IRS Releases New Guidance on Beginning of Construction

by Reed Smith
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Prior to the enactment of the American Taxpayer Relief Act of 2012 (the "Act"), the production tax credit (the "PTC") had been scheduled to expire for wind projects that were not placed in service before January 1, 2013, and for biomass, geothermal, landfill gas, trash, hydropower, and marine and hydrokinetic facilities that were not placed in service before January 1, 2014. The Act extended the PTC for such facilities if construction begins before January 1, 2014. The actual date the project is placed in service is not relevant; the key is whether construction begins during 2013. Taxpayers can elect to take investment tax credit (the "ITC") in lieu of the PTC.

On April 15, 2013, the IRS issued an advance copy of Notice 2013-29 (the "Notice"), which provides guidance on what it means to begin construction for purposes of PTC and ITC qualification. As expected, the Notice borrows heavily from the rules under the cash grant program, which provided for cash payments in respect of renewable energy projects that were placed in service by a specified credit termination date (the date varied depending on the type of facility), if construction of the project began during 2009, 2010 or 2011.

As in the case of the cash grant program, a taxpayer can establish that it has begun construction of a project either by starting physical work of a significant nature (the "Physical Work Test"), or by satisfying a 5% safe harbor (the "Safe Harbor").

Physical Work Test

A taxpayer satisfies the Physical Work Test by beginning physical work of a significant nature. Both on-site and off-site work (performed either by the taxpayer or by another person under a binding written contract) may be taken into account. Only physical work of a significant nature on tangible personal property and other tangible property used as an integral part of the activity performed by the facility will be considered.

For example, in the case of a facility for the production of electricity from a wind turbine, on-site physical work of a significant nature begins with the beginning of the excavation for the foundation, the setting of anchor bolts into the ground, or the pouring of the concrete pads of the foundation. If the facility's wind turbines and tower units are to be assembled on-site from components manufactured off-site by a person other than the taxpayer and delivered to the site, physical work of a significant nature begins when the manufacture of the components begins at the off-site location, but only if (i) the manufacturer's work is done pursuant to a binding written contract and (ii) these components are not held in the manufacturer's inventory. If a manufacturer produces components for multiple facilities, a reasonable method must be used to associate individual components with particular facilities.

Physical work of a significant nature does not include preliminary activities, such as planning or designing, securing financing, obtaining permits, licensing, conducting surveys, environmental and engineering studies, or clearing a site. Similarly, physical work in connection with property that is not integral to the production of electricity, such as work on a transmission tower, fencing or buildings, typically would not qualify. Work on roads that are primarily for site access or for employee or visitor vehicles typically would not qualify, but construction of onsite roads designed to move material and equipment typically would qualify.

Once physical work of a significant nature has begun, the taxpayer must maintain a continuous program of construction. Disruptions in construction that are due to factors outside the taxpayer’s control are permitted. Examples of permitted construction delays include disruptions due to weather, licensing and permitting, labor stoppages, difficulty in obtaining specialized equipment, and financing delays of less than six months.

Safe Harbor

Construction of a facility will be considered as having begun before January 1, 2014 if a taxpayer pays or incurs (depending on its method of accounting) five percent or more of the total cost of the facility. The total cost of the facility does not include the cost of land or any property not integral to the production of electricity at the facility (as described above). In the case of property that is manufactured, constructed, or produced for the taxpayer by another person under a binding written contract with the taxpayer, costs incurred with respect to the property by the other person before the property is provided to the taxpayer are deemed incurred by the taxpayer when the costs are incurred by the other person.

If the total cost of a facility that is a single project comprised of multiple facilities exceeds its anticipated total cost, so that the amount a taxpayer actually paid or incurred with respect to the facility before January 1, 2014, is less than five percent of the total cost of the facility at the time the facility is placed in service, the taxpayer may still be able to satisfy the Safe Harbor with respect to some, but not all, of the project.

For example, suppose a taxpayer incurs $25,000 in costs in 2013 constructing a five-turbine wind farm that will be operated as a single project, anticipating that each turbine (including its own tower and pad) will cost $100,000 for a total cost for the facility of $500,000. At the time the taxpayer places the wind farm in service, the actual total cost of the facility amounts to $600,000, with each turbine costing $120,000. Although the taxpayer did not pay or incur five percent of the actual total cost of the facility before January 1, 2014, the taxpayer will be treated as satisfying the Safe Harbor with respect to four of the turbines, as their actual total cost of $480,000 is not more than twenty times greater than the $25,000 in costs incurred by the taxpayer in 2013. Alternatively, if construction of the facility began (within the meaning of Physical Work Test) before January 1, 2014, the taxpayer may be able to claim the PTC or the ITC with respect to the entire facility (i.e., all five turbines).

As in the case of the Physical Work Test, the taxpayer must make continuous efforts to advance towards completion of the facility. Such efforts would include incurring additional costs, entering into construction contracts, obtaining necessary permits and performing work of a significant nature. Disruptions due to factors that are outside the taxpayer’s control are permitted.


If you have any questions regarding the Act, or the tax treatment of renewable energy investments generally, please contact one of the authors of this Alert or the Reed Smith attorney with whom you regularly work.

To ensure compliance with Treasury Department regulations, we inform you that any U.S. federal tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Code or (2) promoting, marketing or recommending to another party any tax-related matters addressed herein.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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