IRS Issues Additional Guidance on Beginning of Construction Rules for Renewable Projects

by McDermott Will & Emery
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In Depth

On December 15, 2016, the Internal Revenue Service (IRS) released Notice 2017-04 (the Notice). The Notice provides guidance on how to meet the “beginning of construction” requirements for wind and other qualified facilities (including biomass, geothermal, landfill gas, trash, hydropower, and marine and hydrokinetic facilities). The Notice extends the Continuity Safe Harbor placed in service date by which a facility can meet the beginning of construction tests for facilities that began construction before 2014. Specifically, the Notice states that if a facility is placed in service by the later of (1) a calendar year that is no more than four calendar years after the calendar year during which construction of the facility began, or (2) December 31, 2018, the facility will be considered to satisfy the Continuity Safe Harbor.

Following prior IRS guidance, a facility was considered to have satisfied the Continuity Safe Harbor if the facility was placed in service within the four-year period following when construction commenced or December 31, 2016, whichever is later. The change in the Notice provides welcome guidance for projects that began construction prior to 2014 and were unlikely to be placed in service within the four-year period, but are anticipated to be placed in service by the end of 2018.

The Notice also provides that the “combination of methods” rule set forth in Notice 2016-31 only applies to facilities on which construction begins after June 6, 2016 (the date on which Notice 2016-31 was published). The combination of methods rule prohibits a taxpayer from relying upon the Physical Work Test and the Five Percent Safe Harbor in alternating calendar years to satisfy the beginning of construction rules or the Continuity Requirement. Seemingly, this rule permits projects that met the Physical Work Test and the Five Percent Safe Harbor in different years prior to June 6, 2016, to rely on the method used in the most recent year. Finally, the Notice clarifies that for purposes of the 80/20 Rule, the cost of new property includes all costs properly included in the depreciable basis of the new property.

According to the Notice, the IRS will issue separate guidance addressing the extension and modification of the investment tax credit (ITC) for solar facilities under Section 48.

Background

On December 18, 2015, the Protecting Americans from Tax Hikes Act of 2015 (PATH Act) amended the production tax credit (PTC) and the ITC. Specifically, the PATH Act included multi-year extensions of the PTC and the ITC for wind and solar projects, along with a gradual phase-out of the credit.

In the case of wind, the PATH Act extended the PTC through 2019 (including the corresponding election to take the ITC in lieu of the PTC for wind projects), such that wind projects that begin construction prior to the end of 2019 will be eligible for the PTC or ITC. Previously, the PTC for wind only applied to projects beginning construction before the end of 2014.

The PATH Act also reduced the PTC and ITC for wind by 20 percent for projects commenced in 2017, by 40 percent for projects commenced in 2018, and by 60 percent for projects commenced in 2019. For energy facilities other than wind, such as biomass and geothermal projects, the PATH Act extended the PTC through the end of 2016 and included a corresponding extension of the election to take the ITC in lieu of the PTC. For more information on the PATH Act’s extension of renewable energy tax incentives, including the extension of the ITC for solar projects, click here.

The Notice updates the guidance provided in prior notices (Notice 2013-29, Notice 2013-60, Notice 2014-46, Notice 2015-25 and Notice 2016-31, together referred to herein as the Prior Guidance). The Notice explains that the IRS will not issue private letter rulings to taxpayers regarding the application of the Notice, the Prior Guidance or the beginning of construction requirement under Sections 45(d) and 48(a)(5).

Notice 2013-29

Under Notice 2013-29, a taxpayer may establish that construction has begun on a qualified facility by demonstrating that “physical work of a significant nature” has begun (Physical Work Test) or by satisfying a 5 percent safe harbor (Five Percent Safe Harbor). Notice 2013-29 lists several examples of work that meets the Physical Work Test, including, with respect to a wind energy facility, the beginning of the excavation for the foundation, the setting of anchor bolts into the ground or the pouring of the foundation’s concrete pad. Both onsite and offsite work may be taken into account. The IRS also imposed a requirement that a “continuous program of construction,” as defined in the Prior Guidance (Continuous Construction Test), be maintained after performance of physical work in 2013 until the relevant project is placed in service.

The Five Percent Safe Harbor set forth in Notice 2013-29 provides that the construction of a qualified facility is considered to begin before January 1, 2014, if a taxpayer pays or incurs (within the meaning of the accrual rules of Treasury Regulation Section 1.461-1(a)(1) and (2)) 5 percent or more of the total cost of the facility before such date. Thereafter, the taxpayer must make continuous efforts to advance toward completion of the facility (Continuous Efforts Test) in order to be deemed to have begun construction (the Continuous Construction Test and the Continuous Efforts Test are referred to herein collectively as the Continuity Requirement).  

For more information on these tests and their requirements, see McDermott’s article on Notice 2013-29.

Notice 2013-60

In September 2013, the IRS issued Notice 2013-60, clarifying questions left outstanding by Notice 2013-29. Specifically, Notice 2013-60 provided that a facility was to be considered to satisfy the Continuity Requirement if it was placed in service before January 1, 2016 (the Continuity Safe Harbor). Notice 2013-60 also permitted a taxpayer to claim the PTC or ITC even if the taxpayer was not the owner of the facility on the date construction began. For more information, see McDermott’s article on Notice 2013-60.  

Notice 2014-46

Notice 2014-46 clarified that the Physical Work Test focuses on the nature of the work performed rather than the amount or cost of such work. Notice 2014-46 also provided guidance regarding transfers of a facility by the taxpayer after construction has begun, but before that taxpayer placed the facility in service. Notice 2014-46 modified the Five Percent Safe Harbor rule set forth in earlier guidance by providing that, if a taxpayer incurred at least 3 percent of the total cost of such a facility before January 1, 2014, the Five Percent Safe Harbor may be satisfied with respect to some (although not all) of the individual facilities that are part of this larger project. For more information, see McDermott’s article on Notice 2014-46.

