requirements; for projects located in energy communities or serving low-income communities; and for use of “domestic content,” i.e., material sourced from domestic suppliers. (Find more details on these topics in CohnReznick’s Inflation Reduction Act Resource Center.)

However, these rules are new, and it’s taking time for companies to learn how to be compliant. And compliance is critical, as it makes a difference in how much tax credit they’re able to receive; for example, the tax credit for otherwise qualifying energy projects with an output of at least 1 megawatt may drop from 30% to 6% if the prevailing wage and apprenticeship requirements are not met. Plus, penalties for noncompliance can be severe, including fines and back pay for affected workers.

There is also still a lot of room for clarification. For example, the definition of “eligible property” has just recently been clarified for purposes of Section 48 energy credits, and now includes additional guidance for such new technologies as stand-alone storage. Other guidance related to the IRA have recently been proposed, and are awaiting resolution from the Treasury and the IRS.

Monetization of renewable energy credits through transferability

One key development coming out of the IRA: Developers can now monetize renewable energy credits by transferring them to an unrelated third party, where the cash paid is treated as tax-exempt income. It’s a welcome provision because historically projects were configured as tax equity partnerships, and now stakeholders have the option of buying the credits rather than entering into a partnership with developers, which would bring about additional tax and accounting reporting requirements during the life of the partnership.

Transferability is becoming popular; representatives from Bank of America and JP Morgan estimated the tax equity investor market in 2023 to be $20 to $21 billion, and transferable credit in the first year allowable alone north of $4 billion in transactions. While the market continues to receive further guidance, we can expect to see additional types of structures come up, in addition to the more commonly utilized hybrid structures, which combine a traditional tax equity partnership with a sale of the tax credits.

State of decarbonization strategies

As IRA provisions continue to solidify their place in the market, where are they already being utilized?

Overall, companies so far appear more apt to leverage IRA provisions in new builds with single tenants vs. spec building. In these situations, whether they own the building or it is built to suit, developers are looking to see how they can use the IRA strategies to reduce carbon emissions, save energy, and, of course, save money. More and more, there’s reliance on manufacturers’ representatives and/or tax specialists to understand how to apply these rules to their designs and projects.

When it comes to retrofitting, many business owners struggle with the concept of retrofitting occupied buildings and keeping their business fully functional while the work is in progress. While there are several options to consider, such as use of swing spaces or floor-by-floor renovations (which are not as energy-efficient), professionals agree that any planning requires a longer- vs shorter-term perspective. While decarbonization may not appear to “pencil out” due to the longer-term nature of seeing the returns, those returns can actually be sizable, when pricing in the available rebates and other tax incentives as well as de-risking against future adverse climate events. In addition, it’s best practice to do an energy audit and/or engineering assessment up front, before conducting any upgrades at all, to gain a fuller understanding of what is needed.

Additionally, as interest rates and inflation remain high, many business owners are in a holding pattern, particularly as regulations are pending and many buildings remain either partially or fully empty due to COVID-era work arrangements. Many mid-size companies that are more resource-challenged are taking a wait-and-see approach as new (and possibly less expensive) technologies come out, new state/federal rules are introduced, and so forth.

In the mid-size sector, there are increasingly more questions as to who is responsible for quantifying the business case for decarbonization investments, such as the sustainability, finance, or strategy teams. The reality is that it takes all of these teams, in cross-functional collaboration, to successfully build the business case and plan, because doing so requires decarbonization and climate risk data from sustainability, capital costs and discount rate data from finance, and market data from strategy.

Successful decarbonization implementation requires integrated policies

Ultimately, integrated policies that combine regulation, incentives, and investments are the levers for successful implementation of decarbonization strategies. Pre-planning for new technologies, at the front end and at the design stage, is also imperative for optimal implementation, as well as budgeting and costing. And finally, don’t forget the human element: Education and awareness, internal acceptance, and continued innovation for low-carbon solutions are additional factors in meeting net-zero goals.

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