The final regulations:
- Generally, apply prospectively (either in the taxable year following December 12, 2024, or projects the construction of which begins, and which are placed in service, after December 12, 2024).
- Provide a more taxpayer-favorable result for the determination of an “energy project,” but also add significant complexity by providing that an energy project is not placed in service until the last energy property within the project is placed in service.
- Expand on the cleaning and conditioning equipment eligible for the ITC with respect to qualified biogas property.
- Clarify the treatment of costs with respect to qualified interconnection property.
Background on the energy credit
Section 48 of the Internal Revenue Code (the “Code”) provides for an ITC calculated as a percentage of the basis of each “energy property” placed in service by a taxpayer in a taxable year. The Inflation Reduction Act of 2022 (the “IRA”) significantly modified the ITC, including by expanding the types of assets that qualify, providing for bonus tax credits for assets meeting certain criteria related to domestic content, energy communities, and low-income communities, and imposing prevailing wage and apprenticeship requirements to qualify for a full 30% tax credit rate (and the full ten percentage points for any bonus credits), subject to exceptions for projects under one MWac or that began construction before January 29, 2023.
- Regulations under section 48 have not been updated since 1987. The final regulations both address new concepts from the IRA and formally adopt other concepts—such as the 80/20 Rule described below—that originated from other tax guidance issued over the years.1
Application date of the final regulations
The new ITC regulations do not apply to existing projects (unless a taxpayer elects to apply them). The regulations that (i) generally define the types of property for which the ITC is available (e.g., solar property or fuel cells) and (ii) provide special rules for purposes of the ITC (e.g., the 80/20 rule, discussed below) apply to property that is placed in service during a taxable year that begins after December 12, 2024. The rules for “energy projects” (which group certain energy properties together for purposes of prevailing wage and apprenticeship (“PWA”)2 compliance or exclusions and certain bonus increases to the ITC (“adders”)) apply to projects placed in service and the construction of which begins after December 12, 2024. Taxpayers may elect to apply either or both of the (i) the energy project regulations and (ii) the regulations defining the types of property available for the ITC and the special rules applicable to the ITC right away, provided that they follow the applicable regulations in their entirety.
Observation
Projects placed in service by the end of the year are only impacted by these regulations if a taxpayer so elects. Projects need to be evaluated on a case-by-case basis.
The final regulations: The “energy project” definition is less sweeping, but also creates significant questions.
The final regulations increase the number of “single project” aggregation factors that must be present, from two factors to four factors, to aggregate multiple energy properties into a single energy project. Multiple energy properties constitute a single “energy project” if (i) a “taxpayer” (which includes related parties) owns the properties and (ii) any four of the traditional aggregation factors are satisfied (i.e., (a) the properties are constructed on contiguous pieces of land, (b) the properties are described in a common power purchase agreement, thermal energy, or other off-take agreement or agreements, (c) the properties have share a common intertie, (d) the properties share a common substation, or thermal energy offtake point, (e) the properties are described in one or more common environmental or other regulatory permits; (f) the properties are constructed pursuant to a single master construction contract, and (g) the properties are financed pursuant to the same loan agreement.).
The last property defines when an energy project is placed in service. An “energy project” is considered placed in service on the day on which the last energy property in such energy project is placed in service, which impacts, for example, energy community qualification under section 48(a)(14) of the Code.
Observation
What happens when multiple energy properties are placed in service across tax years? Do taxpayers have to amend their returns to receive the full credit or adders? Do certain properties not get the full ITC or adders if placed in service in prior years? The fact that “energy project” status is more elective and may be planned around is somewhat helpful, but this rule may create significant complexity.
Observation
There is a separate recapture rule for the increased ITC if prevailing wages are not paid during the five-year recapture period. However, the PWA recapture period begins on the date the energy project is placed in service, meaning that the PWA recapture period apparently extends beyond the ITC recapture period for an individual property within such energy project.
A taxpayer now elects when to determine whether properties are a single energy project. A taxpayer may elect when to determine whether properties constitute an “energy project” at any point during the construction of such properties, or during the taxable year in which the last energy property in a project is placed in service.
Observation
If the energy project determination is made only when the last property in an energy project is placed in service, it’s unclear what practical purpose making a determination before placed in service serves.
The “single project” rule applies only for purposes of determining qualification for the 30% ITC and the energy community and domestic content adders. “Beginning of construction” for other purposes relies on traditional facts-and-circumstances safe harboring guidance (e.g., IRS Notice 2018-59).
Observation
The rule in the final regulations provides more certainty to taxpayers for when to aggregate energy properties. Previously, there were concerns properties that would not intuitively be aggregated would constitute a single energy project (e.g., residential solar projects spread across jurisdictions that were constructed under a master equipment procurement and construction agreement, and financed pursuant to the same loan agreement would be aggregated). However, this rule also adds complexity, because now taxpayers may potentially have to apply multiple “single project” tests, depending on the purpose of the test (such as the test in IRS Notice 2018-59 for beginning-of-construction purposes, or the test in Treas. Reg. 1.48(e)-1, for claiming the low-income adder under section 48(e) of the Code).
