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Government Incentives for ESG in Commercial Real Estate

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The Inflation Reduction Act (IRA) of 2022 signifies a monumental shift towards a more sustainable future. By allocating $369 billion to combat climate change, this legislation aims to reduce the nation's carbon footprint by 40% of 2005 levels by 20301. The IRA has the potential to transform the commercial real estate industry by incentivizing the adoption of Environmental, Social, and Governance (ESG) practices. This report delves into the IRA's key provisions, explores other government incentives supporting ESG in commercial real estate, and examines eligibility requirements, application processes, and available resources.

The Inflation Reduction Act (IRA) and Commercial Real Estate

The IRA extends and enhances two significant tax incentives for energy efficiency in commercial buildings: Section 179D and Section 45L of the Internal Revenue Code2. These incentives, previously set to expire, have been extended for 10 years and their value increased1. Furthermore, the IRA introduces opportunities to transfer credits or receive direct payments from the IRS, providing added financial flexibility for developers3. In addition to these incentives, the IRA offers bonus credits for projects that meet prevailing wage and apprenticeship requirements, utilize domestic content, and focus on energy communities and low-income communities4. These bonus credits can significantly amplify the financial benefits of ESG initiatives.

Section 179D - Deduction for Energy Efficient Commercial Building Property

Section 179D offers a tax deduction to owners and long-term lessees of new or existing commercial buildings that meet energy efficiency standards1. The deduction is calculated on a per-square-foot basis, with the amount increasing with greater energy savings5. For buildings achieving a minimum 25% energy reduction compared to a reference standard, developers can deduct up to $2.50 per square foot5. An additional $0.10 per square foot deduction is available for each percentage point reduction beyond the 25% threshold, up to a maximum of $5.00 per square foot5. The IRA expands the availability of this deduction to tax-exempt organizations6.

Section 45L - Tax Credit for Energy Efficient Homes

Section 45L of the Internal Revenue Code offers a tax credit for energy-efficient dwelling units within multifamily buildings1. For homes acquired in 2023 through 2032, the credit amount ranges from $500 to $5,000 per dwelling unit, depending on the energy efficiency standards met7. A tax credit of $2,500 is available for single-family and multifamily homes certified to an eligible version of the ENERGY STAR program requirements8. For multifamily dwelling units, the tax credit is $500 per dwelling unit, or $2,500 when prevailing wage requirements are met8. Rental units meeting the Zero Energy Ready Homes (ZERH) standard can receive $5,000 per unit1. Multifamily projects must comply with prevailing wage labor requirements to be eligible for the maximum incentive1. The IRA expanded the 45L tax credit by increasing the credit amount, removing the previous three-story height restriction, and allowing its use in conjunction with the 179D deduction for buildings four stories or greater9.

Other Government Incentives Supporting ESG in Commercial Real Estate

Beyond the IRA, several other government incentives encourage ESG initiatives in commercial real estate. These include:

  • Investment Tax Credit (ITC): Provides a tax credit for installing renewable energy generation equipment, such as solar, geothermal, and wind technologies1. The IRA increased the ITC cap to 70% of project costs.
  • Renewable Electricity Production Tax Credit (PTC): Offers a tax credit for each kilowatt-hour of electricity generated from specific renewable energy sources, including wind, hydropower, and clean hydrogen1.
  • Historic Tax Credit (HTC): Supports the rehabilitation of historic buildings, contributing to community revitalization and the preservation of cultural heritage1.
  • Property Assessed Clean Energy (PACE) Financing: Enables building owners to finance energy efficiency, renewable energy, water conservation, and resiliency improvements through a special property tax assessment10. PACE financing offers several benefits, including:
  • Long-term financing terms (typically 10+ years) 10
  • Lower monthly payments 10
  • No upfront costs 10
  • Fixed interest rates 6
  • Transferability of the assessment upon the sale of the property 6
  • Potential for combining with other utility, local, and federal incentive programs 10

However, PACE financing also has certain requirements:

  • State or local legislation authorizing C-PACE financing 6
  • Involvement of a private lender and a local authority to oversee the program 6
  • Green Banks: The IRA has allocated $20 billion to green banks, which play a crucial role in supporting emission reductions by providing financing for sustainable projects11.

Financial Benefits of ESG Initiatives

Investing in ESG initiatives can yield significant financial benefits for commercial real estate owners and developers. Studies indicate that deep retrofits for existing buildings can reduce energy use by up to 79%, resulting in direct cost savings in utilities and improved financial performance12. Furthermore, ESG-compliant buildings may qualify for lower insurance premiums due to reduced risk, as they are better equipped to withstand natural disasters and other environmental challenges12. Another potential benefit is the "green premium" in rent, where tenants are willing to pay higher rents for sustainable and healthy buildings12. This premium can range from 5% to 15%, and in some cases, can be as high as 45%12.

Grants for GHG Reduction Projects

The IRA has spurred the creation of several grant programs aimed at reducing greenhouse gas emissions. The EPA received $27 billion to award grants to nonprofits, including Housing Finance Agencies and Community Development Financial Institutions, to provide loans for carbon reduction projects, such as green upgrades in multifamily affordable housing13. In addition, the IRA allocated $9 billion to states for the High-Efficiency Electric Home Rebate (HEEHR) and the Home Energy Performance-Based, Whole House Rebates (HOMES) programs13. These programs provide cash rebates for energy efficiency upgrades, such as heat pump HVAC and water heaters, in both single-family and multifamily homes, with multifamily affordable housing qualifying for double the rebate amount13. Furthermore, the U.S. Department of Housing and Urban Development (HUD) received $1 billion to implement a Green and Resilient...source

Beyond the IRA, the EPA announced more than $4.3 billion in grants for projects in 30 states aimed at reducing greenhouse gas emissions across various sectors, including commercial and residential buildings14. These grants, funded through the Climate Pollution Reduction Grants program, support the development and implementation of plans for reducing greenhouse gas emissions and other harmful air pollution14.

