The Proposed Regulations REG-132569-17 (Proposed Regs) provide some clarity to long-awaited questions regarding the Section 48 Investment Tax Credit (ITC). The ITC is a clean energy credit altered by the Inflation Reduction Act of 2022 (IRA) that allows taxpayers to claim a credit based on the amount of their investment in energy property. While §48 provided initial rules, submitted comments and further considerations have resulted in these new Proposed Regs, which provide clarity to three broad topics: 1) §48 definitions and clarifications (amending §1.48-9), 2) rules applicable to energy property (introducing §1.48-14), and 3) clarifications to prevailing wage and apprenticeship (PWA) requirements (withdrawing and replacing §1.48-13).
Why this matters to you: To claim the ITC, the first step is to determine whether the property is eligible for the credit. These Proposed Regs give taxpayers a better idea of what may qualify come Final Regulations (whether it be the type of property or what components of a project would qualify as energy property), so they can help with planning investments, modeling out clean energy or construction projects, and determining whether investments from the past year could result in a credit.
Section 1.48-9: §48 Definitions & Clarifications
There is a defined list of the type of property eligible for the ITC. The Proposed Regs dig deeper into each of these categories, and adopt or alter previously proposed definitions. While clarifications as to certain aspects of each category also are included, there remain requests for comments that indicate the potential for future guidance.
The following chart examines the proposed definitions, clarifications, and updates for eligible property for the §48 credit per the Proposed Regs REG-13256-17. These definitions and clarifications are subject to change until final regulations are issued.
| Property | Proposed/Updated Definition(s) | Clarifications/Notes |
|---|---|---|
| Solar Energy Property | The Proposed Regs adopt but modify the statutory definition:
|
|
| Fiber-Optic Solar Energy Property | Proposed Regs adopt the statutory definition:
| N/A |
| Electrochromic Glass Property | Proposed Regs clarify the statutory regulations. Definition clarifications:
| Included in each type:
|
| Geothermal Energy Property | The Proposed Regs adopt but modify the statutory definition:
| Proposed Regs would not specifically include costs incurred to drill failed or nonproducing wells. In fact, the U.S. Department of the Treasury and the IRS have determined that these costs cannot be included in the basis of the geothermal energy property for purposes of calculating the §48 credit. |
| Qualified Fuel Cell Property | Proposed Regs adopt the statutory definition:
| Electricity-only generation efficiency may be calculated by dividing the heat rate of the fuel cell, e.g., kilowatt-hours (kWh) electricity produced per kilogram (kg) of fuel consumed, by the higher heating value of the fuel, e.g., kWh per kg. |
| Qualified Microturbine Property | Proposed Regs adopt the statutory definition:
| A stationary microturbine power plant also includes all secondary components located between the existing infrastructure for fuel delivery and the existing infrastructure for power distribution, including equipment and controls for meeting relevant power standards, such as voltage, frequency, and power standards. |
| Combined Heat and Power (CHP) System | The Proposed Regs adopt a simplified version of the statutory definition:
|
|
| Qualified Small Wind Energy Property | The Proposed Regs adopt a simplified version of the statutory definition:
| N/A |
| Geothermal Heat Pump Equipment | The Proposed Regs adopt the statutory definition with a modification:
| Energy distribution equipment may be considered geothermal heat pump equipment. |
| Waste Energy Recovery Property (WERP) | The Proposed Regs adopt the statutory definition:
|
|
| Energy Storage Technology | The Proposed Regs adopt the statutory definition:
|
|
| Qualified Biogas Property | The Proposed Regs adopt the statutory definition:
|
|
| Microgrid Controllers | The Proposed Regs adopt the statutory definition:
| An eligible microgrid includes an electrical system that is capable of operating in connection with the larger electrical grid whether or not the microgrid is physically connected to the electrical grid. |
Section 1.48-9: Definition of Energy Property
The Proposed Regs provide more insight into which components may qualify as energy property.
