The Inflation Reduction Act: New Incentives

The Inflation Reduction Act changes the ‘financial calculus’ for designing energy-efficient projects. Billions of dollars are available for projects to adopt high-performing systems and reduce their carbon footprint.

The Inflation Reduction Act (IRA), passed in 2022, is widely viewed as the largest government investment in climate change initiatives in modern times. Of the $739 billion in investments earmarked by the bill, $369 billion targeted energy and climate issues.

The IRA expands existing programs and launches new initiatives targeting projects that embrace commitments to renewable energy and carbon reduction. The building industry — and its outsized impact on carbon, accounting for 40% of greenhouse gas emissions globally — was a primary target for billions of dollars in incentives to create more efficient projects.

New discounts and tax breaks will “move the market,” providing immediate benefits for projects designed to meet energy standards and expand the use of more efficient systems, says LPA Director of Sustainability and Applied Research Ellen Mitchell. “The IRA changes the financial calculus for the affordability of high-performing systems and on-site renewable energy.”

The new incentives, coupled with the growing focus on ESG investing, are changing the value proposition of sustainability. In a volatile market, carbon tracking and reduction metrics have the opportunity to make or break a project. The Urban Land Institute’s 2023 Sustainability Outlook notes lenders who are “already nervous about providing finance due to the macroeconomic uncertainty will be further dissuaded if an asset has no clear path to decarbonization.” Investment bank Credit Suisse issued a report last year concluding that the IRA “definitively changes the narrative [about climate change] from risk mitigation to opportunity capture,” suggesting that the real danger these days is missing out on the economic boost available from the bill.

“The new incentives can provide an immediate return-on-investment for many projects,” says LPA Director of Commercial Nick Arambarri. “Especially for existing building stock, there’s a real opportunity to fund major renovations and upgrades.”

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Redding Rancheria Tribal Health Center. For the first time, tribal governments will be eligible for tax incentives to reduce carbon emissions.

The impact of the bill is expected to be widespread, with several programs supporting new research and manufacturing of green technologies in the U.S. There has already been a significant uptick in investments in renewable technologies. In the months after the legislation passed, manufacturers committed more than $40 billion in plants to make batteries and equipment for wind and solar power, according to the Wall Street Journal.

“Short term, both privately funded and, for the first time, tax-exempt projects have the potential to realize savings immediately through tax rebates and direct payback elections,” Mitchell says. “Long term, the demand for energy-efficient systems and new technology will drive down the cost for the entire market.”

The bill also marks a significant shift in the political debate. The IRA focuses on incentives for businesses rather than more restrictive and punitive strategies, such as a carbon tax or cap and trade programs. “It’s no longer about penalties; it’s about incentivizing market behaviors,” says LPA Director of Engineering Erik Ring. “The lesson here is that incentivizing businesses to adopt climate initiatives is politically palatable while punishing businesses for their carbon emissions [through a carbon tax] is not.”

For developers and building owners, there are direct financial rewards for using more efficient technologies, renewable energy and electric vehicle (EV) charging. Many elements are complex and include specific small-print requirements — such as meeting prevailing wage standards or addressing underserved communities. But specific provisions can help developers and building owners in the near term.

Key Opportunities

Analyses by the U.S. Green Building Council, American Institute of Architects and other industry groups have identified several potential benefits for builders and owners.

Tax Deduction for Energy-Efficient Commercial Buildings
The IRA significantly expands and makes permanent the tax break for meeting energy-reduction targets. The deduction moves from $1.80 per square foot to a sliding scale of $2.50 to $5 a square foot. The new measure also makes the tax break available for retrofits of existing buildings. New construction must achieve 25% to 50% reduction from the most recent ASHRAE 90.1; retrofits must demonstrate a 25% to 50% reduction from the existing buildings, which is often a much lower bar. (Note: To receive full credit, projects must meet prevailing wage and apprenticeship requirements.)

The new incentives can provide an immediate return-on-investment for many projects. Especially for existing building stock, there’s a real opportunity to fund major renovations and upgrades.

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The measure also opens the deduction to REITs, and maintains the provision allowing schools, municipal agencies and other public entities to allocate the deduction to a project designer. The changes provide “certainty we have not had around these things, to be able to design and plan a project and know what the incentives are going to be,” said Ben Evans, Federal Legislative Director for the U.S. Green Building Council (USGBC), during a recent presentation.

Clean Electricity Tax Credit
The new legislation expands and extends the Investment Tax Credit (ITC) for clean energy property investments, including solar, geothermal, heat pumps and combined heat and power. The credit can go as high as 30% of costs, if prevailing wage and apprenticeship requirements are met. The credit can go up 10% if domestic content requirements are met and another 10% if the project is located in a designated “energy community” such as a brownfield site.

The IRA also expands eligibility to cover new technologies, including energy storage technology, microgrid controllers and dynamic glass. “Starting in 2025, for most technologies, ITC converts to a tech-neutral structure with similar incentives based on GHG [greenhouse gas] reduction,” the USGBC reports.

EV Infrastructure Tax Credit
The IRA significantly boosts the tax credit for “qualified alternative fuel vehicle refueling property,” including EV charging systems. A credit is available for 30% of expenses, up to $100,000 per charging/fueling unit on commercial properties. But there are restrictions. In addition to meeting prevailing wage and apprenticeship program requirements, eligible properties must be in targeted rural or low-income census tracts starting in 2023.

