Section 45L: Everything old is new again

A longstanding energy efficiency credit that taxpayers have enjoyed since 2005, section 45L, has expanded the credit amount under the Inflation Reduction Act (IRA). Homebuilders and developers, particularly those receiving Department of Housing and Urban Development (HUD) loans, may now qualify for the enhanced benefits under the section 45L tax credit requirements.

The revised version of the 45L tax credit is available for newly built energy-efficient homes placed into service after Jan. 1, 2023, and before Dec. 31, 2032. The IRA bulked up eligibility requirements but also increased the benefit. The amount of credit per unit the taxpayer will receive depends on which requirements are satisfied. Although the base credit is $500 per unit, it is possible to receive up to $5,000 per unit. Under the prior law, $2,000 per unit was the maximum credit a taxpayer could receive.

Eligibility and credit amounts

Homebuilders and developers constructing qualified multifamily homes may be eligible for the credit. It also includes taxpayers who hire a third-party contractor to construct the building and then sells or leases it.

For a building to qualify, it must be located in the United States and construction or reconstruction and rehabilitation must be substantially completed after section 45L’s date of enactment. The critical component: It must satisfy the specified energy savings obligations.

The base credit threshold requires the units to be certified under Energy STAR Version 3.1 energy-efficient home program as applicable to the building location. Certified units will yield a $500 credit per unit. Since both the Energy STAR 3.1 certification and the section 45L certification could cost up to $500 per unit, it may not make financial sense for most developers to pursue the credit.

The next 45L threshold increases to a $1,000 credit per unit. These units must meet the Energy STAR 3.1 along with the Zero Energy Ready Home (ZERH) program requirements. A ZERH fundamentally requires units be constructed to allow for easy installation of solar energy that results in the unit consuming a net zero energy consumption if renewable solar energy is operable.

The largest 45L credit must meet the “prevailing wage” standard. Those who have received HUD financing already abide by that standard. Certain state financing also requires homebuilders follow Davis-Bacon Act prevailing wage stipulations. Combining the Energy STAR 3.1 requirement and prevailing wage multiplies the $500 credit by 5 times to a credit of $2,500 per unit. If ZERH requirements are met, the $1,000 per unit credit increases 5 times to $5,000 per unit.

It is worth noting that certification is not a simple or inexpensive process. The certifier must be accredited or authorized by the Residential Energy Services Network (RESNET) or an equivalent rating network. The process will most likely involve multiple inspections throughout construction, so developers who are interested in this credit should build the energy efficiency component into their business model from the beginning. Conveniently, the net zero and Energy Star certifications can be performed simultaneously.

Further potential changes and benefits

A significant change in the IRA for affordable housing projects is that it doesn’t preclude taxpayers who qualify for 45L from also claiming other credits, including the low-income housing tax credit (LIHTC). Rather, they can combine credits without impacting the calculation of the LIHTC.

IRS clarification is expected on guidance regarding the number of building stories that a section 45L project is allowed. Under pre-IRA rules, an energy-efficient home was limited to a building of three stories or less. Now that the certification process is based on Energy STAR rules, there are no building story limitations under Energy STAR. IRS guidance might modify the energy-efficient home definition to include all residential structures.

Another change with the IRA is extending its deadline to the end of 2032. Since its inception, section 45L has gone through a cycle of expiring and renewal multiple times, giving it a feeling of impermanence. Contractors were never certain if it would be around when they needed it. The IRA’s new deadline will allow more homebuilders to plan accordingly should they want to use it.

The IRA allowed for some credits to be sold if the holder didn’t need them. This is not the case with 45L.

Considerations

Affordable housing projects should be considering how or if they qualify for 45L. For those in the early stages, now is the time to integrate energy-efficient elements into their plans. If a project was recently completed, the developer should talk with a real estate tax professional to determine whether that project qualifies for the credit. And even though buildings over three stories don’t yet qualify, they may want to proceed like they do in case anticipated guidance expands the credit to those types of buildings. Regardless, the rewritten section 45L is well suited for affordable housing projects and should be a part of conversations for any multifamily project that uses HUD or state financing that requires prevailing wage standards.

Think you have a project eligible for 45L? Submit a project qualification form to find out.