Defining Energy Property
In general, there are multiple parts or pieces of property that must be installed or present in order for clean energy property to function as intended. For example, framing, interconnection property, or power conditioning equipment all could be part of the overall system that allows for clean energy property to operate. In fact, the taxpayer would not pay for this “additional” property were it not for the clean energy property installed. Therefore, the Proposed Regs state that,
“Components of an energy property are those that would be included in a unit of energy property because they are functionally interdependent (as described in proposed §1.48-9(f)(2)(ii)) as well as property owned by the same taxpayer that is an integral part of such energy property (as described in proposed §1.48-9(f)(3)). Additionally, components of property must not be a type of property specifically excluded from energy property (as described in proposed §1.48-9(d)).”
A unit of energy property is essentially a group of components that operate together for a specified purpose. If different components depend on each other to accomplish this purpose, are all owned by the taxpayer, and can operate separate from other property within the broader project, then the amalgamation of components is considered a unit of property. The technical term for the coordinated operation of these components is functional interdependence:
“The placing in service of each component is dependent upon the placing in service of each of the other components in order to perform its intended function as provided in section 48(c) and as described in proposed §1.48-9(e). Energy property, with certain exceptions, includes all components necessary to generate or store electricity or thermal energy for transmission, distribution, or use up to (but not including) the stage that transmits, distributes, or uses electricity or thermal energy.”
It does not in fact matter whether the components share the same location as long as they remain functionally interdependent and the components are a part of the unit of property. Further, the Proposed Regs specifically exclude power purchase agreements, renewable energy certificates, goodwill, and going concern value from the definition of energy property due to this functional interdependency requirement.
Section 1.48-14: Rules Applicable to Energy Property
The Proposed Regs cover a variety of other topics meant to clarify what property taxpayers can use for the ITC:
Retrofitted Energy Property (80/20 Rule)
Many credits within the IRA require “original use” for the taxpayer to claim the credit. Essentially, property has to be new property for which the taxpayer is the first user. The Proposed Regs have adopted what is colloquially referred to as the “80/20 Rule” to handle retrofits. If “the fair market value of the used property is not more than 20 percent of the qualified facility’s total value (that is, the cost of the new property plus the value of the used property),” then the costs incurred for new components is considered a part of a qualified facility eligible for a clean energy credit. The 80/20 Rule does not only apply to the definition of energy property. Taxpayers also can use this concept when it comes to determining when construction has begun for purposes of the ITC, which is critical when determining prevailing wage rates for the PWA Bonus Credit.
Dual-Use Property (50% Cliff)
The Proposed Regs changed the approach to dual-use property based on submitted comments in response to Notice 2015-70. As background, it is possible for energy property to be used for both qualifying and disqualifying purposes. In these situations, the question is whether any or only a portion of the property’s basis would qualify for the §48 credit. Historically, at least 75% of the energy would have to qualify for any portion of the property itself to be considered eligible for the ITC (“the 75-percent Cliff”). Further, the “dual-use rule” previously “preclude[d] an energy property from receiving and aggregating energy from a combination of qualifying sources (solar energy property, wind energy property, and geothermal equipment).” However, upon issuance of the Proposed Regs, both of these rules were modified. The Proposed Regs change the 75% cliff to a 50% cliff, allowing more flexibility with more complex energy systems. The altered rule would state:
Similar to the operation of the 75-percent Cliff in existing §1.48-9, if the energy used from qualifying sources is between 50 percent and 100 percent, only a proportionate amount of the eligible basis of the energy property will be taken into account in computing the amount of the section 48 credit. If less than 50 percent of the energy used is from qualifying sources, then the eligible basis is zero, and the property is not eligible for the section 48 credit.
