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10 minute read | December.19.2024
The U.S. Department of the Treasury (Treasury) and Internal Revenue Service (IRS) have released final regulations for the energy investment tax credit (ITC) under Section 48 of the Internal Revenue Code, which was significantly revised and expanded by the Inflation Reduction Act (IRA).
The regulations in effect at the time the IRA passed had not been revised since 1987, so Treasury focused significant time and attention to drafting final regulations that address several issues arising from the new IRA provisions as well as technological advancements.
The final ITC regulations follow previous IRA final regulations regarding the prevailing wage and apprenticeship (PWA) requirements and tax credit transfer rules.
The ITC is available for property for which construction begins before January 1, 2025.
For property that begins construction on or after January 1, 2025, the “tech-neutral” clean energy investment credit under Section 48E is available.
Proposed regulations for Section 48E were released in June, but final regulations have not yet been released. The Section 48E credit adopts a tech-neutral approach to property placed in service at a qualified electricity generating facility for which the anticipated greenhouse gas emissions rate is not less than zero.
Overall, Treasury has emphasized a function-oriented, rather than technology-oriented, approach to determining the equipment or components that may constitute ITC-eligible energy property.
For this reason, with some exceptions, Treasury declined to add specific examples of energy property that some commenters requested (see below for revisions to qualified biogas property).
The final rules adopt the proposed rules’ approach in characterizing energy property as including a unit of energy property that is an integral part of energy property.
Orrick observation: Treasury’s emphasis on function rather than form provides flexibility for future advances in technology.
With respect to solar energy property, the regulations treat the unit of energy property as all the solar panels connected to a common inverter. Prior guidance did not explicitly say what constitutes a unit of energy property for solar energy property.
For purposes of the PWA requirements, the domestic content bonus credit, and the increased credit rate for energy communities, the proposed regulations would have treated multiple energy properties as a single project if, at any point during the construction of multiple energy properties, they were owned by a single taxpayer (or certain related taxpayers) and met two or more of the following specified factors:
As numerous commenters pointed out, this definition posed significant challenges to owners of multiple energy properties that would not generally be considered one project, such as residential rooftop solar systems installed pursuant to the same construction and loan agreements. An overly strict rule could have prevented these aggregated smaller projects from benefitting from the one MW exception to the PWA requirements and made it more difficult to qualify for the domestic content and energy community credit adders. Treasury acknowledged that the proposed rule was too rigid and revised the final regulations to require four or more factors to be present to be considered a single project.
Also, the proposed rules would have required multiple energy property to be grouped together as a single energy project if the requirements above were met at any point during the construction of the properties.
The final regulations provide that the taxpayer can choose to assess the factors either (i) at any point during construction, or (ii) during the taxable year the energy properties are placed in service. The final regulations clarify that an energy project is placed in service when the last of the energy properties are placed in service.
The final regulations also do not adopt the proposed rule that a single energy project determination for purposes of beginning of construction would be treated as being made for the PWA requirements, the domestic content bonus credit, and the increased credit rate for energy communities. Thus, although the factors used in the single project analysis are similar, they will be assessed differently depending on the purpose. Furthermore, even if multiple energy properties are treated as a single energy project for these purposes, the energy properties must be reported separately when claiming the ITC.
Orrick observation: Treasury declined to adopt the facts-and-circumstances approach for defining an energy project provided in the beginning of construction guidance and stated that the increased credit rates and bonus credits for the ITC require greater certainty. Thus, we expect the rule will be strictly construed as a bright-line test and may require new strategies during project planning and development.
The proposed regulations would have provided that upgrading equipment is not a functionally interdependent component of qualified biogas property. Although upgrading equipment allows the injection of biogas into a pipeline, it is not necessary to the statutory provisions that require the biogas contain not less than 52% methane and that it be captured for sale or productive use.