Synergies with the Bipartisan Infrastructure Law (BIL)

The Bipartisan Infrastructure Law (BIL) complements the IRA in promoting sustainable development. The BIL provides funding for a wide range of infrastructure projects, including transportation, energy, and water systems15. These investments can catalyze complementary projects and create opportunities for developers to achieve profitable outcomes while supporting ESG goals15. For example, public investments in highway conversions that improve public transportation, walkability, and access to green space may unlock opportunities for developers to create more sustainable and livable communities15.

Eligibility and Application Processes

This section provides an overview of the eligibility and application processes for the key incentives discussed in this report.

Section 179D

To qualify for the 179D deduction, buildings must meet or exceed energy efficiency standards set by the American Society of Heating, Refrigerating and Air-Conditioning Engineers (ASHRAE)16. A third-party certification is required to demonstrate compliance with these standards1. The IRS has not yet released detailed guidelines for the updated 179D deduction under the IRA1.

The application process for the 179D deduction involves several steps:

  • Determining Eligibility: Ensure the building meets the energy efficiency requirements and that the applicant is either the building owner or a qualified designer16.
  • Conducting an Energy Efficiency Study: A detailed study is necessary to assess the building's energy performance and identify qualified improvements17.
  • Obtaining an Allocation Letter (for Designers): Designers working on government-owned or tax-exempt buildings must obtain an allocation letter from the building owner to claim the deduction16.
  • Filing Form 7205: This form is used to calculate and claim the 179D deduction18.

Section 45L

Eligibility for the 45L tax credit requires that homes meet either Energy Star or Zero Energy Ready Homes certification19. A Home Energy Rating System (HERS) rater, who is also an Energy Star Rater, must conduct an energy model and inspections to verify compliance19.

While specific application procedures for the 45L tax credit are not readily available, claiming the credit likely involves:

  • Obtaining Certification: Ensure the dwelling unit has received the required Energy Star or Zero Energy Ready Homes certification.
  • Documenting Compliance: Gather documentation to demonstrate compliance with the program requirements, including energy efficiency standards and prevailing wage requirements, if applicable.
  • Claiming the Credit: File the necessary tax forms and include the required documentation to claim the 45L tax credit.

Resources and Organizations

Several organizations provide guidance and support for navigating government incentives for ESG initiatives in commercial real estate:

  • GRESB: A global leader in ESG standards for infrastructure and real estate investments, providing benchmarking and reporting solutions20.
  • Sustainability Accounting Standards Board (SASB): Offers industry-specific standards for ESG reporting20.
  • Better Buildings Solution Center: Provides resources and tools for energy efficiency and renewable energy in buildings, including information on the IRA and other incentives21.
  • Green Building Initiative: Offers resources and tools for green building certification and sustainable design21.
  • Northeast Energy Efficiency Partnerships (NEEP): Provides information and resources on energy efficiency programs and policies in the Northeast United States21.
  • American Council for an Energy-Efficient Economy (ACEEE): Conducts research and advocates for energy efficiency policies and programs21.
  • Moss Adams: An accounting and advisory firm with expertise in ESG and sustainability reporting22.
  • PwC: Provides consulting services on real estate strategy, transformation, and ESG, including guidance on navigating government incentives23.

Case Studies and Examples

While specific case studies of commercial real estate projects utilizing IRA incentives are not readily available, reports highlight the potential for these incentives to drive significant investment in energy efficiency and renewable energy24. For example, one analysis suggests that deep retrofits of existing buildings can reduce energy use by up to 79%, leading to substantial cost savings and improved financial performance12.

The research also points to the potential for combining IRA and Bipartisan Infrastructure Law (BIL) funding to support green infrastructure projects25. This "blending and braiding" of funding streams can create synergistic opportunities for sustainable development25. For instance, a municipality could combine IRA tax credits for clean vehicles with BIL grants for electric vehicle charging infrastructure to accelerate the decarbonization of its fleet4.

Conclusion

The Inflation Reduction Act and other government incentives present a significant opportunity for commercial real estate owners and developers to invest in ESG initiatives. By leveraging these incentives, the industry can contribute to a more sustainable built environment while realizing substantial financial benefits, including cost savings, increased property values, and a competitive advantage in the market. The IRA, in particular, has the potential to drive a transformative shift towards greater sustainability in the commercial real estate sector1.

However, navigating the complexities of these programs requires careful planning and execution. Stakeholders should stay informed about program updates, eligibility requirements, and application processes. Consulting with experts and utilizing available resources can help maximize the impact of these incentives. Early adoption is crucial for staying ahead of the curve and capitalizing on the financial and environmental benefits of ESG initiatives.

As the commercial real estate industry continues to evolve, embracing ESG principles will be essential for long-term success. By proactively pursuing sustainable practices and leveraging government incentives, the industry can create a more resilient, efficient, and equitable built environment for future generations.

Works cited

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  2. IRA Tax Credits – Commercial Buildings and Property, accessed December 15, 2024, https://neep.org/ira-tax-credits-commercial-buildings-and-property
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  10. PACE Funding: Financing ESG and Sustainability in Real Estate - EisnerAmper, accessed December 15, 2024, https://www.eisneramper.com/insights/blogs/real-estate-blog/pace-funding-finance-esg-re-blog-0822/
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  14. U.S. Announces Over $4 Billion Funding for Projects to Reduce GHG Emissions Across Key Sectors - ESG Today, accessed December 15, 2024, https://www.esgtoday.com/u-s-announces-over-4-billion-funding-for-projects-to-reduce-ghg-emissions-across-key-sectors/
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