Multifamily Incentives
Incentives for energy-efficient single-family homes will be extended to multifamily projects, including the Home Builder Tax Credit, which had previously been limited to buildings under three stories. Credits are available for up to $2,500 per unit for meeting Energy Star standards or $5,000 per unit for meeting Department of Energy zero-energy-ready standards. Rebates are also available for building retrofits that achieve energy savings and for electrification projects for low- and moderate-income projects.

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The design for the net zero Environmental Nature Center Preschool campus, which earned a national AIA COTE Top Ten award, demonstrated the ability to integrate sustainability goals with the school’s mission on a tight site.

Benefits for Tax-Exempt Entities and Tribal Nations
The IRA changes the rules to allow tax-exempt entities and Indian tribal governments to take advantage of tax incentives in other ways. Many of the incentives, such as the ITC, allow for a direct payback on qualifying systems through the IRS. Others, such as 179D, allow tax-exempt entities to allocate deductions directly to a project designer. (See sidebar.)

Wild Cards

In addition to specific benefits for projects, the bill also supports a wide range of initiatives that could have a broader effect on the industry.

Support for Environmental Product Declarations (EPDs)
Initiatives in the bill will spur efforts to address planning, monitoring and data reporting. Designers are applauding the addition of $250 million focused on supporting the development, standardization and transparency of environmental product declarations (EPDs), an important step in measuring and reporting carbon results. “The funds will help standardize EPDs so they become a more useful tool to analyze building materials and the greenhouse gas implications,” Mitchell says.

Green Federal Buildings
The bill sets aside more than $3 billion for the General Services Administration (GSA) to acquire and install low-embodied carbon materials and products for use in the construction or alteration of federal facilities. Part of the funds will support converting existing buildings to high-performance green buildings, while almost $1 billion is targeted to support emerging technologies. The focused government spending “will help make products with lower embodied carbon thresholds more ubiquitous for our clients,” says Mitchell.

Disadvantaged Communities
Several of the bill’s initiatives focus on disadvantaged and low-income communities. A Neighborhood Access and Equity Grant program administered through the Department of Transportation will receive $3 billion to help develop walkable, safe neighborhoods by removing existing transportation infrastructure that adversely impacts communities. Another $3 billion was set aside for Environmental and Climate Justice Block Grants for local governments, universities or community-based nonprofits to implement environmental projects benefiting disadvantaged communities. Eligible projects could be anything from mitigating climate and health risks of heat islands to resiliency initiatives and programs to reduce indoor air pollution, the USGBC reports.

The bill also designates $27 billion for a Greenhouse Gas Reduction Fund controlled by the Environmental Protection Agency (EPA) for initiatives with what the USGBC termed “flexible project eligibility.” Targets include $7 billion in competitive grants for low-income and disadvantaged communities to utilize zero-emission technologies and $8 billion in competitive grants for climate-related activities in low-income and disadvantaged communities.

Some are underestimating the impact some of these provisions can have, especially the tax incentives.

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Programs will reward schools for providing healthier, safer environments, including new funds to monitor and reduce air pollution and greenhouse gas emissions.

Air Pollution in Schools
The EPA will also administer $37.5 million to monitor and reduce air pollution and greenhouse gas emissions in schools in low-income and disadvantaged communities. An additional $12.5 million will go toward technical assistance to help schools address environmental issues and air pollution, and to develop school environmental quality plans that include standards for building, design, construction and renovation.

Industry observers believe the long-term effect of the IRA could be far greater than the initial reports. Many of the incentives for zero-carbon electricity and electric vehicles are uncapped; the listed expenditures are only estimates. If the industry embraces the opportunities, government financial support for sustainable buildings could reach $800 billion, double the initial estimates.

“Some are underestimating the impact some of these provisions can have, especially the tax incentives,” said Evans of the USGBC.

Major clean energy subsidies included in the act could start to reduce the country’s emissions as early as this year, “if the government can fast track implementation,” Rhodium Group, a research firm, concluded in a recent report. The financing will provide the sparks that will lead to the development of the new technologies necessary to achieve zero carbon goals.

“The fight against climate change is going to change more in the next four years than it has in the past 40,” Robinson Meyer recently wrote in The Atlantic. “Clean energy is now the safe, smart, government-backed bet for conservative investors.”

Sources: U.S. Green Building Council, American Institute of Architects


Opportunities for Tax-Exempt Organizations

The Inflation Reduction Act (IRA) is a game changer for nonprofits, government agencies and other tax-exempt organizations interested in designing more energy-efficient, sustainable projects. For the first-time, tax-exempt groups — including school districts, city governments and tribal governments — will be able to take advantage of federal tax incentives to lower their carbon footprint and save money.

The IRA provides “unprecedented opportunities for state governments and political subdivisions … to combat climate change by stimulating the development of clean energy and carbon neutrality,” according to Deloitte, the consultancy.

The act allows groups to receive certain tax credits as direct payments from the Internal Revenue Service, streamlining access to key incentives. Billions of dollars are available through a wide variety of programs focused on key areas, including renewable energy, energy-efficient systems, electric vehicle charging, carbon-reduction programs and battery systems.”

The Inflation Reduction Act recognizes that state, local and tribal governments, as well as nonprofit organizations and other tax-exempt entities, have played and will continue to playa central role in making investments to build a clean energy economy,” the Treasury Department noted in a statement.