New Energy Efficient Home Credit Provides Benefits to LIHTC Developments

The Inflation Reduction Act (IRA), enacted in August 2022, represents $370 billion in investments in “green” energy sources. In addition to providing incentives for private investment in clean energy solutions within the United States, the IRA is intended to lower energy costs for families and create well-paying jobs and new economic opportunities for workers.¹ Consistent with these priorities, the IRA extended and increased the new Energy Efficient Home Credit available under IRC §45L and added specific provisions designed to benefit developers of federal low-income housing tax credit (LIHTC) developments.

On September 27, 2023, the Internal Revenue Service (IRS) released guidance on the Energy Efficient Home Credit in Notice 2023-65. The guidance provided in this notice addresses: (i) the person who is eligible for the credit, (ii) how to determine the applicable amount of the credit, (iii) energy-saving requirements, (iv) certification requirements, and (v) substantiation requirements.

General Rules

Under §45L, an Energy Efficient Home Credit may be claimed by eligible contractors for building and selling qualified new energy-efficient homes. This is an as-of-right credit; there is no application process to use the Energy Efficient Home Credit. The home must be constructed by the eligible contractor and acquired by a person from the eligible contractor for use as a residence during the taxable year. Acquisition would include a purchase or lease of the property.

The IRA extended the Energy Efficient Home Credit, so it applies to homes acquired on or before December 31, 2032. For these purposes, the term “construction” includes “substantial reconstruction and rehabilitation.” The term "substantial reconstruction and rehabilitation" is not currently defined, so guidance likely would be helpful for developers of LIHTC developments. 

What is an “Eligible Contractor”?

Section 45L provides that the eligible contractor is the person who constructed the home. The IRS has clarified that to be an eligible contractor, a person must “own and have a basis” in their home during construction, and stated that if the person that hires the third party contractor to construct the home owns and has the basis in the home during its construction, the person that hires the third party contractor is the eligible contractor and the third party contractor is not an eligible contractor.²

This guidance clarifies that a developer of a LIHTC development that hires the contractor would qualify as an eligible contractor.

What is a Qualified New Energy-Efficient Home?

A “qualified new energy-efficient home” is defined as a dwelling unit that satisfies all the following conditions:

• It must be located in the United States;
• Its construction must be “substantially completed” after August 8, 2005; and
• It must be (1) a certified new single-family home that meets certain Energy Star requirements, (2) a certified manufactured home that meets certain Energy Star requirements, (3) a certified multifamily home that meets certain Energy Star requirements, or (4) a certified zero energy ready home.

A multifamily dwelling unit meets the applicable energy-saving requirements if the following two conditions are satisfied: First, the home must satisfy the most recent Energy Star Multifamily New Construction National Program Requirements, as in effect on January 1, 2023, or on January 1st of three calendar years before the date when the home is acquired—whichever is later. Second, the home must satisfy the most recent Energy Star Multifamily New Construction Regional Program Requirements applicable to the location of such home, as in effect on January 1, 2023, or January 1 of three calendar years before the date the dwelling was acquired—whichever is later. A dwelling unit will be considered to meet these respective program requirements if it is certified under the rules of such respective program requirements.

How Much is the Energy Efficient Home Credit?

The Energy Efficient Home Credit amount equals the applicable amount for each eligible home. For certified new multifamily homes that meet the Energy Star requirements, the “applicable amount” is $2,500 per unit if certain “prevailing wage requirements” are satisfied, and $500 per unit if prevailing wage requirements are not satisfied.  For new multifamily homes that are certified as zero energy ready homes (ZERH), the applicable amount is $5,000 if prevailing wage requirements are satisfied or $1,000 if prevailing wage requirements are not satisfied.

Generally, in order to satisfy the prevailing wage requirements for an energy project, a taxpayer must ensure that any laborers and mechanics they employ, including those employed by any contractor or subcontractor, for the construction, alteration, or repair of the development, are paid wages at rates at least equal to the prevailing rates for construction, alteration, or repair of a similar character pursuant to local guidelines as determined by the Secretary of Labor. These wage rates are found in general wage determinations at https://sam.gov/content/wage-determinations.

