Maximizing Tax Incentives for CRE Projects

By better leveraging tax deductions and incentives, developers can reduce the capital needed from debt and equity sources.

Tax deductions and incentives tend to be complex, but they can provide much-needed relief to commercial real estate owners and developers who understand how to leverage them. Especially in the current economic climate, these financial tools can offset some of the challenges posed by declining property values and high interest rates. This article describes the most common incentives available to CRE stakeholders.

Cost Segregation Studies

Cost segregation studies are a popular tax strategy that allows property owners to accelerate depreciation on certain building components, thereby reducing taxable income in the year a building is acquired. This strategy is further enhanced by the bonus depreciation rules allowable at the federal level, where 60% of qualifying property purchased and placed in service in 2024 can be expensed immediately.

Assume a commercial building is acquired for $10 million, and $9 million of the purchase price is allocated to the building. The building owner would be entitled to depreciate the building over 39 years, producing an annual depreciation deduction of approximately $230,700. A cost segregation study done on that same building could allow portions of the building to be depreciated over shorter lives, depending on the type of building and its related components. For example, if the study concludes that 10% of the building qualifies as 5-year property and 5% of the building qualifies as 15-year property, the federal tax depreciation allowable for a building purchased in 2024 would be approximately $1,372,000.

In certain situations, a cost segregation study can be detrimental if other incentives are being pursued. For instance, if the intent is to sell the building within one to two years of acquisition, the depreciation deductions generated would have to be recaptured at ordinary income tax rates, thereby diminishing the value of the cost segregation study. Additionally, projects with historic tax credits generally do not undergo cost segregation studies because doing so would reduce the amount of costs eligible for the tax credits. In many cases, credits are more favorable than deductions, since a credit represents a dollar-for-dollar reduction of one’s tax liability.

Bonus depreciation is scheduled to phase out by the end of 2026 (2027 for self-constructed property with a longer production period). Qualifying assets placed in service by the end of 2024 are eligible for 60% bonus depreciation, but the same assets, if placed in service in 2025, will qualify for only 40% bonus depreciation. It is not known at this time whether there will be any new legislation that changes the rules for bonus depreciation.

Section 179D Energy Efficiency Deduction

The Section 179D deduction incentivizes energy-efficient building design and retrofitting. It allows commercial building owners to deduct the cost of energy-efficient improvements such as lighting, HVAC systems and building envelope upgrades, which otherwise would have to be capitalized and depreciated over 39 years.

The deduction is worth up to $1 per square foot of building space if the building is certified by way of a qualified study to reduce annual energy and power costs by greater than 25%. If the project also satisfies prevailing wage and apprenticeship requirements, the deduction increases to $5 per square foot. Generally, the prevailing wage under the Inflation Reduction Act of 2022 allows for increased credit where documentation demonstrates that project laborers are paid no less than the rates set by the Department of Labor. The apprenticeship requirements for increased credit state that a minimum percentage of labor hours be performed by qualified apprentices, with ratios and participation rules. Projects of less than 1 megawatt or those that began construction prior to Jan. 29, 2023, may qualify under a transition rule that exempts such projects from having to satisfy prevailing wage and apprenticeship requirements.

EV Charging Station Credits

The installation of high-speed electric vehicle charging stations is eligible for a tax credit of up to 30% of the project’s total costs, limited to $100,000 for each charging station. As of 2023, charging stations are eligible only if located in an eligible census tract (defined as a low-income community or a nonurban area). Thus, the project’s exact location should be checked against those eligible locations to ensure the credit can be used and maximized.

Section 45L Tax Credits

Landlords of mixed-use projects and other multifamily rental developments may wish to consider an incentive under Section 45L of the tax code, which allows a tax credit of up to $5,000 per unit if the unit meets certain energy efficiency standards and satisfies the prevailing wage and apprenticeship requirements. The energy efficiency standards are typically set by the Department of Energy or the Environmental Protection Agency and involve achieving specific levels of energy savings, such as Energy Star certification or Zero Energy Ready Home standards. The best time to undergo a Section 45L study is immediately after a property is developed, before it is occupied by tenants.

Historic Tax Credits

The federal historic tax credit (HTC) provides a valuable incentive for owners rehabilitating and preserving structures listed in the National Register of Historic Places. Projects are eligible for a tax credit equal to 20% of the qualified rehabilitation expenditures claimed ratably over five years. Some states, such as New York, have their own historic rehabilitation credits programs that mirror the federal credit.