In addition, the dual-use rule allows aggregation of energy sources when arriving at this now 50% threshold. The Proposed Regs now would “permit taxpayers to calculate credit basis by aggregating all inputs from qualifying sources that would otherwise individually qualify for the section 48 credit (all types of energy property and any qualified facilities for which an election is made to claim the section 48 credit as a “qualified investment credit facility” under section 48(a)(5)).” The measuring period for this test is the 365 (or 366) days following the date placed in service or a 365-day period beginning the day after the last day of the immediately preceding annual measuring period.
Energy Property That Could Be Eligible for Multiple Credits
Though the §45 Production Tax Credit (PTC) and §48 ITC are mutually exclusive, a taxpayer may have energy property eligible for multiple credits. For example, the §25D credit and the §48 credit can be claimed on the same property that is used for different purposes. See Q&A #27 of Notice 2013-70. However, proposed §1.48-14(c)(2) states that “in no event may a taxpayer claim both a section 48 credit and another Federal income tax credit with respect to the same eligible basis in an energy property.”
Incremental Cost
The Proposed Regs indicate that “incremental cost” is key to this determination. Incremental cost is defined as “the excess of the total cost of equipment over the amount that would have been expended for the equipment if the equipment were not used for a qualifying purpose related to the section 48 credit.” The incremental cost is, therefore, what is eligible as basis for the ITC.
Special Rules Concerning Ownership
In the case that there are multiple owners in a single piece of qualifying property, the Proposed Regs state that each owner’s credit is limited to the “extent of the party’s fractional ownership interest.” If “Owner A” owns 50% of the energy property, then the credit generated from that portion of the property’s basis would be allocated to Owner A. Proposed Reg §1.48-14(e)(4) provides multiple examples.
Election to Treat Qualified Facilities as Energy Property
One of the more quizzical portions of the updated §48 credit under the IRA is the rule that allows for an election to treat qualified facilities, i.e., facilities that would be otherwise qualified for the §45 production tax credit, as energy property eligible for the §48 credit. Note that this facility cannot have been (and will not be) claimed and allowed for the PTC, and that the election to pursue the §48 credit is irrevocable. These facilities include: “wind, closed- and open-loop biomass, geothermal, solar, landfill gas, trash, hydropower, marine and hydrokinetic facilities.” This election allows, for example, large wind facilities, i.e., facilities not meeting the definition of qualified small wind energy property, to qualify for the ITC when not otherwise eligible. The property within these facilities that is considered the qualified property must meet the general requirements of other §48 eligible property: tangible property (not including a building or its structural components), an integral part of the qualified facility, subject to depreciation or amortization, constructed or acquired by taxpayer, and original use commences with the taxpayer.
To make this election, taxpayers must file Form 3468, Investment Credit, with the income tax return for the year the energy property is placed in service. It is important to note that this is an “all or nothing” election for the property as a whole, even if multiple owners have fractional interests in the property. If one owner elects to treat the property as a §48 qualified investment credit facility, then the election is binding on “all taxpayers that directly or indirectly own an interest in the facility.”
Inclusion of Qualified Interconnection Costs
It is easy to understand that the cost of a solar panel, wind turbine, or battery would each qualify for the §48 credit based on the definition previously detailed in this article. However, for each of these properties to function for their qualifying purposes, there often is “interconnection property” that must be present to allow the property to “come online.” More specifically, interconnection property is defined as:
With respect to an energy project which is not a microgrid controller, any tangible property that is part of an addition, modification, or upgrade to a transmission or distribution system that is required at or beyond the point at which the energy project interconnects to such transmission or distribution system in order to accommodate such interconnection; is either that is constructed, reconstructed, or erected by the taxpayer, or for which the cost with respect to the construction, reconstruction, or erection of such property is paid or incurred by such taxpayer; and the original use of which, pursuant to an interconnection agreement, commences with a utility.
