Real estate: Potential impacts of The Inflation Reduction and CHIPS Acts

The Inflation Reduction Act

The USD 437bn IRA included and expansion of and changes to tax deduction 17D and tax credit 45Q. According to the Billy Grayson, executive vice president of the Urban Land Institute, “These tax rebates could result in tens and tens of billions of retrofits that otherwise might not have happened because they wouldn’t have been cost-effective enough to meet the investment threshold.” Source: CoStar, 26 August 2022.

Although the 179D tax deduction was in existence prior to the signing of the IRA, the new bill significantly expands the benefits. The deduction for energy efficient commercial and multifamily buildings was previously capped at USD 1.80/square foot (SF). However, owners of these structures can now deduct between USD 2.50 and 5.00/SF (up to USD 5,000/unit for both multi and single-family residential units from the USD 2,000/unit) provided the building meets certain suitability standards and hires construction workers who are paid at or above prevailing wage rates. For CRE, reduction in a building’ energy use by 25% would entitle the owner to a deduction of USD 2.50/SF while a reduction of 50% would allow for a USD 5/SF deduction. In addition, according to the 26 August 2022 CoStar article, building owners were only eligible for the 179D deduction if their property was better than Standard 90.1 which was a uniform energy efficiency benchmark set by the American Society of Heating, Refrigerating and Air Conditioning Engineers. Pursuant to the implementation of the IRA, a property is required only to show improvement relative to its history to be eligible for the deduction.

In addition to the expansion of the 179D deduction, the IRA increases the federal tax credits for section 45Q carbon capture projects. When originally introduced in 2008 45Q allowed for a tax credit of USD 20/metric ton of CO2 permanently stored. Under the IRA this credit was expanded to USD 60/ton and the minimum carbon reduction threshold was reduced to 12,500 metric tons from 25,000 to be eligible for the credit. The IRA also provides for tax rebates for the installation of solar panels, EV charging stations and heat pumps as well as incentives for the de-carbonization of both single and multifamily affordable housing properties. According to a 16 August 2022 article in Bisnow, the IRA extends the commercial tax credit for solar panels to 2034, with a phase out beginning in 2032. Beginning retroactively on 1 January 2022, tax savings for installing panels will be 30% of the panel’s cost. In addition, a landlord installing solar energy systems will be eligible to depreciate the cost of installation over an accelerated period of just five years.

As REITs do not pay income taxes the IRA will allow REITs to utilize the 179D deductions as an offset to the retained earnings and profits that are passed through to shareholders in the form of dividends. The majority of REIT dividends are taxed as ordinary income to investors. Under the IRA the 179D deduction can be used to reduce a shareholder’s basis and have all or some of the dividend treated as a return of capital. As such, the IRA could potentially convert a REIT shareholder’s tax liability to a capital gain from ordinary income. In addition, the IRA provides for an acceleration of the 179D deduction as opposed to spreading it out over the life of the investment. At this time it is too early to assess the potential impact on shareholders of individual REITs as each company and property type will have varying amounts of capital investment and likely substantially different investment timelines.

Homeowners will also be eligible for certain tax benefits under the IRA. In addition to receiving USD 1,200/year or 30% of the cost of “green upgrades” homeowners may be eligible for up to USD 14,000 in tax rebates for energy efficient upgrades including new HVAC systems, re-insulation of one’s house, installing a heat pump water heater, installing solar panels, upgrading electrical panels, replacing doors and windows and upgrading appliances that meet Energy Star standards. The amount of the rebate will vary by type of upgrade.

It is also possible that the provision of the IRA implementing a 15% tax on book income could lead to increased investment in affordable housing. The 15% minimum book tax could possibly incentivize investors to pursue tax credits associated with affordable housing investments and apply those credits to affordable housing. We recognize this is speculation at the current time, but given the affordability challenges in the current housing market, this outcome could be a win/win.

The CHIPS and Science Act of 2022

Of the approximately USD 53bn allocated in the CHIPS Act some USD 39bn will be earmarked for the development and/or expansion of semiconductor fabrication facilities including USD 10bn directed towards geographies that currently do not have a substantial technology presence. Although the CHIPS act will not directly allocate funds to real estate it is likely that construction of these facilities will lead to increased demand for residential (for-rent and for-sale), industrial and retail real estate to accommodate the needs of construction workers, development and operating companies and ultimately the full time employees of these facilities. Recently announced development sites include Columbus, OH, Malta, NY and Ocotillo, AZ with more likely coming in the future. We believe this could provide an interesting opportunity for real estate investment capital to migrate to secondary and tertiary markets where cap rates and risk-adjusted potential returns could be higher than their primary market peers.

We wish to emphasize that the above is based on an initial reading of the bills (or summaries of the bills from third party sources). More details regarding the exact requirements for achieving any tax benefits are needed. UBS does not dispense tax advice and clients are urged to consult their tax advisors prior to engaging in any construction of retrofit activity.

Main contributor: Jonathan Woloshin

Read original blog – What are the potential impacts of The Inflation Reduction and CHIPS Acts on US real estate?, 6 October 2022.

This content is a product of the UBS Chief Investment Office.