An Untapped Source of Savings for State and Local Government Owners of Property

By Drew ErteschikJ.M. Durnovich and Cosmo Zinkow


It is almost unheard of that a state or local government entity is able to tap into a new source of cost savings that has not already been tapped.  Fortunately, however, as a result of a recent administrative ruling from the North Carolina Department of Administration, state and local government entities are now able to pursue millions of dollars in taxpayer savings.

The authors of this article are two government litigators—who, in full disclosure, represented the petitioner who sought the administrative ruling[1]—and their future colleague, who is currently a third-year law student.  We are sharing this information with you, the lawyers who represent state and local government entities in North Carolina, in the hope that you will use it to help your public clients realize these cost savings for their taxpayers.

This article has three parts:

The first part discusses the source of these cost savings, which emanate from a federal tax deduction for energy-efficient construction, as well as the IRS’s special tax rules for applying that deduction to government-owned property.

The second part discusses the State of North Carolina’s recent administrative ruling, which overturned a previous rule that impeded state government entities from realizing millions of dollars in cost savings through the federal tax deduction.

The third part provides the practical information that state and local government attorneys need to unlock these cost savings for their clients, as well as the most up-to-date information on how long these savings are likely to last (spoiler alert: you need to act soon).


The Federal Tax Deduction for Energy-Efficient Projects

In 2005, Congress passed the Energy Policy Act, which created a tax deduction for the cost of energy-efficient commercial property.[2]  The deduction, codified at 26 U.S.C. § 179D, creates a valuable incentive for property owners to construct energy-efficient projects by allowing the property owners to take a tax deduction of up to $1.80 per square foot of qualifying construction.

The Section 179D deduction reduces the net cost of the construction project and increases the owner’s return on investment.  Thus, Section 179D is designed to incentivize owners of commercial property to invest in energy-efficient construction.

Congress recognized, however, that governmental entities do not pay taxes like private property owners.  For that reason, Congress enacted legislation to incentivize energy-efficient construction on property owned by federal, state, and local government entities.  That legislation allows local governments to transfer—or, in the IRS’s terms, “allocate”—their tax deductions to the private contractors that work on the energy-efficient buildings for the local governments.[3]

Pursuant to Congress’ direction, the IRS issued a formal notice governing the tax deductions available under Section 179D.[4]  In the IRS Notice, the IRS promulgated a “special rule for government-owned buildings,” which clarified that governmental entities may choose to allocate their tax deductions to the private contractors who work on the energy-efficient construction projects.[5]  The governmental entity is the only entity that can make the allocation, and the amount of the allocation is within the government’s sole discretion.  The plain language of both Section 179D and the corresponding IRS Notice also clarify that the allocation is permissive, not mandatory.

The IRS Notice also contains guidance about the amount of the deduction, permitting either a full or partial deduction and setting procedures for computing those amounts.[6]  The IRS Notice similarly allows the governmental entity to allocate the deduction among multiple contractors if more than one contractor “is responsible for creating the technical specifications for installation of energy efficient commercial building property (or partially qualifying commercial building property for which a deduction is allowed under Section 179D) on or in a government-owned building.”[7]  For example, state and local government entities can allocate their deductions in pro rata percentages to various contractors based on how much energy-efficient work they performed on a particular construction project.

For a contractor to claim a Section 179D deduction, “an authorized representative of the government-owned building” must provide the contractor with written authorization for the allocation for the government-owned building.[8]  The IRS Notice details mandatory content required in these allocation forms, and sets strict requirements on when and by whom they can be signed.[9]  Critically, these allocation forms must be signed by an authorized government representative.[10]

The Section 179D Allocation

If a contractor receives an allocation, it reduces its taxable income by the amount of the deduction, thereby resulting in significant value in the form of tax savings to the contractor.[11]  Thus, for the contractor, this tax deduction often reduces their federal tax liability by hundreds of thousands or even a million dollars or more for each transferred or “allocated” deduction.

State and local government entities have an incentive to allocate the deductions, however, which encourages them to build energy-efficient buildings consistent with federal energy policy.  In exchange for the government entity’s allocation of a valuable deduction that the contractors would otherwise not receive, the contractors can credit a portion of that deduction’s value to the government.

