Section 45L Energy Credit and Cost Segregation

Section 45L is a federal tax credit that incentivizes the construction of energy efficient residential dwelling units. The credit is claimed by the eligible contractor who constructs the property and is calculated on a per unit basis depending on the energy efficiency certification achieved.

The program was originally enacted in 2006, expired and was renewed several times, and was made permanent with enhanced credit amounts by the Inflation Reduction Act of 2022. The residential energy credit now provides a stable tax incentive for builders who incorporate energy efficient design and construction practices.

Unlike Section 179D which applies to commercial buildings, the 45L energy credit targets residential properties and is structured as a credit rather than a deduction. The credit provides dollar for dollar tax reduction and can be claimed for single family homes, townhomes, and individual dwelling units within multifamily buildings.

To qualify for the Section 45L credit, the dwelling unit must be located in the United States, constructed by the taxpayer for use as a residence, and acquire certification under an approved energy efficiency program. The dwelling must be originally used by the homeowner or tenant, meaning it must be new construction rather than renovation.

Eligible property types include detached and attached single family homes, townhomes, and dwelling units within multifamily residential buildings. Manufactured homes that meet federal construction standards can also qualify if they achieve the required energy efficiency certification.

Energy certification programs

• ENERGY STAR Residential New Construction Program
• ENERGY STAR Multifamily New Construction Program
• DOE Zero Energy Ready Home Program
• Comparable energy efficiency standards approved by IRS

The dwelling must be certified by an approved third party certifier before the credit is claimed. Certification must be obtained through established program protocols and documented according to IRS requirements for the new home energy credit.

The Section 45L credit amount varies based on the energy efficiency standard achieved and whether prevailing wage requirements are met. The credit is calculated per dwelling unit, so multifamily developers can multiply the per unit credit by the number of qualifying units in a project.

The credit is claimed in the tax year the dwelling unit is sold or leased. For developers building spec homes for sale, the credit is realized when the home closes. For build to rent developers, the credit is claimed when the unit is placed in service as a rental property. This timing affects coordination with cost segregation for rental properties.

The interaction between Section 45L cost segregation is particularly favorable for residential developers because the 45L credit does not reduce the depreciable basis of the property. This means developers who retain properties as rentals can claim the full 45L credit at construction completion and then perform cost segregation on the full property basis to accelerate ongoing depreciation.

For build to rent developers, the sequence is straightforward. Obtain 45L certification during construction, claim the credit when units are placed in service as rentals, and then implement cost segregation to identify short life components for accelerated depreciation. Both benefits apply to the same property without reduction or conflict.

The 45L and cost seg combination is especially powerful for multifamily developers because the credit multiplies by the number of units while cost segregation percentage benefits remain consistent. A 100 unit multifamily project could generate $250,000 in 45L credits at the standard tier plus significant accelerated depreciation through cost segregation.

Only the eligible contractor can claim the Section 45L credit. The eligible contractor is defined as the person who constructed the dwelling unit or, in the case of a manufactured home, the manufacturer. The credit cannot be transferred to the home buyer or tenant.

For typical residential development, the eligible contractor is the developer or builder who owns the property during construction and bears the economic risk of the development. If a developer hires a general contractor to construct homes, the developer as owner typically remains the eligible contractor for 45L purposes.

For developers using entity structures, the credit flows through to the individual owners based on their ownership interest. This is similar to how cost segregation benefits flow through partnerships and LLCs to individual partners.

Section 45L requires certification from an approved third party certifier that each dwelling unit meets the applicable energy efficiency requirements. The certifier must be authorized by the certification program (ENERGY STAR, Zero Energy Ready Home, etc.) and must follow established protocols.

Certification should be obtained during or shortly after construction while documentation is fresh and inspection access is available. The certification must be completed before the credit is claimed on the tax return.

Required documentation

• Third party certification from approved certifier for each unit
• Documentation showing eligible contractor status
• Construction cost records supporting basis calculations
• Prevailing wage compliance documentation if claiming enhanced credit
• Written allocation if credit is shared among multiple parties

When coordinating with cost segregation, ensure construction cost documentation supports both the 45L certification and the detailed component analysis required for cost segregation. Consistent documentation across both programs streamlines the overall tax benefit realization process.

The Section 45L credit applies differently to multifamily and single family developments, affecting coordination with cost segregation. For multifamily properties, the credit is calculated per dwelling unit, which can result in substantial total credits for large projects.

Multifamily developers who retain properties as investments benefit from both the upfront 45L credit multiplied by unit count and ongoing accelerated depreciation through cost segregation. A 200 unit apartment building could generate $500,000 in 45L credits at the standard tier while also reclassifying millions in components to shorter recovery periods.

Single family developers typically build homes for sale rather than retention. In this case, the 45L credit provides immediate benefit at sale while cost segregation is not applicable because the developer does not hold the property for depreciation. However, developers who build spec homes and temporarily rent them before sale could claim both benefits during the rental period.

The build to rent sector presents exceptional opportunities for combining Section 45L cost segregation benefits. Build to rent developers construct single family homes or townhomes specifically for rental rather than sale, retaining long term ownership of entire subdivisions as rental portfolios.

For these developers, each qualifying home generates a 45L credit at placed in service while the entire portfolio is eligible for cost segregation. The credits provide immediate cash flow benefit, while accelerated depreciation reduces taxable income from rental operations over time.

Build to rent projects with energy efficient construction can achieve compelling total returns. A 50 home subdivision with $2,500 per home 45L credits generates $125,000 in immediate tax credits. Cost segregation might accelerate $3 million to $5 million in depreciation deductions to the early years, creating substantial tax deferral on top of the credits.

For more comprehensive approaches to maximizing benefits across programs, see Cost Segregation and Energy Tax Incentives.

Section 45L can be coordinated with other tax incentives beyond cost segregation. Developers should evaluate the full range of available benefits to maximize total tax advantages from energy efficient residential construction.

State and local energy efficiency incentives often layer on top of federal programs. Some states offer additional tax credits or rebates for energy efficient construction, which can be claimed alongside Section 45L. Utility company rebates for energy efficient equipment generally do not affect 45L eligibility.

For affordable housing developers, the 45L credit can be combined with the Low-Income Housing Tax Credit on qualifying projects. Energy efficient design supports both programs and creates multiple benefit streams. Similarly, projects in designated zones may be eligible for additional location based incentives.

To understand coordination with affordable housing programs, review R&D Tax Credits and Real Estate Development for insight into research credit opportunities for innovative construction methods.