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The Overlooked Incentive: The New Energy Efficient Home Tax Credit

July 2013

(Reprinted with permission of Tax Credit Advisor, July 2013)

Key Takaways

The new energy efficient home tax credit (45L) is a source of potential extra benefits for affordable housing developers and investors. The Section 45L credit offers multiple possible benefits including potentially generating extra equity in LIHTC projects. It is also important to weigh the tradeoffs – including increased cost of energy-efficient building materials and equipment and reduction in basis issues – when contemplating this tax credit.

An overlooked federal incentive, the new energy efficient home tax credit, is a source of potential extra benefits for affordable housing developers and investors, says Christopher Thomas, a partner at CohnReznick LLP.

Governed by Section 45L of the Internal Revenue Code and reauthorized by the fiscal cliff legislation enacted in January, the tax credit is equal to $2,000 per unit for newly constructed or qualified owner-occupied or rental housing units that meet certain energy-savings standards. Construction or rehabilitation of a unit must be substantially completed and the unit occupied before 2014. The tax credit is claimed by the unit owner in the year in which the unit is occupied.

A dwelling unit can be a detached house, townhouse, or apartment. In an apartment building, the tax credit is received for each qualified apartment unit. Buildings cannot be more than three stories above grade.

To satisfy the energy standard, a unit’s energy consumption must be at least 50% less than a similar unit constructed in accordance with the 2006 International Energy Conservation Code, with at least 10% of the energy savings attributable to the building envelope. An engineer must analyze each unit for energy consumption and certify that its performance meets the energy standard to qualify the unit for the tax credit. According to Thomas, newly constructed units have an easier time satisfying the energy standard than rehabilitated units.

Multiple Possible Benefits According to Thomas: the Section 45L tax credit can benefit developers and investors in LIHTC projects by:

  • Furnishing an extra bonus to LIHTC projects with excess eligible basis. Since such projects are capped in the amount of housing credits that they can receive, extra equity can be generated for a project by providing Section 45L tax credits to the limited partner investor – if the investor wants these credits and is willing to pay for them. Thomas has seen pricing for Section 45L tax credits range from 70 to 85 cents per dollar of tax credit. Section 45L tax credits can also generate extra equity in LIHTC projects that don’t have excess eligible basis in cases where the investor is willing to pay for them.
  • Providing additional tax benefits to the developer, if the investor doesn’t want to take the Section 45L tax credits. With the consent of the limited partner, the partnership agreement can be amended to bifurcate the Section 45L tax credit from the project’s other tax credits and losses and allocate all the Section 45L tax credits to the general partner.
  • Providing an alternative way to maintain the projected yield to the limited partner investor if there is late or insufficient delivery of projected housing tax credits and losses by the developer. If the investor is agreeable, the Section 45L tax credits can be provided to the limited partner to make up the shortfall in yield and spare the developer an adjuster reducing the amount of equity to the project.

According to Thomas, there are tradeoffs. The depreciable basis and LIHTC eligible basis of an LIHTC development must both be reduced by the amount of the Section 45L tax credit. This will reduce depreciation losses to the investor as well as the amount of housing tax credits if the project doesn’t have excess eligible basis. In addition, there are the extra costs for the energy analysis and certification by an engineer or other professional to qualify a housing unit for the Section 45L tax credit. These additional costs, however, can make up for the loss of depreciation deductions to the investor, in transactions in which the majority of the project’s tax losses flow to the investor.

Finally, more energy-efficient building materials and mechanical equipment (such as HVAC systems with higher “SEER” ratings) that help a unit qualify for the Section 45L tax credit are generally costlier. But Thomas indicated that this may not be an issue at all. “A lot of times,” he says, “merely going from a SEER 13.5 to a SEER 15 HVAC system is enough. The extra incremental cost would easily be supported by the return of the tax credit...And that doesn’t take into consideration the greater utility cost savings during the time of operation.” Thomas said developers can probably get a quick read on whether their proposed new LIHTC project would qualify for the Section 45L tax credit by having an energy engineer review the plans and specs early in the planning and design stage. An engineer should be able to tell if the project would qualify and, if not, be able to suggest adjustments so that it would, he said.

This article was distributed as part of the July 2013 Affordable Housing News and Views newsletter.

Circular 230 Notice: In compliance with U.S. Treasury Regulations, the information included herein (or in any attachment) is not intended or written to be used, and it cannot be used, by any taxpayer for the purpose of i) avoiding penalties the IRS and others may impose on the taxpayer or ii) promoting, marketing, or recommending to another party any tax related matters.

This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.

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