New Guidelines on Energy Property ConstructionIn late June, the IRS issued new guidance on changes to IRC Section 48 instituted with the Bipartisan Budget Act of 2018. Prior to these changes, the requirement to be eligible for the investment credit under Section 48 was that energy property had to be placed in service by a particular date, now however, if construction has begun prior to January 1, 2022, taxpayers are eligible for the credit.
In Notice 2018-59 the IRS describes two methods for which to determine the beginning date of construction: The Physical Work Test and a Five Percent Safe Harbor. As noted above, in order to be eligible for the credit, construction must begin prior to January 1, 2022. However, the credit is phased down for construction start dates from January 1, 2020 and before January 1, 2022 and is further limited for property not placed in service prior to January 1, 2024.
Under the Physical Work Test, the construction of the property is considered to have begun once physical work of a significant nature begins. This test focuses solely on the nature of the work that has been performed, and does not focus on the amount of work, or the cost of the work. The IRS clearly states that this is a facts and circumstances test in which they will look at work performed by the taxpayer or work done for the taxpayer under a binding written contract with a third party. Both off and on-site work is considered. The Notice lists out specific examples of what constitutes off site work and/or on-site work with reference to specific energy property. What is not considered work of a significant nature are any preliminary type of costs, to name a few: planning, researching, clearing lots and permits and licensing. Substantial physical work does not include items that would normally be held by the taxpayer in inventory.
The Five Percent Safe Harbor is deemed to have been met if the taxpayer incurs five percent or more of the total energy cost of the property (all costs included in the depreciable basis of the property). Costs do not include any land, or any property that is not integral to the energy property. If actual costs of the project run over and the taxpayer no longer meets the Five Percent Safe Harbor, then the property does not satisfy the Five Percent Safe Harbor and does not qualify for the credit. If the taxpayer is dealing with multiple pieces of energy property in a single project, the IRS gives options in terms of how to meet the safe harbor requirements.
The taxpayer may meet the requirements of both methods prior to the required date for construction to begin (January 1, 2022). In this situation, the method satisfied first dictates the date used for determining when construction has begun.
For both methods, the taxpayer must continually work towards the completion of the project once the construction has been deemed to have started, this is called the Continuity Requirement. The IRS states that this is a facts and circumstances test. In regard to the Physical Work Test, the taxpayer must continue to perform physical work of a significant nature. In regard to the Five Percent Safe Harbor, examples of activities undertaken to meet the completion continuity requirement include: incurring/paying additional costs included in the total cost of the property; entering into written contractual agreements to have part of the energy property made now or in the future; and obtaining necessary permits or performing physical work of a significant nature. Additionally, there is a continuity safe harbor clause which states that the continuity requirement is automatically met if the energy property is placed in service no more than four calendar years after the construction on the property initially began.
There are certain circumstances for which disturbances for the continuity requirement are excusable but note that if the continuity safe harbor is being used, then there are no excusable disturbances. A few examples of excusable disturbances include delays due to severe weather, delays due to natural disasters and delays due to permitting or financing.
Energy property can still qualify as originally placed in service, and therefore qualify for the credit, as long as the old components do not make up more than 20 percent of the total cost of the property. It is important to note however that with regard to meeting the beginning of construction requirements (the Physical Work Test or the Five Percent Safe Harbor) only the new property is included when determining if substantial work was performed or five percent of costs incurred.
Transfers of energy property is permitted. Under IRC 48, the taxpayer that is permitted to claim the credit is the taxpayer who owns the property when it is originally placed in service. The amount applicable towards the credit however is only the taxpayer’s basis in the property. This also means that the property can be transferred without losing the qualification under the Physical Work Test or the Five Percent Safe Harbor.
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