Tax Court rules Section 179D deduction satisfied and successfully allocated

The Tax Court recently issued an opinion in Johnson, et. al. v. Commissioner (160 T.C. 2), holding that a taxpayer who designed and installed a heating, ventilation and air conditioning (HVAC) system for a governmental entity properly included the allocated Section 179D(a) deduction in its 2013 federal income tax return.

The taxpayer bringing the case had entered into a contract with the governmental entity to maintain, inspect and update the HVAC system. The taxpayer worked with South Side — a control and parts distributor for commercial HVAC contractors — to install the new system. Subsequently, the taxpayer obtained an allocation letter from an authorized representative of the property owner, which provided that the full federal income tax deduction available under Section 179D attributable to the HVAC system was allocated to the taxpayer.

The taxpayer claimed the deduction on its 2013 federal income tax return and provided the allocation letter and the necessary certification to satisfy the requirements of Section 179D. However, the IRS denied the deduction and the taxpayer brought the issue to the Tax Court for resolution.

Although the court held that the taxpayer satisfied the statutory requirements and was entitled to the deduction, the IRS asserted several arguments of which three were noteworthy. First, the IRS asserted that the taxpayer failed to satisfy one of the requirements under Section 179D(c)(1)(D) that the installation of the HVAC was “part of a plan” for energy efficiency because the property owner did not have specific intent and forethought to achieve the energy saving targets when updating the system but instead did so as an emergency replacement. The Court dismissed this argument by stating that nothing in the statute nor subsequent guidance requires taxpayers to provide a statement with respect to intent and forethought with the required certification; deductions under Section 179D do not provide for specific preparation or proof of planning to satisfy the necessary requirements.

Second, the IRS asserted that the taxpayer was not the “designer” and entitled to the allocation of the deduction because it was only responsible for the maintenance and that the majority of the installation and upgrades were performed by South Side, whom the IRS considered to be the “designer” entitled to allocation. The Tax Court classified the IRS’ assertion as an overstatement; further, the taxpayer’s programming modification, technical specifications, providing of estimates for the replacement and installation of new equipment could reasonably establish it as the “designer” and South Side’s assistance as a subcontractor at the taxpayer’s discretion did not invalidate its “designer” status.

Third, the IRS attempted to assert that the allocation letter was insufficient in describing the amount of the Section 179D deduction allocated to the taxpayer. The letter provided to the taxpayer indicated that it was allocated “the full amount” of the deduction, and the court agreed that was sufficient to establish the allocation in accordance with the statute, even if the specific dollar amount was not included.

The arguments the IRS asserted are items to consider when taxpayers are looking at any potential risk when claiming a deduction under Section 179D — especially as a designer. Taxpayers seeking to claim a Section 179D deduction after 2022 should refer to the most recent guidance in Notice 2022-61, as well as our recent story, “IRS starts clock on wage and apprenticeship rules” for necessary requirements to receive the expanded benefit of current energy deductions.