Sec. 179D and passthrough entities.

• Author: Hesse, Christopher W.

Sec. 1790 was added to the Code in 2005 by the Energy Tax Incentives Act of 2005, Pi. 109-58, effective for property placed in service after December 31,2005. Originally scheduled to expire December 31,2007, it has been extended twice and now expires for property placed in service after December 31, 2013. The committee report noted that the provision provides a deduction "equal to energy-efficient commercial building property expenditures made by the taxpayer" (Joint Committee on Taxation, Description and Technical Explanation of the Conference Agreement of H.R. 6, Title XIII, the "Energy Tax Incentives Act of 2005"(JCX-6O-O5), p. 79 (July 28,2005)). The conference agreement limited the deduction amount to $1.80 per square foot, with a partial deduction allowed for building subsystems. The Sec. 179D deduction reduces the adjusted basis in the property for depreciation purposes.

Recognizing that depreciation deductions provide no tax incentive for a public entity's ownership of a building, the committee report noted that "the Secretary shall promulgate regulations that allow the deduction to be allocated to the person primarily responsible for designing the property in lieu of the public entity" (id. at 80). Consequently, architects qualify forthe Sec. 179D deduction that otherwise would be provided to the building owner. This provision was codified at Sec. 179D(d)(4).

Notice 2008-40, Section 3.06, provides that the designer does not include any amount in income on account of the Sec. 179D allocation, nor is the designer required to reduce future deductions, even though such a reduction in deductions would comport with how Sec. 179D benefits nonpublic building owners.

This provision has unexpected consequences for partnership and S corporation designers. For firms structured as passthrough entities, the deduction at the entity level reduces the owners' aggregate tax basis in the entity interest. This deduction, however, does not consume cash. (Consider it a "free" deduction.) The entity has the same cash available for distribution to its owners, but the owners' tax bases in the entity have been reduced due to the passthrough deduction. Ultimately, the owners will have capital gain from receiving distributions in excess of tax basis (Sec. 704(d) for partnerships and Sec. 1366(d) for S corporations). The effect of Sec. 179D: A "free" current ordinary deduction is provided to the...