The U.S. Department of the Treasury (Treasury Department) recently released a notice of proposed rulemaking regarding four significant aspects of the investment tax credit (ITC) under Section 48 of the Internal Revenue Code (Code). These include (i) the definition of “energy property” that qualifies for the ITC, (ii) the prevailing wage and apprenticeship requirements introduced by the Inflation Reduction Act of 2022 (IRA), (iii) the 80/20 rule for retrofitted property, and (iv) qualified interconnection property in connection with a project having a nameplate capacity of not greater than 5 MWAC.
Energy Property Definition
Generally
The proposed regulations provide a number of definitions related to energy property and ITC qualification, including definitions related to the “original use” and “placed in service” requirements and definitions of “solar energy property,” “geothermal energy property,” “energy storage technology,” and “qualified biogas property,” among others. The proposed regulations also provide additional clarity regarding how to identify a unit of energy property, how to distinguish one energy property from another, and how to identify components of energy property. The proposed regulations provide that a unit of energy property includes all functionally interdependent components of property owned by a taxpayer and operated together and that can operate apart from other energy properties within a larger energy project. A unit of energy property includes all integral components of the property other than transmission property. The proposed regulations provide a number of examples that are helpful for purposes of identifying an item of energy property that qualifies for the ITC and the components of the energy property that are taken into account as part of the energy property for purposes of calculating the ITC.
One particularly interesting aspect of the proposed regulations is the definition of electrical energy storage property, which was added to the list of property that qualifies for the ITC by the IRA. The proposed regulations provide that electrical energy storage property includes but is not limited to rechargeable electrochemical batteries of all types (such as lithium ion, vanadium flow, sodium sulfur, and lead-acid), ultracapacitors, physical storage such as pumped storage hydropower, compressed air storage, flywheels, and reversible fuel cells.
The proposed regulations also clarify that power conditioning and transfer equipment that is treated as an integral part of energy property, and therefore qualifies for the ITC, includes transformers, inverters, and converters that modify characteristics of electricity or thermal energy into a form suitable for use or for transmission or distribution. This essentially codifies the rules that were generally applied previously. The proposed regulations include examples related to eligible basis for ITC purposes of power conditioning and transfer equipment that is used by multiple energy properties or that is simultaneously used by an energy property and a qualified facility for which the production tax credit is claimed. In one example, two different taxpayers paid for and own a portion of a substation that is used by two energy properties (each owned by one of the taxpayers) and this allows each taxpayer to claim the ITC with respect to its basis in the shared substation. In the other example, a single taxpayer owns an energy property and a qualified facility that share power conditioning and transfer equipment. The example makes clear that the portion of the cost that is allocable to the energy property is eligible for the ITC.
Prevailing Wage and Apprenticeship Regulations
Generally
The IRA reduced the base energy percentage for the ITC to 6% and added a five-times multiplier to 30% for an energy project that satisfies prevailing wage and apprenticeship requirements. In August 2023, the Treasury Department released Prop. Reg. § 1.48-13 as part of a comprehensive notice of proposed rulemaking regarding these requirements. The Treasury Department is now withdrawing the August version of Prop. Reg. § 1.48-13 and replacing it with a much more comprehensive set of proposed regulations regarding the application of the requirements to ITC property and the impact of recapture of the ITC.
The proposed regulations provide additional clarity on how the ITC recapture rules would apply for an energy project with respect to which the five-times multiplier was claimed but with respect to which a taxpayer subsequently fails to satisfy the prevailing wage requirements for the alteration or repair of such project within the five-year recapture period. Whether a recapture event has occurred would be determined at the close of each taxable year that begins or ends within the five-year recapture period. New recordkeeping requirements would require a taxpayer to annually verify compliance with the prevailing wage requirement following the close of each recapture year. If an increased credit is subject to recapture, the increase in tax related to the recapture would be assessed with respect to the taxable year in which the recapture event occurred. The recapture for failure to satisfy the prevailing wage requirement would apply only to the increased credit amount and would not apply with respect to the base portion of the ITC.
Definition of Energy Project and Single Project Factors
For purposes of the prevailing wage and apprenticeship requirements, as well as the increased ITC amounts for domestic content and energy communities under changes made by the IRA, the proposed regulations would clarify that the term “energy project” means one or more energy properties that are operated as part of a single project. Additionally, a qualified facility eligible for the production tax credit under Section 45 of the Code and that is co-located with ITC energy property would not be considered part of an energy project unless the taxpayer affirmatively elects to claim the ITC with respect to the co-located property. The proposed regulations provide that multiple energy properties would be treated as a single energy project for purposes of the prevailing wage and apprenticeship requirements if they are owned by a single taxpayer and two or more of the single project factors set forth in IRS Notice 2018-59 are present. This is a departure from IRS Notice 2018-59, which provides that whether two energy properties constitute a single project depends on all relevant facts and circumstances, including all of the enumerated factors.
Clarification of the One-Megawatt Exception and Nameplate Capacity
An energy project with a maximum net output of less than 1 MWAC of electrical (or equivalent thermal) energy is exempt from the prevailing wage and apprenticeship requirements. The proposed regulations provide that electrochromic glass property, fiber-optic solar, and microgrid controllers are not eligible for the one-megawatt exception.
The calculation of the nameplate capacity of an energy property varies by applicable technology. The calculation of the nameplate capacity for an electrical generating unit and electrical energy storage property would be based on the maximum electrical generating output in megawatts that the unit is capable of producing on a steady-state basis and during continuous operation under standard conditions, as measured by the manufacturer and consistent with the definition provided in 40 CFR § 96.202. Where applicable, the International Standard Organization conditions are used to measure the maximum electrical generating output. The calculation of nameplate capacity for purposes of the 1 MWAC exception for other technologies, including thermal energy storage property, hydrogen storage property, qualified biogas property, and hydrogen production is based on equivalent measurements in BTU per hour or standard cubic feet per hour, as applicable.
The 80/20 Rule
Under the 80/20 rule of IRS Notices 2016-31 and 2018-59, retrofitted energy property can qualify as originally placed in service for purposes of the ITC if it contains a maximum of 20% used components by total value, taking into account the capitalized cost of new components plus the value of used components. The proposed regulations would codify and clarify the 80/20 rule.
Interconnection Property for Projects with Output of 5 MWAC or Less
The IRA makes eligible for the ITC amounts paid or incurred for qualified interconnection property in connection with the installation of energy property with a maximum net output of not greater than 5 MWAC, to provide for the transmission or distribution of the electricity produced or stored by the energy property. The proposed regulations clarify that any amount reimbursed to the taxpayer for these costs reduces eligible basis for purposes of the ITC. The proposed regulations also clarify that qualified interconnection property is not taken into account when determining whether energy property satisfies the requirements for the increased ITC for domestic content or energy communities.
If an energy project is comprised of multiple energy properties with a combined nameplate capacity of more than 5 MWAC, each of the energy properties would be eligible to include amounts paid for qualified interconnection property if each energy property satisfies the 5 MWAC limitation.
The proposed regulations update and modernize many of the existing rules regarding the ITC that were issued through IRS Notices and other guidance from the IRS and Treasury Department. The proposed regulations provide helpful clarity regarding a number of issues, and provide clarity regarding the application of a number of new provisions that were added by the IRA. The Treasury Department is seeking comments from the public on a substantial portion of the proposed regulations, and the rules contained in the proposed regulations may change when the final regulations are released.