However, it is important to note that the related energy property must have a net output of not greater than 5 MW (as measured in alternating current, and on a by-property basis, even if multiple properties are included in an energy project). If these requirements are met, then the cost of the interconnection property can be included in the eligible basis when calculating the ITC. However, interconnection property placed in service in relation to the following types of energy property is not qualified for the §48 credit: microgrid controllers, electrochromic glass property, fiber-optic solar energy, energy properties that generate thermal energy (such as certain geothermal property), and qualified biogas property.
Therefore, while the basis of qualifying interconnection property can be included in the basis for the calculation of the §48 base credit, the Proposed Regs clarify that taxpayers do not need to consider the location of manufacture of this interconnection property when considering the Domestic Content or Energy Community Bonus Credits. For example, taxpayers can ignore interconnection property when calculating either the 10% steel or 40% manufactured product domestic content threshold for the bonus credit percentage.
Practically speaking, when accounting for interconnection property, if including this property in the overall ITC credit claimed, then the expense for the interconnection property should be reduced. In short, there is no “double benefit” of both a credit and a deduction for the same property allowed (a concept that applies to the “main” energy property as well). Further, if a taxpayer is reimbursed for any portion of the property, then the qualifying basis should be reduced accordingly.
Oftentimes, a taxpayer pays a third party to construct or implement their energy property. To claim a credit in these cases, the Proposed Regs state that “final information with conclusive details such as a true-up report with the actual costs, final invoices, proof of payment or reimbursement, and permission to operate documentation or any other final project accounting documentation should be maintained.”
Section 1.48-13: Prevailing Wage & Apprenticeship (PWA) Clarifications
The following section outlines clarifications and changes provided in the Proposed Regs. For further background surrounding the requirements in general, see our related FORsights articles (“Prevailing Wage & Apprenticeship Proposed Regulations: What This Means for You” and “FAQs Answered: Prevailing Wage & Apprenticeship Requirements”). Three overarching topics include: the definition of an “energy project” for the PWA requirements, guidance concerning the One-Megawatt Exception, and recapture rules if PWA requirements are not satisfied.
Section 48(a)(10)(C) Recapture Rules
If a §48 energy credit is claimed on energy property that is then disposed of within five years, recapture would apply to the taxpayer (or transferee when considering recapture in general, or transferor when considering the PWA requirements). The guidance states, “The five-year recapture period begins on the date the project is placed in service and ends on the date that is five full years after the placed in-service date.” At the end of each year within the five-year period, taxpayers should consider whether a recapture event has occurred. This analysis should be included within the PWA documentation requirements as otherwise outlined. Further, there may be reporting requirements that attest to the fact that no recapture event has occurred at the close of each recapture year. If a recapture event has occurred, then the percentage used varies depending on the year of the recapture event per §50(a).
Observation From Forvis Mazars: Note that any annual compliance requirement to this effect may require a nonprofit making the direct pay election to file a Form 990-T for the five-year recapture period, even if it otherwise would not have to.
Definition of Energy Project
At times, the §48 credit references energy property and, other times, energy projects. In short, an energy project is defined as “one or more energy properties that are operated as part of a single energy project.” Therefore, the two terms are definitionally intertwined. However, when looking between credits, the relationship between energy properties and projects gets murkier. The Proposed Regs state that “Section 45 qualified facilities that are co-located with section 48 energy property will not be considered part of an energy project (unless they elect under section 48(a)(5) to be treated as energy property).” This election is discussed further in this article above.
Unlike the election needed for §45, for qualified facilities to be treated as an energy project under §48, there is no election needed for multiple pieces of energy property to be considered as one energy project when certain factors apply. The Proposed Regs outline these factors:
“If at any point during the construction of the multiple energy properties, they are owned by a single taxpayer … and any two or more of the following factors) are present:
- The energy properties are constructed on contiguous pieces of land;
- The energy properties are described in a common power purchase, thermal energy, or other off-take agreement or agreements;
- The energy properties have a common intertie;
- The energy properties share a common substation, or thermal energy off-take point;
- The energy properties are described in one or more common environmental or other regulatory permits;
- The energy properties are constructed pursuant to a single master construction contract; or
- The construction of the energy properties are financed pursuant to the same loan agreement,”
then the qualified facilities are treated as one single energy project for §48.
