Strategic Tax Credits to Decarbonize Buildings

Originally published on RMI.org
By Heather Clark, Mark Kresowik & Darien Crimmin

There is much talk about the urgency of climate change and how federal policy is currently being crafted to address it. However, there remains a critical need for targeted tax credits for zero-carbon buildings and retrofits. Buildings are the largest single contributor of global greenhouse gas (GHG) emissions, producing approximately 40 percent of global emissions.

To meet Biden’s ambitious climate goals of cutting GHG emissions by 50 percent by 2030, we must construct only zero-carbon buildings and retrofit roughly 4 million buildings annually (5 percent of existing buildings) to be all-electric, super-efficient, and grid-interactive. We must also power our buildings with clean renewable energy and reduce the embodied carbon of building materials.

We are encouraged by leaders in Congress who have called for an infrastructure plan that includes action to avoid the worst impacts of climate disruption. We are also encouraged by legislation under consideration, including the Clean Energy for America Act and the GREEN Act, which support the transition to a fossil-fuel free economy through tax credits for clean energy production, clean vehicles, and other technologies. However, when it comes to decarbonizing buildings, these proposals still fall short of what is needed.

Status of the Technology

Decarbonizing buildings is not a far-off dream. We have the technology and building science needed to build zero-carbon new buildings and to make deep carbon reductions in existing buildings. Achieving zero-carbon buildings (i.e., buildings that are all-electric and are so efficient that 100 percent of their energy load can be provided by either on-site or off-site clean renewables) is well within reach for new construction and certain major renovations.

In existing buildings, deep energy retrofits can cut a building’s energy use in half or more by super insulating and air sealing, improving ventilation with heat recovery, and replacing existing fossil fuel combustion or electric resistance heating with high efficiency electric equipment (e.g., heat pumps). Deep energy retrofits are strikingly impactful compared with typical weatherization efforts that reduce a building’s energy usage by only 15 to 20 percent or less.  However, similar to solar energy two decades ago, decarbonizing buildings needs targeted incentives to overcome cost barriers and become readily adopted in the marketplace.

Tax Credits to Spur a Market

Utilizing tax credits to jump start the decarbonization of our economy has a proven track record. We have a robust renewable energy investment tax credit (ITC) that has fueled the solar industry, helping it grow by 50 percent annually in the past decade. Congress has proposed to extend and improve the ITC to ensure disadvantaged communities can benefit.

We also have a $7,500 electric vehicle (EV) tax credit that helped create an entirely new industry, one of the world’s most valuable companies, and electric vehicle commitments by all three major American vehicle manufacturers. Congress has proposed to extend, expand, and increase the value of the EV tax credit up to $12,500.

However, when it comes to buildings, the current provisions in the tax code and modifications being discussed by Congress simply aren’t in alignment with President Biden’s ambitions and the shared intent of many members of Congress to address the climate crisis.

These tax credits and deductions do not incentivize deep carbon savings in buildings. They are also often too low, too cumbersome, and too complicated to motivate homeowners and the building industry to action to achieve the deep carbon and energy savings necessary to meet President Biden’s climate ambitions. Additionally, the existing energy efficiency tax credits and deductions often cannot be utilized in federally supported low-income housing or by low-income households, leaving out those most in need.

But it doesn’t have to be this way. Now is the time to design a suite of tax credits to spur market transformation for building decarbonization while improving the health, safety, and comfort of all Americans. Such targeted tax credits will support a future where buildings are heated, cooled, and powered using renewable electricity. They will also allow historically disenfranchised communities to be included in the benefits and to take part in the workforce needed to get there.

To achieve this building vision, we propose a set of six tax credits that, when strategically deployed, match our actions with our climate ambitions. We believe this suite of tax credits should be refundable, so project owners can receive the full value of the tax credit, whether or not they have the tax liability to offset it. Refundable tax credits would open up decarbonization to a whole new group of owners. These range from lower-income Americans who may not owe enough taxes to benefit from the tax credits to Real Estate Investment Trusts that aren’t structured to utilize tax credits.

