Tax Court in Brief | Johnson v. Comm’r | Section 179D Energy Efficient Building Property Deduction

Share this Article
Facebook Icon LinkedIn Icon Twitter Icon
Freeman Law

Freeman Law

(214) 984-3000
freeman@FreemanLaw.com

Freeman Law is a tax, white-collar, and litigation boutique law firm. We offer unique and valued counsel, insight, and experience. Our firm is where clients turn when the stakes are high and the issues are complex.

The Tax Court in Brief – January 23rd – January 27th, 2023

Freeman Law’s “The Tax Court in Brief” covers every substantive Tax Court opinion, providing a weekly brief of its decisions in clear, concise prose.

For a link to our podcast covering the Tax Court in Brief, download here or check out other episodes of The Freeman Law Project.

Tax Litigation:  The Week of January 23rd, 2022, through January 27th, 2023

Johnson v. Comm’r, 160 T.C. No. 2| January 25, 2023 |Nega, J. | Dkt. No. (Consolidated) 19973-18, 19975-18, 19978-18, 20001-18

Summary: In this 32-page, consolidated opinion, the Tax Court addresses deficiencies from disallowance of a 26 U.S.C. § 179D energy efficient building property deduction claimed by Edwards 4 Engineering, Inc. (Edwards), an S corporation, for the 2013 taxable year. Petitioners (6 total) are shareholders of Edwards and reported their proportionate shares of the claimed deduction on their individual tax returns.

Edwards contracted with a federal government entity, the VA, to supply and install components of a federal building’s HVAC system. The VA signed a letter that agreed, pursuant to I.R.C. § 179D(d)(4), to allocate to Edwards the full amount of the I.R.C. § 179D deduction to which the VA would otherwise be entitled for the installation of the property. Edwards maintained a full-time staff at the VA to perform the services. Edwards presented evidence of hours logged, invoices submitted, and payments received for the various projects involved in the overall service arrangement. Edwards also presented evidence of subcontractors engaged and paid. Edwards also engaged Alliantgroup, LP (Alliantgroup), to conduct an Energy Efficient Commercial Building Tax Deduction Study (study) for the 2013 taxable year with respect to a certain Building 200. An allocation letter was presented to Edwards, and a VA representative signed off on the letter. The allocation letter stated, in relevant part, that “the owner of the Building allocates the full federal income tax deduction available under Section 179D attributable to the HVAC . . . to Edwards . . . for their work on the Building.” Attached to the allocation letter was a table which stated the placed in service date and the cost of the property installed in Building 200 with respect to the projects at issue. Alliantgroup then proceeded with conducting the study. A certificate of compliance related to Building 200 was issued, stating, among other things, that the total annual energy and power costs of this building had been reduced by more than 50 percent due to the installation of the systems, among other qualifying and compliance conclusions regarding Edwards’ work and services performed on the building. The study was performed in accordance with section 179D(d)(6)(C) and Notice 2006-52, section 5.05, 2006-1 C.B. at 1179. See Key Points of Law below for further reference to Notice 2006-52. Alliantgroup informed the VA that Alliantgroup had completed the study for Building 200 and determined that Edwards had been allocated a section 179D deduction in the amount of $1,037,237. The letter provided the projected annual energy costs for Building 200 and a list of the energy efficient features installed in Building 200.

Edwards filed a Form 1120S, U.S. Income Tax Return for an S Corporation, for the 2013 taxable year, claiming a section 179D deduction of $1,073,237. Petitioners, as direct or indirect shareholders of Edwards, reported their proportionate shares of the claimed section 179D deduction on their Forms 1040 for the 2013 taxable year. By notices of deficiency, the IRS disallowed the section 179D deduction claimed by each Petitioner. Petitioners each petitions challenging the disallowance, and the cases were consolidated.

Key Issue: Whether Edwards is entitled to a deduction of $1,073,237 under section 179D for the 2013 taxable year?

Primary Holdings: The installed property was EECBP within the meaning of I.R.C. § 179D(c)(1). The property: (A) was depreciable; (B) was located in or on property in the U.S.; (C) was installed as part of a plan to achieve the energy savings target; (D) installed resulted in computed energy savings; and (E) the certification and notice to building owner required by section 179D(d)(5) and (6) were sufficient. And, Edwards was primarily responsible for designing the EECB installed. The VA properly allocated the available amount of an I.R.C. § 179D deduction to Edwards as the person primarily responsible for designing the EECBP. The installed property was placed in service in tax year 2013. However, based on the limitations for deduction allowed by section 179D(b), Edwards was entitled to an I.R.C. § 179D deduction of $304,640.

