This summary discusses how this federal bill impacts a company’s ability to obtain a tax deduction for replacing existing lighting from an accounting perspective.  We will address the following six simple points:

• What is and how does House Bill 1331-6 affect a taxpayer (C corporation, owners of S corporations, owners of Limited Liability Company(s) or Sole Proprietors) when a new lighting system is installed?

• Who is the taxpayer--the landlord or the tenant?

• What qualifies a taxpayer for a tax deduction under this new law?

• What steps must be taken from an accounting basis to certify and claim a tax deduction?

• What are the limits on this tax deduction?

• Why should a certified public accounting firm be involved in this process?

• Review of a case study.

1. What is and how does House Bill 1331-6 affect a taxpayer (C corporation, owners of S corporations, owners of Limited Liability Company(s) or Sole Proprietors) when a new lighting system is installed?

Federal House Bill 1331-6 was signed by President Bush on August 5, 2005, and it allows an immediate tax deduction of the cost of the lighting system if the taxpayer reduces their electrical usage on lighting by more than 50%.

In comparison, if the taxpayer were to purchase a lighting system that does not meet the standards, it must be depreciated over the life of the asset, generally 39 years.

If a metal halide lighting system utilizing fixtures that consume 464 watts is replaced with a T-5 system that consumes only 232 watts, the taxpayer can claim a tax deduction for the entire cost of the halide lighting system.

2. Who is the taxpayer--the landlord or the tenant?
   
   In general, the person who claims the deduction is the person who owns the property for tax purposes. Between a landlord and tenant, ownership is a question of fact, and the determination depends on the arrangements between the parties. If the tenant pays for the investment, constructs it according to its own specifications and there are no concessions in the lease, it is likely that the tenant will be the owner of the improvements for tax purposes and eligible to claim the deduction.

3. What qualifies a taxpayer for a tax deduction under this new law?
   
   The House Bill 1331-6 is specific as to the criteria that must be met to qualify for this tax deduction. We recommend that the taxpayer utilize a professional engineering firm that is accredited by the Department of Energy for both energy auditing and “building modeling." The taxpayer should expect the engineering firm to provide a certified report that substantiates that the taxpayer qualifies for the tax deduction.

4. What steps must be taken from an accounting basis to certify and claim a tax deduction?
   
   The tax deduction can be claimed for the year that the new lighting equipment is placed in service (purchased and installed). A professional certified public accounting firm will prepare the proper forms and gather the documentation to attach to the taxpayer's federal income tax return.
   
   There are published government certification forms that are required to be completed and attached to the federal income tax return.

5. What are the limits on this tax deduction?
   
   Like many tax laws, this is broad reaching.  In addition to allowing an immediate write-off for lighting, there is a provision for heating, cooling, ventilation and hot water systems and a provision for the building envelope.
   
   The deduction is limited to the actual cost of the new lighting expenditure for equipment and installation. The deduction for lighting is further limited to $.60/sq. ft. Any amount paid over and above these limits must be depreciated over a life usually of 39 years. Under limited circumstances, such lighting could qualify for five or seven year depreciation.
   
   Immediate deductions of lighting fixtures were typically only available to small taxpayers that purchased portable lighting. "Small" taxpayers can deduct up to $112,000 of portable lighting. The $112,000 limitation is reduced (but not below zero) by the amount by which the cost of property placed in service during the 2007 tax year exceeds $450,000. One of the really exciting parts of House Bill 1331-6 is that it allows large corporations, regardless of how much property is acquired and placed in service, to benefit from the lighting retrofits. Further, smaller companies can also benefit even if the lighting is considered 39-year real property.
   
   It is of paramount importance that a company realize that the tax deduction is only offered for a limited time. The deduction is set to expire with respect to any property placed in service after December 31, 2008.

6. Why should a certified public accounting firm be involved in this process?
   
   What we have tried to provide is a simple overview.  In actuality, there are complicated steps that should be taken to maximize the tax benefit to the owner of the building. For example, an architect may qualify for the benefit if the architect is the party designing the lighting for a tax-exempt organization. This rule applies because the tax-exempt organization would not benefit from a write-off.
   
   Somerset CPAs can help you understand the tax savings of acquiring the property by comparing an immediate write-off with depreciating the lighting fixtures. Further, our accounting professionals may recommend that other costs associated with the lighting fixture be amortized over a period other than 39 years. Further, if you are replacing older equipment, we can advise on the write-off associated with the equipment that will be discarded.
   
   It would be a shame for a company to take a large stride forward to save energy and not take full benefit of the tax deductions available to them. 

If you have questions or comments, please contact Kenneth J. Hedlund, CPA at 317-472-2103 or 800-469-7206.

A 220,000 sq. ft. northern Indiana distribution center presently has 675 metal halide 400 watt light fixtures. The company moved into this facility in 2002 and purchased all new lighting at that time.

The tax value of the existing lighting net of accumulated depreciation is $115,000.

The corporate engineer computed that they would experience an annual energy cost savings of $62,800.

Summary of Payback in First Full Year¹

Total cost of energy efficient lighting                                    $135,000²
Tax benefit of first year write-off under Energy Bill 1331-6        (52,800)³
Tax benefit of abandonment of existing lighting                       (46,000)⁴
Annual energy cost savings per Engineering Study                 (62,800)
Net tax and energy savings in excess of investment in
  first full year                                                                    $(26,600)
_________________________

¹Calculations disregard the time value of money savings.
²$135,000 = 675 lights x $200.00/light (full fixture value)
³$52,800 = Lesser of [$.60/sq.ft. x 220,000 sq. ft. = $132,000 or $135,000] x 40% federal and state tax rate.
⁴$46,000 = $115,000 undepreciated cost of lighting abandoned x 40% federal and state tax rate.

Work-In-Process is provided by Somerset for our clients and other interested persons upon request. Since technical information is presented in generalized fashion, no final conclusion on these topics should be made without further review. For additional information on the issues discussed, please contact Ken Hedlund or another member of our Construction & A/E Team. This document is not intended or written to be used, and cannot be used, for the purpose of avoiding tax penalties that may be imposed on the taxpayer. Somerset provides tax, accounting, information systems, litigation and valuation services, wealth management, and management consulting services. We are passionate about your success.

Somerset CPAs, P.C.
3925 River Crossing Parkway, Third Floor
Indianapolis, Indiana 46240
317.472.2200 • 800.469.7206 • FAX 317.208.1200
www.somersetcpas.com