Save energy and reduce taxes? Go figure

Many veterinary practices operate in older buildings with leaky windows, poor insulation and patched roofs. Despite escalating energy costs, the harsh reality is few veterinarians are aware of the many incentives – both cash and tax incentives – available to help reduce that operating expense.

On August 8, 2005, President George W. Bush made history when he signed H.R. 6, the Energy Policy Act of 2005. Only recently, however, has the Internal Revenue Service provided guidelines for commercial building owners and veterinary practices that lease the building that houses their operations to qualify for a unique tax deduction to make their buildings energy-efficient.

The tax provisions of the Energy Policy Act set a precedent because, for the first time, legislation contained a market transformation incentive in the form of a tax deduction for owner improvements in commercial building efficiency. In other words, the actual amount of the tax deduction is based on how energy efficient a commercial building is made, not how large the expenditure is for equipment and other "property" necessary to reach that goal.

Performance caps

This unique new deduction for commercial building owners and tenants is performance based rather than based on the cost of the equipment, systems or property. The Energy Act placed a ceiling or "cap" on the amount deducted of $1.80 per square foot. Thus, a veterinary practice that spends $5,000 to acquire a lighting system that qualifies their 2,000-square-foot building for this unique write-off may claim an immediate tax deduction of $3,600 ($1.80 x 2,000 square feet). The balance, $1,400, is depreciable.

Generally, under this law that became effective Jan. 1, 2006 (expiring after 2008), veterinary practices that upgrade energy systems such as heating and cooling (as well as contractors that build homes with energy efficient materials) can file for tax credits and deductions that could save them tens of thousands of dollars.

The instant tax write-off is already proving to be a boon to building owners who, until now, had to write off building improvements by depreciating them over 39 years. Businesses and veterinary practices can save even more if they use government-specified building materials and stock buildings or other property with energy-efficient appliances.

What buildings, what property?

The IRS's guidelines define energy-efficiency commercial building property as property that is:

(1) Installed on (or in) any building located in the United States that falls within the scope of energy standards established by the American Society of Heating, Refrigeration and Air Conditioning Engineers or the Illuminating Engineering Society of North America.

(2) Installed as part of (i) the interior lighting system, (ii) the heating, cooling, ventilation and hot water systems or (iii) the building envelope; and

(3) Certified as being installed as part of a plan designed to reduce the total annual energy and power costs of interior lighting systems, heating, cooling ventilation and hot water systems of the building by 50 percent or more, when compared to a reference building, which meets the standards established by the industry in 2003.

Planning savings

In order to qualify for an immediate tax deduction, rather than as a capital expenditure, the energy-efficient property must be installed as part of a plan intended to reduce the total annual energy and power costs of the building by 50 percent or more. Actually, the 50-percent reduction is somewhat misleading. The rule requires that costs must be reduced "by 50 percent or more in comparison to a reference building which meets the minimum requirements of Standard 90.1-2001," a publication of the American Society of Heating, Refrigeration and Air Conditioning Engineers and the Illuminating Engineering Society of North America.

Further complicating matters, the definition of energy-efficient commercial building property requires that the veterinary practice get certification for the plan to reduce its building's overall energy and power costs. While the IRS has been charged with designing and governing this certification process, the U.S. Department of Energy has created, and is maintaining, a public list of software that must be used to calculate energy savings for purposes of providing the required certification.

Partial savings

Under a loophole in the new rules, a reduced deduction may be available for a building even if the reduced energy-efficient property was not installed as part of a certified plan to reduce overall energy and power costs. The IRS will issue rules containing specific energy-efficient targets and methods of calculating such targets, for each of the separate systems, namely, interior lighting, heating, cooling, ventilation and hot water.

Any veterinary practice that replaces any of these systems in an existing building and meets the designated target will be eligible for a partial deduction. The partial deduction is available for the costs of energy-efficient systems installed up to $0.60 per square foot of the building.

Generally, the deduction reduces the depreciable basis of the building. When it comes to early disposition or abandonment of the equipment or property, the commercial building energy saving write-off is treated as a depreciation deduction for Section 1245 recapture purposes. In other words, the write-off must be repaid if disposed of during the recapture period.

Certifying energy savings

Before any veterinary practice can claim the deduction for energy-saving equipment, systems or property installed on, or in, a commercial building, they must obtain certification of the energy savings from a qualified individual. The certification must satisfy all the IRS's requirements.

Surprisingly, a veterinarian taking advantage of this unique tax write-off is not required to attach the certification to the tax return on which the deduction is taken. The rules do require taxpayers to maintain such books and records as are sufficient to establish the entitlement to, and amount of, any deductions claimed.

The bottom-line

This instant tax break might be important for veterinary practices and businesses, which, until now, have had to write-off building improvements by depreciating them over 39 years. The deduction is equal to energy-efficient commercial building property expenditures made by the veterinarian, subject to a cap. The deduction is limited to an amount equal to $1.80 per square foot of the property for which such expenditures are made. The deduction is allowed in the year in which the property is placed in service. For tax purposes, "placed in service," generally means the time at which the property is ready for its intended use.

If, for example, a veterinary operation spends $18,000 on improvements and upgrades to a 10,000-square-foot facility, it qualifies for an $18,000 deduction. At the maximum federal tax rate of 35 percent, that generates a $6,300 federal tax break. Remember, however, certain certification requirements must be met in order to qualify for the deduction.

Going solar

Above all, do not forget the Energy Act also increased the business investment credit for solar energy property from its current level of 10 percent to 30 percent. That increased 30-percent credit only applies, however, to solar energy property, hybrid solar lighting systems and qualified fuel-cell property. Any other energy property, the credit percentage remains at only 10 percent.

Energy savings

Studies show that 75 percent of the energy for commercial buildings is electric and 65 percent of the use is HVAC driven. On average, $2 per square foot is spent for electricity costs, ranking it among the top three operating expenses. Rates are rising 5 percent to 15 percent annually but as many experts point out; this is a controllable expense by taking energy-efficient measures.

The commercial building deduction, enacted as part of the Energy Policy Act of 2005, allows veterinary practices to deduct the cost of energy-efficient property installed in commercial buildings. Under the recently released guidelines, anyone who upgrades energy systems such as heating and cooling can file for tax credits and deductions that could save them money.

Before claiming the deduction, however, the veterinarian or practice must obtain a certification that the required energy savings will be achieved. The IRS's recently issued guidelines outline the certification process and the qualifications that must be met by the person providing the certification.

Mr. Battersby is a financial consultant in Ardmore, Pa.