In practice, the amount credited to the government is generally fifty percent or more of the deduction’s value.  These credits to governments amount to substantial savings on construction costs, and, therefore, provide the incentive for governments—non-taxpaying entities for which tax deductions would otherwise not create an incentive—to build energy-efficient buildings.

Section 179D itself is silent on whether and how contractors should credit government entities in exchange for allocating Section 179D deductions, but there are at least two strong reasons why government entities should pursue a credit of at least fifty percent of the deduction’s value.

First and foremost, allocating deductions without receiving substantial value in return would result in a windfall for the contractors at taxpayer expense.  This is because the value of the Section 179D deductions are in no way contemplated by the contractors’ construction contract or otherwise factored into the contractors’ compensation for those contracts.  Rather, pursuant to those contracts, the government fully compensates the contractors for their work.  Thus, if the government allocates deductions to contractors without receiving any value in return, it is granting private contractors a windfall above and beyond the already negotiated price of the construction contract.

Second, it is the taxpayers, not the private contractors, who pay for the costs of constructing energy-efficient buildings.  Given that taxpayers are paying for these additional costs, it only makes sense that they are entitled to receive at least a substantial portion of the benefit of a deduction that is intended for those who bear those costs.

For these and other reasons, a number of local government entities in North Carolina have successfully negotiated with private contractors to receive value in exchange for allocating their deductions to the contractors—typically a portion of the deduction’s value or a reduction in contract fees.  Other local government entities, however, have yet to tap into these cost savings, perhaps because they were not aware that they existed.

Meanwhile, state government entities—including state agencies, community colleges, and the seventeen-member University of North Carolina System—were prohibited from tapping into these cost savings until recently.  This was due to a misguided rule that the State overturned in December 2017.

The State of North Carolina’s Rule Reversal

The State’s Prior Rule

Before 2012, state government entities negotiated with private contractors to receive a reduction in construction costs in exchange for allocating the tax deduction.  In 2012, however, the State Building Commission adopted a new rule (“the 2012 Rule”).  The 2012 Rule barred the State from seeking cost savings—for example, part of the value of the tax deduction or a reduction in construction costs—in exchange for allocating the State’s tax deduction.  Instead, the 2012 Rule, without articulating a clear rationale, required the State to give away its valuable deductions to private contractors for free.

In 2017, however, Efficiency Energy, LLC, a company that coordinates and manages government entities’ allocation of Section 179D deductions, brought a challenge to the 2012 Rule.

Efficiency Energy filed a petition for declaratory ruling with the North Carolina Department of Administration, which requested that the Department rescind the 2012 Rule.  In short, Efficiency Energy petitioned the Department to make it permissible for state government entities to take advantage of Section 179D cost savings on behalf of the taxpayers.

Efficiency Energy’s challenge to the 2012 Rule was grounded in the North Carolina Constitution, the IRS’s rules governing Section 179D deductions, and the public policy considerations described above, which embrace stewardship of public funds rather than allowing a windfall for private contractors.

On December 18, 2017, the Department of Administration granted Efficiency Energy’s petition.  The Department issued a thorough declaratory ruling, which concluded that the 2012 Rule was “untenable and unnecessary.”[12]  The Department further ordered that the 2012 Rule “is hereby vacated and rescinded, and is of no force or effect.”

As a result, the Department restored the potential for state government entities to pursue millions of dollars in taxpayer savings.

Advice for State and Local Government Entities

If you are a lawyer for a state or local government entity and are wondering whether the savings described in this article are worth your time, consider the following example of a state or local government center with 2,000,000 square feet of qualifying property:

If the government allocates the full $1.80-per-square-foot deduction to a single contractor and the contractor pays a tax rate of 35 percent, that contractor would receive a total reduction in taxes of $1,260,000.  If the government does not negotiate with the contractor, the contractor gets a $1,260,000 benefit for free.

By contrast, if the government negotiates for 50 percent of the value, the contractor still retains a benefit of $630,000, but the government—and its taxpayers—will save $630,000.

State and local government entities that are interested in pursuing these savings should act fast, however, because they may expire at the end of 2020.