This “grouping” of energy property can be important both for administrative purposes and for credit calculation purposes. The IRA created the opportunity for multiple “bonus credits,” and the grouping concept for the §48 credit also applies to these bonus credits. Namely, the PWA Bonus Credit, the Domestic Content Bonus Credit, and the Energy Community Bonus Credit. These bonus credits consider the “energy project,” not the “energy property.” Therefore, a taxpayer that has one piece of otherwise qualifying energy property for one of the bonus credits may have their eligibility for these bonus credits tainted if another piece of energy property within an energy project does not meet the requirements. For example, there are two solar panels being installed on the taxpayer’s land. The solar panels meet the aforementioned factors and are, therefore, considered together as an energy project. In this example, Solar Panel #1 is placed in service in February, and the taxpayer meets the PWA requirement during the entirety of its construction. In June, Solar Panel #2 is placed in service, and it happens that the taxpayer mistakenly underpaid a few of the workers during its construction. Considering Solar Panel #1 and #2 are deemed to be part of the same energy project, neither Solar Panel #1 nor Solar Panel #2 are eligible for the PWA “five times” bonus credit for the year.
It is important to note that “this rule would apply to an energy project for which construction begins after the date final regulations are published.”
One Megawatt Exception
The “five times” bonus credit allows taxpayers to multiply the base credit percentage under §48 by five automatically if the One-Megawatt Exception applies (and, as a result, the PWA requirements need not be considered). However, the specifics of how this “one megawatt” is calculated and applied to each qualifying energy property had not previously been explained. The Proposed Regs state “nameplate capacity will provide the necessary guidance to determine the maximum electrical generating output in MWs of electrical (as measured in alternating current) or thermal energy that the unit is capable of producing on a steady state basis and during continuous operation under standard conditions.” For example, the Proposed Regs discuss the specificities of the nameplate capacity for an electrical generating unit, electrical energy storage property, thermal energy storage, hydrogen energy storage, projects that produce thermal energy or fuels, and property generating thermal energy.
Note that not all energy properties qualify for the One-Megawatt Exception, meaning in order to obtain the “five times” bonus credit taxpayers would need to meet the PWA requirements. Nonqualifying properties include electrochromic glass property, fiber-optic solar, and microgrid controllers.
Timing Considerations
The rules within the Proposed Regs “would apply for property placed in service after 12/31/22 and during a taxable year beginning after the date final regulations are published.”
Given the variation and specificity of applicability dates, the timing considerations are provided here:
Except for the provisions of proposed §§1.48-13 …, these regulations generally are proposed to apply with respect to property that is placed in service after December 31, 2022, and during a taxable year beginning after the date final regulations are published in the Federal Register. … A taxpayer may rely on proposed §§ 1.48-9, 1.48-14 … with respect to property that is placed in service after December 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 (within the meaning of sections 267(b) and 707(b) of the Code) apply proposed §§ 1.48-9 and 1.48-14 in their entirety and in a consistent manner. Proposed §1.48-13 is proposed to apply to projects placed in service in taxable years ending after the date final regulations are published in the Federal Register, and the construction of which begins after the date final regulations are published in the Federal Register. However, proposed §1.48-13(d) is proposed to apply to energy projects the construction of which begins after [the date of publication in the federal register]. Taxpayers may rely on §1.48-13 with respect to construction of a property or project beginning on or after January 29, 2023, and on or before the date these regulations are published as final regulations in the Federal Register, provided, that beginning after the date that is 60 days after August 29, 2023, taxpayers follow proposed §1.48-13 in its entirety and in a consistent manner.
If you have any questions or need assistance, please reach out to a professional at Forvis Mazars.