Notice 2015-25

Notice 2015-25 extended the relevant Continuity Safe Harbor placed in service dates under the earlier notices so that the beginning of construction guidance mirrored the statutory extension of the PTC and the ITC under the Tax Increase Prevention Act of 2014 (TIPA). Prior to the extension under TIPA, Sections 45(d) and 48(a)(5) required that construction of a qualified facility begin before January 1, 2014, for the facility to be eligible for the PTC or the ITC. Based on the language of those sections as in effect before TIPA, the guidance prior to Notice 2015-25 provided advice on determining whether construction had begun on a qualified facility prior to January 1, 2014. Because TIPA extended the date by which construction of a qualified facility must begin to January 1, 2015, Notice 2015-25 extended the Continuity Safe Harbor placed in service date to meet the Continuity Requirement to January 1, 2017. For more information, see McDermott’s article on Notice 2015-25.

Notice 2016-31

Notice 2016-31 extended the relevant Continuity Safe Harbor placed in service dates to correspond with the extension and modification of the PTC by the PATH Act. Specifically, Notice 2016-31 provided that a facility will be considered to satisfy the Continuity Requirement if the facility is placed in service by the later of (1) a calendar year that is no more than four calendar years after the calendar year during which construction on the facility began, or (2) December 31, 2016. As an example, Notice 2016-31 provides that if construction on a wind facility began on January 15, 2016, and the facility is placed in service by December 31, 2020, the facility will be considered to satisfy the Continuity Safe Harbor.    

Notice 2016-31 also set forth a “combination of methods” rule under which a taxpayer cannot alternate between the Physical Work Test and the Five Percent Safe Harbor to satisfy the beginning of construction requirement or the Continuity Requirement. For example, if a taxpayer relied on the Physical Work Test to satisfy the beginning of construction rules in 2015, and then in 2016 incurred costs totaling 5 percent or more of the total cost of the facility, the taxpayer could not then use the Five Percent Safe Harbor to satisfy the beginning of construction requirement or the Continuity Requirement. Instead, the Continuity Safe Harbor is applied beginning in 2015. 

Notice 2016-31 also (1) revised and added to the list of excusable disruptions that will not be taken into account when determining whether the Continuity Requirement has been met, (2) provided additional examples of work that meets the Physical Work Test for different types of renewable energy facilities, (3) revised the list of preliminary activities that do not constitute “physical work of a significant nature” for purposes of the Physical Work Test, (4) provided additional guidance on whether and how multiple facilities are treated as a single facility for beginning of construction purposes, and (5) provided additional guidance on the application of the Five Percent Safe Harbor to retrofitted facilities. 

For more information on these tests and their requirements, see McDermott’s article on Notice 2016-31.

Notice 2017-04

The Notice modifies the Continuity Safe Harbor by providing that if a taxpayer places a facility in service by the later of (1) a calendar year that is no more than four calendar years after the calendar year during which construction of the facility began, or (2) December 31, 2018, the facility will be considered to satisfy the Continuity Safe Harbor. By changing the date from December 31, 2016, to December 31, 2018, the Notice allows certain projects on which construction began prior to 2014 to qualify for the Continuity Safe Harbor. For example, if construction began on a facility on January 15, 2013, and the facility is placed in service by December 31, 2018, the facility will be considered to satisfy the Continuity Safe Harbor. Under the Prior Guidance, this facility would not have been eligible for the Continuity Safe Harbor, and the taxpayer would have needed to demonstrate that the Continuity Requirement was met under the relevant facts and circumstances. Alternatively, if construction begins on a facility on January 15, 2016, and the facility is placed in service by December 31, 2020, the facility will be considered to satisfy the Continuity Safe Harbor.    

The Notice also states that the “combination of methods” rule set forth in Notice 2016-31 only applies to facilities on which construction begins after June 6, 2016 (the date on which Notice 2016-31 was published in IRB 2016-23). Therefore, if a taxpayer meets the Physical Work Test with respect to a facility in 2014 and the Five Percent Safe Harbor test for the facility in 2015, the taxpayer seemingly can apply the Continuity Safe Harbor test from 2015, meaning that the taxpayer must place the facility in service by December 31, 2019, in order to satisfy the Continuity Safe Harbor. Taxpayers that begin construction on facilities after June 6, 2016, however, will be prevented from restarting the four-year window for placing the facility in service by using the other beginning of construction method to qualify the facility as having begun construction in the later year. 

The Notice provides that, as indicated in the Prior Guidance, a retrofitted facility may qualify as originally placed in service for purposes of the PTC and ITC if the fair market value of used property does not constitute more than 20 percent of the facility’s total value. Thus, the cost of the facility’s new property must be at least 80 percent of the facility’s total value (the 80/20 Rule). The Prior Guidance indicated that the Five Percent Safe Harbor is applied only with respect to the cost of new property used to retrofit an existing facility, and that all costs properly included in the depreciable basis of the facility are taken into account to determine whether the Five Percent Safe Harbor has been met. The Notice clarifies that for purposes of the 80/20 Rule, the cost of new property includes all costs properly included in the depreciable basis of the new property. Taxpayers had questioned whether indirect costs that were allocable to the depreciable basis could be included for these purposes, and the Notice appears to affirmatively answer this question.      

Conclusion

The Notice provides much-needed guidance with respect to facilities on which construction began prior to January 1, 2014, that otherwise would not have been placed in service within the four-year Continuity Safe Harbor window. The Notice also provides useful clarity with respect to the “combination of methods” rule and the scope of eligible property under the 80/20 Rule.

 

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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