First, we recommend improving the existing Energy Efficient Home Credit (45L) for energy efficiency in new housing and major renovations and the Commercial Buildings Energy-Efficiency Tax Deduction (179D) for energy efficiency in existing commercial and multifamily buildings. Incentive levels in both programs need to be increased for buildings that achieve zero-carbon performance standards. We recommend homes that achieve a zero-carbon performance standard receive a $12,500 tax credit. Similarly, we recommend that the $5.00 per square foot maximum deduction proposed for 179D be increased to a $15–$20 per square foot tax credit to encourage commercial building owners to reduce energy usage by 50 percent or more.

In addition to increasing 45L and 179D incentives and modifying rules so they can be utilized for federally supported low-income housing, we also need to go one step further so that low-income housing is not left behind. Thus, we recommend enabling a Low-Income Housing Tax Credit Deep Energy Basis Adjustment (LIHTC-DEBA) that provides a 30 percent basis adjustment within the 4 percent Low-Income Housing Tax Credit program for deep energy retrofits in existing buildings. This simple adjustment would reward investors and properties that complete deep energy retrofits, and bring the health, safety, and comfort benefits to American households that need them most.

Finally, to further spur market transformation and ensure lead paint doesn’t defer projects we encourage the adoption of three additional tax credits. A new Home Lead Safety Tax Credit (36B) will assist with mitigation of lead in the estimated 22 million American households with a lead paint hazard, as homes are decarbonized. A new Clean Heating and Cooling Tax Credit (45X) will lower the costs of clean heating and cooling technologies that replace existing fossil fuel combustion or electric resistance heating technology in existing commercial and multifamily buildings.

And to help manufacturers scale up production capacity, we support updating the former Energy Efficient Appliance Credit (45M). This is a manufacturer’s tax credit that will increase domestic manufacturing supply chain capacity, create high-paying jobs, and further accelerate the market adoption of heat pump technologies in both new construction and home retrofits.

The Details

• Energy Efficient Home Credit (45L) for new housing and major retrofits—Improve the existing 45L tax credit by adding a new incentive tier with a $12,500 tax credit for exemplary zero-carbon performance for residential units that achieve a HERS Index less than or equal to 40 prior to inclusion of on-site renewables (or equivalent, as determined by the Secretary of Energy).Ensure 45L can be utilized on federally supported low-income housing and Federal Historic Tax Credit projects by eliminating basis reduction associated with energy benefits. Ensure 45L can be utilized for single-family to high-rise multifamily buildings, including both new construction and major renovations.
• Commercial Buildings Energy-Efficiency Tax Deduction (179D) for existing commercial and multifamily buildings—Create a $15 per square foot credit for buildings that achieve a 50 percent reduction in energy use intensity (EUI [kBTU/ft²]) with respect to such building’s energy usage for the prior 12 months. The applicable credit would increase by $0.50 per square foot up to maximum credit of $20 per square foot for each percentage point reduction above the 50 percent EUI reduction. Ensure 179D can be utilized on federally supported low-income housing and Federal Historic Tax Credit projects by eliminating basis reduction associated with this energy benefit.
• Low-Income Housing Tax Credit Deep Energy Basis Adjustment (LIHTC-DEBA) for existing buildings—Add a 30 percent basis adjustment to the 4 percent Low-Income Housing Tax Credit program for deep energy retrofits in existing buildings that achieve a minimum of a 50 percent reduction in site EUI with respect to such building’s energy
• Home Lead Safety Tax Credit (36B)—Create a new Home Lead Safety Tax Credit to ensure that as buildings are decarbonized, the health and safety issues associated with lead paint hazards are also addressed.
• Clean Heating and Cooling Credit (45X) for existing buildings—Create a 45X Clean Heating and Cooling Credit, a 30 percent investment tax credit for clean heating and cooling technologies that replace existing fossil fuel combustion or electric resistance heating technology in existing commercial and multifamily buildings. Ensure 45X can be utilized on federally supported low-income housing and Federal Historic Tax Credit projects by eliminating basis reduction associated with this energy benefit.
• Energy Efficient Appliance Credit (45M)—Provide a manufacturer tax credit to accelerate market adoption of clean heating technology, including heat pumps and heat pump water heaters, by updating section 45M of the tax code. Manufacturers would be eligible for the tax credit based on the number of additional units they make.

The suite of tax credits highlighted above will not only jump start the decarbonizing of our nation’s buildings but also helps ensure an equitable and just energy transition for all Americans.