Qualified Opportunity Zone Investments

Three main tax benefits are available with a qualified opportunity zone (QOZ) investment:

1. Deferral of capital gains that are invested into an entity that self-certifies to the IRS as a qualified opportunity fund (QOF) that will own QOZ property. The capital gains are deferred until the earlier of either the date on which the qualified investment is made or Dec. 31, 2026. Any taxes owed on the deferred capital gains would have to be paid on or before April 15, 2027.
2. For QOF investments made prior to 2021, 10% of the deferred capital gain can be excluded from taxable income when the gains must be recognized in 2026. For QOF investments made prior to 2019, the exclusion percentage increases to 15%.
3. After a minimum 10-year holding period, the QOF investor may exclude from their income the gain on sale of their qualified investment in the QOF. Alternatively, any gain on the sale of the qualified property owned directly or indirectly by the QOF may be excluded from the investor’s income as well. This is arguably the most lucrative benefit of the QOZ incentive.

While the rules and structuring of such investments are complex and require careful planning and execution at both the federal and state levels, investors can defer paying tax on certain capital gains in exchange for making eligible investments in these projects, while at the same time paving the way for a potential tax-free exit from the investment after a minimum holding period of 10 years. Capital gains contributed to a QOF after Dec. 31, 2025, will not qualify for a deferral but would still be eligible for benefit No. 3 above. There has been discussion about extending or refining the QOZ incentive, but it is unclear whether this will happen. Despite this uncertainty, QOZ investments remain a viable option, particularly for investments intended to be held for at least 10 years.

Brownfield Tax Incentives

Several states have developed programs to incentivize the cleanup of brownfields. The credits can pay off because the cleanup costs are often substantial. Keep the following considerations in mind:

• Brownfield projects often require substantial expenditures of capital up front, so it is critical that the project has sufficient funding during the development phase.
• The incentives can differ depending on the state in which the project is located. For instance, New York requires completion of a comprehensive application process and payment of a $50,000 fee before starting the project.
• Once the project is completed and credits are claimed, the taxing authorities will closely examine the tax returns given the dollar amounts of the credits. While each situation is different, the audit process can drag on for multiple years. Project sponsors should expect that components of the claim may be contested. This involves examination by a brownfield cleanup expert to ensure such challenges are fair and substantiated by authoritative guidance. The audit process will delay the time that investors can see a return on their investment for funding the cleanup costs up front.

Case Study

Consider the following example: A developer is looking to transform an old industrial facility sitting on contaminated land in New York state into a mixed-use development, with retail and warehouse space on the ground level and 100 residential rental units on the remaining levels. In addition, the municipality has encouraged installation of five high-speed EV charging stations, which the developer agrees to include. A simplified version of the developer’s budget for this project is as follows:

• Demolition and removal work: $5 million
• Walls, stairs, elevators: $3 million
• Plumbing and electrical work: $2 million
• Structural components: $10 million
• Paving: $500,000
• Signage: $500,000
• Soft costs: $500,000
• Brownfield cleanup costs: $5 million
• Developer fees (arms-length): $4 million
• Charging stations: $1 million
• Total costs: $31.5 million

The developer can leverage various credits in connection with this project, including the federal HTC for a building listed in the National Register of Historic Places or located in a registered historic district, and state historic tax credits for a project located in certain census tracts. In addition, the property is in a QOZ, so the developer can inject eligible capital gains from the sale of another property into this project. The following is an overview of the cost savings:

• QOZ investment, initial investment (capital gain deferral): $2 million (capital gain deferral — time value of money between investment of capital gain and April 15, 2027)
• QOZ investment, exit after 10 years (exclusion of capital gain on sale of the investment or the underlying property): Unknown/variable, but expected to be substantial (minimum 10-year holding period required)
• Tax credits for charging stations (30% of the costs, up to $100,000 per single charging station): $300,000
• Federal historic tax credits (20% of the total rehabilitation costs, claimed over a 5-year period): $2 million
• State historic tax credits (20% of the total rehabilitation costs, claimed over a 5-year period): $2 million
• Section 45L tax credits ($5,000 per qualified residential rental unit): $500,000
• Brownfield tax credits (estimate of 20% of the cleanup costs for project): $1 million
• Total tax credits to be earned over the next 5 years: $7.8 million

A Caveat

The availability of one or more incentives should not be the sole reason for pursuing a particular project component. For instance, in the above case study, if the property’s tenants do not utilize EVs, the developer will likely want to spend that money on other value-add areas. In addition, many tax credits and incentives are now tied to prevailing wage and apprenticeship requirements, which means a project’s out-of-pocket costs will invariably be higher than if such requirements did not have to be considered.

Jess LeDonne, JD, is director of policy and legislative affairs at The Bonadio Group. Joseph Wutz, CPA, is partner at The Bonadio Group. Nancy Cox, CPA, partner, and Jamie Card, CPA, partner, also contributed to this article.

• Magazine Article
• Finance
• Brownfields
• Tax
• EV Charging Stations