The definition of “energy property” and the types of property that are ITC-eligible received certain significant updates, particularly in regards to qualified biogas property and energy storage technology.
The regulations retain the definition of “energy property” as any property functionally interdependent or an integral part of energy property and largely finalize the definitions of specific types of energy properties, except as provided below.
Biogas retains and expands the correction providing that cleaning and conditioning equipment qualify. For biogas property, the regulations now specify that equipment that cleans and conditions the gas is ITC-eligible. This equipment includes gas upgrading equipment, such as an anaerobic digestor. ITC-eligible property also includes a waste feedstock collection system, a landfill collection system, and mixing or pumping equipment. The regulations also permit combustion in the form of flaring.
Observation
Property considered “integral” to qualified biogas property will qualify for the ITC if owned by the taxpayer owning the unit of energy property. However, the taxpayer placing the unit of energy property in service need not own such integral property to qualify for the ITC. Certain biogas projects may want to consider applying the final regulations right away.
Hydrogen energy storage technology’s “end-use” requirement is removed and the energy storage technology definitions are expanded. The final regulations remove the “end use” requirement for hydrogen storage technology, which had required that hydrogen be stored for the production of energy. Now, hydrogen may be stored for any purpose. The definition of “thermal energy storage” was also expanded.
Energy storage technology qualifies for the ITC even if it is co-located with, or shared by, a facility eligible for a separate credit. This means that it is treated as separate property for purposes of the ITC, regardless of its use by or co-location with a facility eligible for, e.g., credits under section 45V of the Code. However, energy storage property may still be part of an “energy project” consisting of other energy properties (e.g., solar energy property).
The exception to the PWA requirements for projects with less than one MWac of output is clarified.
Under section 48(a)(9)(B)(i) of the Code, an energy project with a maximum net output of less than one MW of electrical (as measured in alternating current) or thermal energy is exempt from the PWA requirements for purposes of claiming the full ITC (the “one MW exception”). The regulations provide that an energy project’s maximum net output is calculated as the sum of the nameplate capacity of each energy property within such energy project and provide rules for determining nameplate capacity for certain energy properties.
A qualifying energy property must have “output.” Therefore, certain energy properties, such as fiber-optic solar energy property and microgrid controllers, per se cannot qualify for the one MW exception.
Observation
Because the one MW exception applies on an energy project level, it appears that projects containing properties without output are thereby disqualified entirely from applying the one MW exception, even if the project contains energy properties with output.
Projects that generate electricity in direct current are included. These projects may determine maximum net output by using the lesser of (i) the sum of the nameplate generating capacities within the unit of energy property in direct current (which will be deemed to be the nameplate generating capacity of the unit of energy property in alternating current) or (ii) the nameplate capacity of the first component of property that inverts the direct current electricity into alternating current.
Energy storage technology qualification is based on maximum net output. Separate rules are provided for electrical, thermal, and hydrogen storage.
The regulations retain the “80/20 Rule” from the proposed regulations.
Energy properties may contain some used property and be treated as newly placed in service if the fair market value of the used components is not more than 20% of the total value of the property, which is determined by taking into account the cost of the new components plus the value of the used components (the “80/20 Rule”).
The 80/20 Rule applies to each “unit” of energy property (i.e. all the functionally interdependent components of property owned by the taxpayer that are operated together and that can operate apart from other energy properties). The regulations provide an example establishing that capital improvements must satisfy the 80/20 Rule.
Observation
Because the 80/20 Rule applies to energy property on a unit-by-unit basis, and units of energy property do not include property that is an “integral part” of energy property, integral property is excluded from the evaluation (although the ITC may be claimed for integral property once the 80/20 Rule is satisfied for the respective unit of energy property).
Observation
Taxpayers had argued that the ITC could be claimed with respect to certain capital expenditures without satisfying the 80/20 Rule. The Treasury and the IRS clarified that expenditures to existing projects do not qualify for the ITC without meeting this rule.
Other rules applicable to energy properties and projects
There is a PWA transition rule waiving penalty payments. Penalty payments are waived for taxpayers who relied upon the PWA guidance issued prior to these regulations and the final PWA regulations, and the taxpayer makes the correction payments by June 10, 2025. The regulations also added special recapture rules for failure to satisfy the PWA requirements.
Energy property only includes “incremental costs” where a component has a qualifying and non-qualifying component. The regulations provide an example of a taxpayer installing a reflective roof along with rooftop solar property. Only the cost of the reflective roof above the cost of ordinary re-roofing may be included in “energy property.”
Other rules from the proposed regulations are left substantively unchanged. The regulations retain the same rules for “dual use” property, the same rules for ownership of energy property by multiple taxpayers, and the same rules for electing the ITC with respect to “qualified facilities” under section 45 of the Code.
Footnotes
1. See our prior guidance on the proposed regulations.
2. See our commentary on the final PWA regulations.