Key Points of Law:

Jurisdiction and Burden of Proof. Where a notice of deficiency issued to an S corporation shareholder includes adjustments to both S corporation items and other items unrelated to the S corporation, the Tax Court has jurisdiction to determine the correctness of all adjustments in the shareholder-level deficiency proceeding. See Winter v. Commissioner, 135 T.C. 238, 245–46 (2010). In general, the IRS’s determinations set forth in a notice of deficiency are presumed correct, and the taxpayer bears the burden of proving them erroneous. Rule 142(a)(1); Welch v. Helvering, 290 U.S. 111, 115 (1933). Deductions are a matter of legislative grace, and the taxpayer generally bears the burden of proving entitlement to any deduction claimed. INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992). A taxpayer claiming a deduction on a federal income tax return must demonstrate that the deduction is allowable pursuant to some statutory provision and must substantiate the deduction by maintaining and producing records sufficient to enable the IRS to determine the taxpayer’s correct tax liability. 26 U.S.C. § 6001; Treas. Reg. § 1.6001- 1(a); Higbee v. Commissioner, 116 T.C. 438, 440 (2001).

Section 179D Deduction. Section 179D provides a deduction with respect to energy efficient commercial buildings. Ordinarily, when a taxpayer incurs expenses for improvements to buildings or other property, the taxpayer is required to capitalize the expenditures and may recover the costs over time through deductions for depreciation or amortization. See 26 U.S.C. §§ 167, 168, 263. Section 179D, however, allows taxpayers an immediate deduction with respect to energy efficient commercial building property. “There shall be allowed as a deduction an amount equal to the cost of energy efficient commercial building property placed in service during the taxable year.” Id. at 179D(a).

EECBP. “Energy efficient commercial building property” (EECBP) is defined in 26 U.S.C. § 179D(c)(1) as property:

(A) with respect to which depreciation (or amortization in lieu of depreciation) is allowable,

(B) which is installed on or in any building which is— (i) located in the United States, and (ii) within the scope of Standard 90.1-2001,

(C) which is installed as part of— (i) the interior lighting systems, (ii) the heating, cooling, ventilation, and hot water systems, or (iii) the building envelope, and

(D) which is certified in accordance with subsection (d)(6) as being installed as part of a plan designed to reduce the total annual energy and power costs with respect to the interior lighting systems, heating, cooling, ventilation, and hot water systems of the building by 50 percent or more in comparison to a reference building which meets the minimum requirements of Standard 90.1-2001 using methods of calculation under subsection (d)(2).

EECBP Energy Costs and IRS Interim Guidance. The statute directs the IRS (Secretary of Treasury) to consult with the Secretary of Energy to promulgate regulations which describe in detail methods for calculating and verifying energy and power consumption and cost, based on the provisions of the 2005 California Nonresidential Alternative Calculation Method Approval Manual. Id. at § 179D(d)(2). Section 179D(d)(3)(A) requires that any such calculation be prepared by qualified computer software. See IRS Notice 2006-52, 2006-1 C.B. 1175 (interim guidance); IRS Notice 2008-40, 2008-1 C.B. 725 (interim guidance); IRS Notice 2012-26 (modifying Notice 2006-52 and Notice 2008-40, the latter of which clarified and amplified Notice 2006-52). The Secretary has not promulgated regulations on the methods of calculation. Notice 2006-52, however, sets forth interim guidance on the methods for calculating and verifying energy and power consumption and cost. See Notice 2006-52, § 3.

Among other things, Notice 2006-52 broadly defines the proposed building as containing the relevant systems “that have been incorporated, or that the taxpayer plans to incorporate,” into the building. Notice 2006-52, § 3.04(1). Under this definition, the systems and components included in the proposed building are not limited to those incorporated into the building within a specific timeframe or by a specific contractor.

EECBP Certifications and “Person Primarily Responsible for Design”. Section 179D(d)(5) provides that each certification required under this section 179D must include an explanation to the building owner regarding the energy efficiency features of the building and its projected annual energy costs as provided in the notice under paragraph (3)(B)(iii). In the case of EECBP installed on or in property owned by arm of the government or a political division, section 179D(d)(4) provides that “the Secretary shall promulgate a regulation to allow the allocation of the deduction to the person primarily responsible for designing the property in lieu of the owner of such property.”

