Executive summary
Treasury and the IRS have released long-awaited proposed regulations on the energy investment tax credit (ITC). The proposed regulations implement changes from the Inflation Reduction Act of 2022 (IRA) as well as prior law changes.
New IRA energy credit guidance
Overview
The proposed energy ITC regulations represent a significant step in implementing the IRA. The ITC provides for a general business credit for certain types of energy property. The credit is claimed for the year the property is placed in service. The amount of the credit is determined by the basis of the qualifying energy property. The credit rate is dependent on many factors, including whether certain labor requirements were met during construction of the project, and whether credit “adders” for domestic content and/or energy communities are satisfied.
The ITC was originally enacted in 1962 to spur economic growth by encouraging investments in various capital projects across many industries including energy, transportation and communications. The ITC has been amended many times since enactment. The current ITC regulations were published in 1981 and last amended in 1987. Treasury has requested comments over the years on various issues and has been actively working on the this regulation project for quite some time. Due to advances in technology and amendments to the ITC since this time, the proposed regulations are welcome to the industry.
The proposed regulations, which were published on Nov. 22, 2023, were 127 pages and cover a wide range of issues. Treasury proposed to amend four provisions in the regulations:
- 1.48-9 – Definition of energy property
- 1.48-13 – Rules relating to the increased credit amount for prevailing wage and apprenticeship
- 1.48-14 – Rules applicable to energy property
- 1.6418-5 – Special rules
The regulations are proposed to generally be effective – and a taxpayer may rely on these regulations – for property placed in service after Dec. 31, 2022 and during a taxable year beginning after the date final regulations are published. Proposed Regulation section 1.6418-5(f) is effective for taxable years ending on or after the date final regulations are published in the Federal Register. Taxpayers may rely on Proposed Regulation sections 1.48-9, 1.48-14, and 1.6418-5(f) with respect to property that is placed in service after Dec. 31, 2022, and during a taxable year beginning on or before the date final regulations are published in the Federal Register provided the taxpayer and all related persons apply such regulations in their entirety and in a consistent manner. Proposed Regulation section 1.48-13 is proposed to apply to projects placed in service in taxable years ending after the date final regulations are published and the construction of which begins after the date final regulations are published; however, Proposed Regulation section 1.48-13(d) is proposed to apply to energy projects the construction of which begins after Nov. 22, 2023.
Comments on the proposed regulations should be submitted by Jan. 21, 2024. A public hearing on the regulations will be held on Feb. 20, 2024.
Types of property eligible for the ITC
The regulations define and set forth the requirements for 'energy property’. Further, they update the rules related to the types of technology that qualifies for the energy credit. The regulations provide definitions for the following:
- Solar energy property
- Fiber optic solar energy property
- Electrochromic glass property
- Geothermal energy property
- Qualified fuel cell property
- Qualified microturbine property
- Combined heat and power system property
- Qualifed small wind energy property
- Geothermal heat pump equipment
- Waste energy recovery property
- Energy storage technology (electrical, thermal, and hydrogen)
- Qualified biogas property
- Micgrogrid controllers
Considerations for determining energy property
The regulations provide additional context on how to determine the components that will be considered energy property eligible for the ITC. Instead of listing specific components, the regulations adopt a function-oriented approach. The regulations provide components of property are functionally interdepent if the placing in service of each component is dependent upon the placing in service of each of the other components in order to generate or store electricity, thermal energy, hydrogen, or otherwise perform its intended function, and all such components will be considered as part of a unit of energy property. Further, the regulations include property that is an integral part of the project to be included as energy property. This may include certain onsite roads to operate the equipment, but fencing and buildings are generally not considered integral property. The regulations also provide that if property is functionally interdependent or an integral part of energy property, it is energy property regardless of whether it is in a separate location. Further, the rules clarify that certain intangible property such as power purchase agreement, renewable energy certificates and goodwill are not energy property because they are not functionally interdependent or an integral part of the energy property.
Prevailing Wage and Apprenticeship Rules for ITC
The regulations provide additional rules related to the increased credit rate where projects satisfy prevailing wage and apprenticeship (PWA) rules, collectively referred to as labor requirements. See prior coverage of PWA rules. Particiular to the ITC, the regulations clarify how the recapture rules apply to credit transfers when it is determined that the PWA rules were not satisfied. It includes rules requiring the taxpayer who generated the ITC to notify the transferee of this failure. Additionally, the regulations clarify the definition of 'energy project’ for purposes of the PWA rules, domestic content requirements, and energy community credit adders. The regulations set forth factors (previously outlined in Notice 2018-59) related the treating multiple energy properties as a single energy project. Rules for related taxpayers are also included.
The regulations also provide additional information on the one-megawatt exception to the PWA rules. The rules provide factors for converting thermal energy into electrical energy for thermal energy storage, hydrogen energy storage, and qualified biogas and hydrogen projects. The rules also provide that electrochomic glass property, fiber-optic solar, and microgrid controllers are not eligible for the one-megawatt exeception because they do not generate electricity or thermal energy. Treasury has requested comments on this point.
Other rules applicable to energy property
The proposed regulations provide additional requirements and rules generally applicable to energy property. These include:
- Clarification of placed in service rules for energy property
- Application of the '80/20 Rule’ to retrofitted ITC energy property
- Expansion of dual use property rule by providing property must only be used more than 50% as qualified energy property (rather than the prior rule of 75%); the rule also permits the aggregation of energy inputs from more than one energy property
- Addressing treatment of energy property eligible for multiple Federal income tax credits
- Providing rules for separate ownership of components of an energy property and rules for determining related taxpayers
- Providing procedures for the election to treat qualified facilities eligible for the renewable electricity production credit as property eligible for the energy credit.
Washington National Tax Takeaways
The proposed regulations provide welcome guidance for the energy ITC. In general, the regulations adopt and follow some of the older rules related to section 38 property in Treasury Regulation sections 1.48-1 and 1.48-2, which were last amended in 1988 and 1985, respectively while making updates specific to today’s energy property.
With respect to definitional guidance, the regulations generally do not make substantive changes from the statutory language. This leaves the area sufficiently gray with respect to many specific components and highlights the importance of application of the facts and circumstances functional interdependence and integral part tests in determining the components of a project eligible for a credit.
A number of clarifications were made in the proposed regulations. For example, the regulations clarify rules related to offshore wind transmission property. Additionally, language and examples were provided related to power conditioning and transfer equipment providing parts related to the functioning or protection of power conditioning equipment (e.g., switches, circuit breakers, etc.) are treated as power conditioning equipment and are energy property. Additionally, the regulations clarify that electrochromic glass property includes secondary glazing and other functionally interdependent components.
Some of the more surprising provisions relate to exclusion of upgrading equipment to the definition of qualified biogas property and the exclusion of certain property from the one megawatt PWA exception. Additionally, Treasury did not generally expand the credit to allow claims by multiple parties who own separate components despite requests for this from commentators. Treasury did, however, expand the dual-use property test in response to requests from commentators.
Treasury has asked for comments on specific provisions. With respect to energy properties ineligible for the one-megawatt exception, Treasury requested comments on whether there are methods of measurement that may allow such properties to use this exception to the PWA requirements. Several comments were requested on provisions related to properties added to the definition of energy property by the IRA, such as energy storage technology, microgrid controller property, and qualified biogas property. It is expected that affected stakeholders will submit comments on the various issues prior to finalization of the regulations.