This is because Section 179D applies to buildings placed in service before December 31, 2017.[13]  Meanwhile, the tax code only allows amendments to returns within three years of the date of filing.[14]  The interplay between these two federal laws is what allows state and local governments to allocate the deductions—and negotiate discounts in exchange for those allocations—until December 31, 2020.

The interplay between these two federal laws also means that, if a state or local government entity placed a building in service up to three years ago, it is likely not too late to realize cost savings.  As one notable example, the One World Trade Center in New York City was placed into service in November 2014, and the Port Authority of New York and New Jersey negotiated the Section 179D Allocation and savings in September 2017.

For these reasons, state and local government entities should examine whether the three-year “statute of limitations” described above would allow them to recover cost savings for buildings that have already been placed in service.

Looking ahead, however, the future of Section 179D remains uncertain after 2020.  Early versions of the federal Bipartisan Budget Act extended the Section 179D program to all buildings completed in 2018 (through tax year 2021),[15] but the final bill only extended it through 2017 (through tax year 2020).  This may suggest that Congress intends to let the program come to an end.

On the other hand, with the 2018 midterms right around the corner, anything is possible.  Indeed, some members of Congress have proposed making Section 179D a permanent feature of the federal tax code.[16]

For these reasons, in addition to examining their past projects, state and local government entities with current or future construction projects should track the current status of the Section 179D program.  After all, even an incremental extension of the program could unlock immense savings for energy-efficient construction scheduled for this year or the immediate future.


As responsible stewards of public resources, state and local government entities (and their lawyers) should take note of the substantial savings described in this article.  The Department of Administration’s declaratory ruling not only frees state government entities to pursue those cost savings for the first time since 2012, but should also prompt local governments who are not currently pursuing these cost savings to assess whether they can do so.

The authors hope that this article may be useful in inviting a dialogue on this important topic.  If state or local government lawyers have questions about any of the issues discussed above, the authors welcome your comments by phone or e-mail.

Drew Erteschik is a partner in the Raleigh office of Poyner Spruill LLP, where he focuses his practice on high-stakes government litigation and co-chairs the firm’s Government and Constitutional Litigation Practice Group.  He is a member of the Section Council of the NCBA’s Government & Public Sector Section.

J.M. Durnovich is a senior associate in the Charlotte office of Poyner Spruill LLP, where he focuses his practice on government disputes and other complex civil litigation.  He is a member of the firm’s Government and Constitutional Litigation Practice Group, and a member of the NCBA’s Government & Public Sector Section.

Cosmo Zinkow is a third-year law student at Campbell Law School, where he is Editor in Chief of the Campbell Law Review.  He is also a member of the NCBA’s Government & Public Sector Section.  Cosmo will join Poyner Spruill as an associate in September 2018.

[1]         This article states the authors’ personal views, and not necessarily the views of their colleagues or of any client of Poyner Spruill LLP.

[2]         Energy Policy Act of 2005, Pub. L. No. 109-58, 119 Stat. 594 (Aug. 8, 2005).

[3]         26 U.S.C. § 179D(d)(4).

[4]         I.R.S. Notice 2008-40, § 3.01.

[5]         In the IRS Notice, the contractors are referred to as “designers,” which is defined as “a person that creates the technical specifications for installation of energy efficient commercial building property (or partially qualifying commercial building property for which a deduction is allowed under § 179D)” and may include “an architect, engineer, contractor, environmental consultant or energy services provider.”  Id. § 3.02.

[6]         Id. § 3.06.

[7]         Id. § 3.03.

[8]         Id. §§ 3.04-.05.

[9]         Id.

[10]        Id.

[11]        Id. § 3.06.

[12]        If readers would like a copy of the Department of Administration’s declaratory ruling or Efficiency Energy’s petition, the authors will be glad to provide it upon request.

[13]        Bipartisan Budget Act of 2018, H.R. 1892, Sec. 40413.

[14]        26 U.S.C. § 179D(h); Id. § 6511.

[15]        Tax Extender Act of 2017, S. 2256, Sec. 313.

[16]        Proposed Amendments to the Internal Revenue Code, H.R. 3507, Sec. 1.