Lighting accounts for over 70 percent of all retrofits and remodels. Nowadays, the decision to relight or remodel a property is no longer one of aesthetics only. With the EPAct and other tax credits and deductions available, and taking into account the reduction of energy costs over time, the potential savings are substantial. The question now is how much money do you want to save? And how do you want to save it?
What Are the Economic Benefits for Relighting?
- EPAct - The Energy Policy Act of 2005 provides for a federal tax deduction of $0.60 per square foot for putting in energy-efficient lighting and the associated controls. Have a certification completed and the benefits are a simple line item adjustment to your tax return. A 200,000-square foot warehouse will generate $120,000 in tax deductions when properly renovated.
- Utility Rebated - In the same way you get a rebate for buying a new energy-efficient refrigerator, you are also entitled to rebates from the utility for installing energy-efficient lighting.
- Energy Savings - Simply put, a new lighting system can reduce your power usage by 50 percent. With energy costs scheduled to double in some areas over the next five years, you can see how important these savings can be.
- 1245/1250 - After a renovation is completed, some of the assets may be considered personal property by the IRS. These assets qualify for bonus depreciation.
- Abandonment - When a property undergoes renovation, such as adding new lighting or a new HVAC system, the old systems are abandoned for accounting purposes. This means that the net book value of the asset is written off as a loss (i.e., taken as a tax deduction). This deduction can provide significant economic benefit to the property owner.
Let's look at an example of a 250,000-square-foot warehouse. The cost of the relighting was $140,000, and the benefits were as follows:
- EPAct: $140,000
- Abandonment: $90,000
- Annual energy savings: $60,000
- Total tax deductions: $230,000
The net after-tax benefit of the tax deductions and the first year energy savings exceeded the cost of the retrofit. In other words, the ROI was under one year!
How Does This All Work?
The IRS splits assets into two categories - 1245 and 1250 - in essence, separating assets into buckets based on their lives. Lighting, by IRS definition, is a 1250 category asset and has an accounting life of 39 years. To qualify for accelerated depreciation (and the one-year bonus depreciation), the asset must have a life of 20 years or less. The lighting 1245/1250 definitions are below, as is the related information on the bonus depreciation.
- Electrical/Light Fixtures: Interior 1250 assets include lighting such as recessed and lay-in lighting, night lighting, and exit lighting, as well as decorative lighting fixtures that provide nearly all the artificial illumination in the building or along building
- Light Fixtures: Interior 1245 light fixtures are those such as neon, track lighting, or grow lights that are decorative in nature and not necessary for the operation or maintenance of the building. If the decorative lighting were turned off, the other sources of lighting would provide sufficient light for operation or maintenance of the building. If the decorative lighting is the primary source of lighting, then it is section 1250 property. See the description on the IRS website under "Personal Property With No Class Life - 7 Years."
A word of warning: Should you decide to take the 1250 asset as a one-year depreciation when you should not have (whether mistakenly or intentionally) and the IRS realizes what you have done, the consequences of violating these accounting rules can be severe and include reclassification of the assets from shorter-lived assets back to building assets and the deduction would be disallowed. If the deduction was excessive, the IRS can impose accuracy-related penalties or even fraud penalties, so it's very important to have a professional properly assess, identify, and document these assets.
The federal Economic Stimulus Act of 2008 included a 50 percent first-year bonus depreciation provision for eligible renewable-energy systems acquired and placed in service in 2008. This provision was extended (retroactively for the entire 2009 tax year) under the same terms by The American Recovery and Reinvestment Act of 2009. Bonus depreciation was renewed again in September 2010 (retroactively for the entire 2010 tax year) by the Small Business Jobs Act of 2010. In December 2010, the provision for bonus depreciation was amended and extended yet again by The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010.
Under these amendments, eligible property placed in service after September 8, 2010 - and before January 1, 2012 - qualifies for 100 percent first-year bonus depreciation. For 2012, bonus depreciation is still available, but the allowable deduction reverts from 100 percent to 50 percent of the eligible basis. To qualify for bonus depreciation, a project must satisfy the following criteria:
- The property must have a recovery period of 20 years or less under normal federal tax depreciation rules;
- The original use of the property must commence with the taxpayer claiming the deduction;
- The property generally must have been acquired during the period from 2008 to 2012; and
- The property must have been placed in service during the period from 2008 to 2012.
If a property meets these requirements, the owner is entitled to deduct a significant portion of the adjusted basis of the property during the tax year the property is first placed in service. As noted above, for property acquired and placed in service after September 8, 2010 and before January 1, 2012, the allowable first-year deduction is 100 percent of the adjusted basis. For property placed in service from 2008 to 2012, for which the "placed in service date" does not fall within this window, the allowable first-year deduction is 50 percent of the adjusted basis.
In the case of a 50 percent first-year deduction, the remaining 50 percent of the adjusted basis of the property is depreciated over the ordinary Modified Accelerated Cost Recovery System (MACRS) depreciation schedule. The bonus depreciation rules do not override the depreciation limit applicable to projects qualifying for the federal business energy tax credit. Before calculating depreciation for such a project, including any bonus depreciation, the adjusted basis of the project must be reduced by one-half of the amount of the energy credit for which the project qualifies. It's also important to note that a 179D Energy Efficient property does not qualify for bonus depreciation.
For selected leased properties, there is a limited time benefit listed below. It is recommended that you have some confirmation of your renovations completed to verify that only qualifying properties were taken as a write-off.
- Qualified Leasehold Improvement Property: An improvement to an interior portion of nonresidential real property (whether or not depreciated under MACRS) by a lessor or lessee under or pursuant to a lease may qualify for bonus depreciation. The improvement must be placed in service more than three years after the building was first placed in service (i.e., the building must be more than three years old). The lessor and lessee may not be related persons. Expenditures for (a) the enlargement of a building, (b) any elevator or escalator, (c) any structural component that benefits a common area, or (d) the internal structural framework of the building do not qualify.
From the EPAct to abandonment and utility rebates, the economics of a lighting retrofit have never looked better and provide incentives that allow many businesses to afford new lighting systems that they otherwise could not have afforded. To achieve these benefits, there are some tax and compliance issues that you need to address. The EPAct tax deductions and the 1245/1250 analysis require a high level of tax and engineering expertise, which can help you to maximize your upgrades and retrofits so that you get the most bang for your buck.