Commence Construction Guidance
On Friday, June 22, 2018, the IRS released its much anticipated guidance setting forth the requirements for establishing the beginning of construction for solar energy projects utilizing the commercial solar Investment Tax Credit (ITC) under Code section 48. The guidance, known as commence construction, is similar to guidance previously issued for the wind production tax credit. This guidance created much needed certainty for financing solar projects. Subsequently, the IRS has released several notices updating and further clarifying this guidance.
Notice 2018-59 provides two methods a taxpayer may use to establish that construction of a qualified solar facility has begun for purposes of claiming the solar investment tax credit (ITC): (1) starting physical work of a significant nature (Physical Work Test), or (2) meeting the so-called Five Percent Safe Harbor test (i.e., paying or incurring five percent or more of the total cost of the facility in the year that construction begins). Both methods require that a taxpayer make continuous progress toward completion of the project once construction has begun.
The Consolidated Appropriations Act of 2015 (P.L. 114-113) extended and modified the ITC for residential (Code section 25D) and commercial (Code section 48) solar energy (i.e., property that uses solar energy to generate electricity, to heat or cool a structure, or to provide solar process heat).
The Act provided that commercial solar projects utilizing section 48 which begin construction by certain specified dates will qualify for the ITC – eliminating the prior law requirement that a project must be placed in service to qualify for the credit. However, it is important to note that the change to a beginning of construction standard was not made to the section 25D residential credit, so individual taxpayers claiming the residential solar ITC must still have their projects placed in service before they can claim the credit.
The credit rate at present is 26 percent for projects beginning construction by December 31, 2022; and 22 percent for projects beginning by December 31, 2023. Property must be placed in service by December 31, 2025, to qualify for a credit rate in excess of 10 percent. In the case of the sec. 48 commercial credit, the credit rate is 10 percent for projects which begin construction on or after January 1, 2024. The residential credit would expire after December 31, 2023.
While a taxpayer must make continuous progress toward completion of the project once construction has begun, taxpayers will be deemed to automatically satisfy this continuity requirement if the project is placed in service by the end of the fourth calendar year after the year in which construction began.
There are three notable exceptions and an important legal end date to be aware of with respect to the four year time frame: for projects that commenced construction in 2016, 2017, 2018, or 2019, continuity safe harbor is satisfied if the project is placed in service by the end of a calendar year that is no more than 6 calendar years after the calendar year during which construction began. For projects for which construction began in calendar year 2020, continuity safe harbor is satisfied if the project is placed in service by the end of the calendar year that is no more than 5 calendar years after the calendar year during which construction began. Lastly, a qualified facility or an energy property construction project that is an Offshore Project or a Federal Land Project (defined in 4.02 of Notice 2021-05) satisfies the continuity safe harbor if a taxpayer places the qualified facility or energy property that is the subject of the project into service by the end of a calendar year that is no more than 10 calendar years after the calendar year during which construction of the project began. Separately, the law states that any solar project must be placed in service by January 1st, 2026, in order to receive the ITC. Practically this means a shorter time frame for safe harbor in later years: for example, a project that starts in 2023 would therefore only receive a two year continuity safe harbor for 2024 and 2025, since the project must be placed in service by January 1st, 2026 in order to receive a credit over 10%.
Although a taxpayer may satisfy both methods of establishing the beginning of construction, construction will be deemed to have begun on the date the taxpayer first satisfies one of the two methods. For example, if a taxpayer performs physical work of a significant nature on energy property in 2018, and then pays or incurs five percent or more of the total cost of the energy property in 2019, construction will be deemed to begin in 2018 under the Physical Work Test, not in 2019 under the Five Percent Safe Harbor. Thus, the Continuity Safe Harbor will be applied beginning in 2018, not in 2019.
Physical Work Test
The Physical Work Test requires that a taxpayer begin physical work of a significant nature. This test focuses on the nature of the work performed, not the amount or the cost. Assuming that physical work performed is of a significant nature, there is no fixed minimum amount of work or monetary or percentage threshold required to satisfy the Physical Work Test. Both off-site and on-site work may be taken into account for purposes of demonstrating that physical work of a significant nature has begun.
Generally, off-site physical work of a significant nature includes, among other things, the manufacture of components, mounting equipment, support structures such as racks and rails, inverters, and transformers and other power conditioning equipment. Examples of on-site physical work include the installation of racks or other structures to affix photovoltaic (PV) panels, collectors, or solar cells to a site.
The physical work can be performed by the taxpayer, by a contractor, or by a subcontractor of the contractor. However, any work performed by a contractor counts only if done under a binding contract that is in place before the physical work begins.
Five Percent Safe Harbor
Construction of energy property will be considered as having begun if: (1) a taxpayer pays or incurs five percent or more of the total cost of the energy property, and (2) thereafter makes continuous efforts to advance towards completion of the energy property.
The continuity requirement under either the Physical Work Test or the Five Percent Safe Harbor will be deemed to have been met if the project is placed in service by the end of the fourth calendar year after the year in which construction began (with notable exceptions mentioned above). If an energy property is not placed in service before the end of the fourth calendar year following the year during which construction began, the satisfaction of the “continuity requirements” for the physical work and safe harbor tests ”will be determined by the relevant facts and circumstances.”
The Notice also provides a list of construction disruptions that will not be considered as indicating that a taxpayer has failed to satisfy the Continuity Requirement, including:
- delays due to severe weather conditions
- delays due to natural disasters;
- delays in obtaining permits or licenses from federal, state, local, or Indian tribal governments, including, but not limited to, delays in obtaining permits or licenses from the Federal Energy Regulatory Commission (FERC), the Environmental Protection Agency (EPA), the Bureau of Land Management (BLM), and the Federal Aviation Agency (FAA);
- delays at the written request of a federal, state, local, or Indian tribal government regarding matters of public safety, security, or similar concerns;
- interconnection-related delays, such as those relating to the completion of construction on a new transmission or distribution line or necessary transmission or distribution upgrades to resolve grid congestion issues that may be associated with a project’s planned interconnection;
- delays in the manufacture of custom components;
- delays due to labor stoppages;
- delays due to the inability to obtain specialized equipment of limited availability;
- delays due to the presence of endangered species;
- financing delays; and
- delays due to supply shortages.
For questions about how to meet the requirements for establishing the beginning of construction of specific solar projects, please seek the opinion of tax counsel.