The IRS has provided guidance and a safe harbor to determine when construction of “energy property” has begun for purposes of the investment tax credit (ITC) under Code Sec. 48.
The Bipartisan Budget Act of 2018 ( P.L. 115-123) effectively extended the 30-percent investment tax credit for five years. In order to receive the credit for solar energy property, fiber optic solar energy property, qualified fuel cell property, and qualified small wind energy property, construction must begin before January 1, 2022.
P.L. 115-123 also extended the 10-percent investment tax credit for qualified microturbine property, combined heat and power system property, and thermal energy property. In order to receive the credit construction on these energy properties must also begin before January 1, 2022.
The IRS has provided two different methods for taxpayers to use to establish the beginning of construction of energy property:
- the Physical Work Test, and
- the Five Percent Safe Harbor Test.
In addition to establishing one of the two tests, taxpayers must also meet a “Continuity Requirement”and make continuous progress towards completion.
Physical Work Test
To meet the physical work test, a taxpayer, or the taxpayer’s contractor, must begin work of a “significant nature.” The significant nature component focuses on the type of work performed, not the actual cost of the work. Off-site and on-site work may both be taken into account to satisfy this requirement. However, the IRS will not take into account preliminary activities when determining whether work of a significant nature has begun.
Physical work of a significant nature also does not include producing components of energy property that are either in a taxpayers’ or the taxpayer’s contractor’s inventory or are typically held in inventory.
Off-site work of a significant nature may include:
- manufacture of components,
- mounting equipment,
- support structures, and
- transformers and other power conditioning equipment.
The IRS has also provided examples of on-site work of a significant nature for each type of energy property.
Five Percent Safe Harbor Test
Under the five percent safe harbor test, a taxpayer will be considered beginning construction if the taxpayer:
- pays or incurs five percent or more of the total cost of the energy property; and
- thereafter makes continuous efforts towards the completion of the energy property.
The total cost does not include the cost of land or any other property that is not integral to the production of the energy property.
The IRS has also provided special rules for taxpayers when the final total cost of the energy property exceeds their budget and results in an initial amount paid that is less than five percent.
Meeting the continuity requirement depends on which test the taxpayer used to establish that construction on the energy property has started.
When the IRS considers whether a taxpayer using the physical work test have met the continuity requirement, it will examine whether the taxpayer has met a continuous program of construction, as determined by relevant facts and circumstances.
When the IRS considers whether a taxpayer has met the continuity requirement for purposes of the five percent safe harbor test, the taxpayer must make continuous efforts to advance towards completion of the energy property. Whether the taxpayer has met this requirement is based on the relevant facts and circumstances. Examples of such relevant facts and circumstances include:
- paying additional amounts included in the total cost of the energy property;
- entering into binding contracts to construct the construct the energy property and/or related components;
- obtaining necessary permits; and
- continuing to perform physical work of a significant nature.
Certain disruptions that are beyond the taxpayer’s control are permitted, and will not result in a taxpayer’s failure to satisfy the continuity requirement.