The person primarily responsible for designing the property “shall be treated as the taxpayer for purposes of this section.” Id. at 179D(d)(4). If the requirements of section 179D(c)(1) are satisfied, the amount of the section 179D deduction allowed is equal to the cost of the EECBP placed in service during the taxable year. Id. at § 179D(a). However, the deduction allowed is not to exceed the excess of the product of $1.80 and the square footage of the building, over the aggregate amount of the section 179D deductions taken with respect to the building for all prior taxable years. To the extent that a section 179D deduction is allowed with respect to any EECBP, the building owner is required to reduce the basis of the property by the amount of the deduction so allowed. Id. at § 179D(b), (e).

Section 179D does not define the “person primarily responsible for designing the property.” Notice 2008-40, section 3.02, however, defines a “designer” as “a person that creates the technical specifications for installation of [EECBP]” and may include, for example, an architect, engineer, contractor, environmental consultant or energy services provider who creates the technical specifications for a new building or any addition to an existing building that incorporates energy efficient commercial building property. Notice 2008-40, § 3.02. Section 3.02 clarifies that “[a] person that merely installs, repairs, or maintains the property is not a designer.” Id.

Certifications and Notice to Building Owner. Before a taxpayer may claim a section 179D deduction with respect to property installed on or in a commercial building, the taxpayer must obtain a certification with respect to the property. Notice 2006-52, § 4, 2006-1 C.B. at 1177. Section 179D(c)(1)(D) requires that EECBP be “certified in accordance with subsection (d)(6).” Section 179D(d)(5) requires each certification to include an explanation to the building owner regarding the energy efficiency features of the building and its projected annual energy costs. Notice 2006-52, section 4 prescribes the manner and method for the making of certifications in accordance with section 179D(c)(1) and (d)(6).

Form of Allocation. Section 179D does not prescribe any particular formal requirements for the allocation of the deduction. Notice 2008-40, section 3.05, 2008-1 C.B. at 726, states that “[b]efore a designer may claim the § 179D deduction with respect to property installed on or in a government-owned building, the designer must obtain the written allocation described in section 3.04.” Notice 2008-40, section 3.04 contains the elements that are evaluated for determining the allocation of the section 179D deduction. Notice 2008-40, section 3.04, requires the allocation letter to state only the “amount” (such as a percentage and not necessarily the dollar amount) of the section 179D deduction allocated to the designer.

“Placed in Service.” Section 179D allows a deduction for “the cost of energy efficient commercial building property placed in service during the taxable year.” 26 U.S.C. § 179D(a). Notice 2008-40, section 3.01 states that “[t]he deduction will be allowed to the designer for the taxable year that includes the date on which the property is placed in service.” Section 179D does not define when EECBP is “placed in service.” Because EECBP is property “with respect to which depreciation . . . is allowable,” the statutes and rules governing depreciable property are relevant to determine when property is “placed in service” for section 179D purposes. See 26 U.S.C. §§ 179D(c)(1)(A), 179(a), 167. Section 167 allows a depreciation deduction for the exhaustion, wear and tear, or obsolescence of property used in a trade or business. Treasury Regulation § 1.167(a)-10(b) provides that “[t]he period for depreciation of an asset shall begin when the asset is placed in service.” In general, property is placed in service when it is “first placed in a condition or state of readiness and availability for a specifically assigned function, whether in a trade or business, in the production of income, in a tax-exempt activity, or in a personal activity.” Treas. Reg. §§ 1.167(a)- 11(e)(1)(i), 1.179-4(e). Property is thus deemed to have been placed in service at the time when it functionally could have been used, rather than when it was actually used. See Waddell v. Commissioner, 86 T.C. 848, 897 (1986), aff’d, 841 F.2d 264 (9th Cir. 1988); Piggly Wiggly S., Inc. v. Commissioner, 84 T.C. 739, 746–47 (1985), aff’d, 803 F.2d 1572 (11th Cir. 1986).

Amount of the Section 179D Deduction. Under section 179D(a) the amount of the deduction allowed is “equal to the cost of energy efficient commercial building property placed in service during the taxable year.” Section 179D(b), however, limits the deduction allowed with respect to any building for any taxable year to the excess (if any) of the product of $1.80 and the square footage of the building, over the aggregate amount of section 179D deductions taken with respect to the building for all prior taxable years. Thus, the amount of the section 179D deduction allowed is equal to the lesser of (1) the cost of EECBP placed in service during the taxable year and (2) the maximum amount of deduction determined under section 179D(b). See Notice 2008-40, § 3.06.

Insights: To say that an EECBP deduction is complex is an understatement. And, the lack of statutorily-required regulations is not helpful. Much thought and preparation should go into a qualified building project before it begins to ensure the design is right for EECBP deduction and qualified experts are in place to provide the required evaluation, certification, and notices required by section 179D and the interim guidance provided by the IRS. Consultation of Johnson, section 179D, and the IRS Notices referenced above is advisable.