The IRS has issued detailed guidance in Notice 2022-61 addressing the application of these requirements to various energy projects, including those covered by §45L. The IRS has also issued a proposed rule to incorporate in regulations certain requirements of the Davis-Bacon Act (40 U.S.C. 3141 et seq.).

Basis Adjustments?

If the Energy Efficient Home Credit is allowed for an expenditure for any property, the increase in the basis of that property that otherwise would result from that expenditure generally must be reduced by the amount of such credit. However, it is noteworthy that the IRA eliminated this basis adjustment for purposes of determining the adjusted basis of any building under §42.

Certification?

An eligible contractor must have a dwelling unit certified as Energy Star compliant or ZERH compliant, as applicable, prior to claiming the Energy Efficient Home Credit with respect to a dwelling unit. However, the eligible contractor is not required to file the certification with the return on which the credit is claimed.

Section 45L generally provides that (i) certification is made according to guidance prescribed by the IRS after consultation with the Secretary of Energy for the certification, and (ii) the guidance must specify procedures and methods for calculating energy and cost savings.

The guidance in Notice 2023-65, which was prepared after consultation with the Secretary of Energy, clarifies that the certification requirements for the effective Energy Star Program are set forth on the Energy Star Webpage, and the certification requirements for the effective ZERH program are provided on the ZERH Webpage. The IRS has stated that it will deem a dwelling unit to meet any certification requirements under §45L(d) if it is certified as meeting these requirements.

Substantiation?

An eligible contractor claiming the Energy Efficient Home Credit must meet the general recordkeeping requirements under §6001 to substantiate that the requirements of §45L have been met. Notice 2023-65 lists the items that must, at a minimum, be retained by an eligible contractor to satisfy the substantiation requirements.

Claiming the Credit?

Eligible contractors, including partnerships and s corporations, may claim the Energy Efficient Home Credit on Form 8908 for each qualified energy-efficient home sold or leased to another person during the tax year for use as a residence. For a developer who is an eligible contractor, that would mean the year that construction is completed and the development is placed in service.  

Does the Energy Efficient Home Credit Make Sense in a LIHTC Development?  

Whether or not the Energy Efficient Home Credit should be included in the capital stack for a LIHTC development likely comes down to a cost-benefit analysis. In short, will the Energy Efficient Home Credit offset any increased costs? The number of units proposed for a particular development may be a factor.

If a LIHTC development must meet Energy Star requirements under its applicable Qualified Allocation Plan, this may be an easy addition.

Some considerations for developers include:

1. There is the potential added cost from a structuring/legal/accounting standpoint to include the Energy Efficient Home Credit.
2. If prevailing wage (commonly referred to as Davis Bacon wage rates) requirements are not satisfied, is the Energy Efficient Home Credit sufficient ($500 per unit if Energy Star requirements are met) to warrant its use? 
3. Alternatively, what is the incremental cost of choosing to satisfy prevailing wage requirements?
4. For a rehabilitation deal, consider the risk posed by the lack of guidance for the term "substantial reconstruction and rehabilitation.” This may limit investor appetite.
5. What is the cost of meeting the Energy Star Multifamily New Construction National Program Requirements, Energy Star Multifamily New Construction Regional Program Requirements, or being certified a zero energy ready home? According to Energy Saver (the U.S. Department of Energy's consumer resource on saving energy and using renewable energy technologies at home), the additional construction cost for a zero energy ready home is about 4%. Will that be offset by the Energy Efficient Home Credit and purchased energy savings? In 2021, Energy Star's Framework Document for Stakeholder Feedback regarding expanding the ENERGY STAR Residential New Construction programs included an illustrative cost and savings summary for ENERGY STAR National v1.2 Multifamily New Construction vs. 2021 IECC Building; the summary reflected net cash flow.⁴ Will the illustration match reality? Will any studies be accepted by investors during underwriting?
6. Finally, consider the burden and cost of the recordkeeping requirements.

While it is a huge win for the affordable housing development community that the Energy Efficient Home Credit will not decrease LIHTC basis, it is not a given that including it in the financing for a development makes sense economically.