Treasury noted that commenters “universally supported” including upgrading equipment as qualified biogas property. Without upgrading equipment, commenters asserted, biogas would essentially be unusable due to its limited utility. Upgrading equipment also comprises a sizable investment portion and could represent up to 85% of the overall investment into biogas systems. In response to these comments, the final regulations provide that gas upgrading equipment is “cleaning and conditioning property” that is qualified biogas property.
The final regulations also clarified the point at which measurement of the methane percentage takes place. Under the proposed rule, the methane content would be measured at the point at which gas exits the biogas production system, which is generally the point when the taxpayer must determine whether it will convert biogas to fuel for sale or use it directly to generate heat or to fuel electricity generation unit. Commenters pointed out that the methane content should be measured at the point at which the gas is ready for sale or applicable productive use. Treasury agreed that the point of measurement in the proposed rules was too early, and the final regulations clarify that the point of measurement to be the point at which the biogas exits the qualified biogas property.
Finally, while the statute requires that qualified biogas property may not capture biogas for disposal via combustion, the final regulations provide combustion in the form of flaring will not disqualify a qualified biogas property, provided the primary purpose of the qualified biogas property is sale or productive use of biogas and any flaring complies with all relevant Federal, State, regional, Tribal, and local laws and regulations.
Orrick observation: Treasury addressed many of the concerns expressed in the comments without significantly altering the language in the proposed regulations. The changes should help alleviate many of the concerns regarding ITC qualification for qualified biogas property.
A taxpayer must directly own at least a fractional interest in the entire unit of energy property for an ITC to be determined with respect to the taxpayer's interest. Property that is an integral part of an energy property is energy property; however, a taxpayer may not claim the ITC for any property not owned by the taxpayer that is an integral part of the taxpayer's energy property. Multiple energy properties (whether owned by one or more taxpayers) may include shared property that may be considered an integral part of each energy property so long as the cost basis for the shared property is properly allocated to each energy property.
Many commenters requested revisions to the proposed rules so that owners of components of energy property or energy projects could receive the ITC, specifically for qualified biogas property, geothermal heat/geothermal energy property, solar energy property, and offshore wind facilities. The commenters pointed out, for example, that in many energy projects, the same owner does not own all of the functionally interdependent components of energy property. An area of particular concern is biogas property, which may comprise several components owned by different taxpayers due to regulatory requirements for landfills, for example.
In the final regulations, Treasury declined to adopt suggestions relating to the ownership certain components that are not an entire energy property or energy project. Its reasoning reflects both policy and practical considerations due to the statutory language of the ITC (as amended by the IRA) and administrative uncertainty in assessing eligibility among different owners.
Orrick observation: While Treasury is reluctant to change ownership provisions that deviate from the IRA’s amendments to the ITC, it acknowledges that some concerns are warranted. Thus, while the final ownership rules remain largely unchanged, Treasury has implemented revisions elsewhere, such as adding gas upgrading equipment as qualified biogas property and deleting the language that gas upgrading equipment is not a functionally interdependent component of energy property, which may allow owners of that equipment to claim the ITC even if another person owns the collection system.
The final regulations confirm that qualified interconnection property may be included in the eligible basis of energy property, but that it is not itself energy property. Thus, qualified interconnection property is not taken into account when determining whether energy property satisfies the PWA requirements, the domestic content bonus credit, or the increased credit rate for energy communities. Costs paid or incurred, if properly chargeable to the capital account of the taxpayer, as reduced by any utility or non-utility payments. The final regulations confirm that the 5 MW limitation for qualified interconnection property is measured at the level of the energy property.
Orrick observation: New and revised examples confirm that multiple energy properties may be measured individually to determine whether the maximum net output meets the qualified interconnection property rule. The preamble notes that the 5 MW limitation is tied to the energy property. As noted above, with respect to solar energy property, the Treasury and IRS view the unit of energy property as all the solar panels that are connected to a common inverter. Thus, it may be possible for large-scale projects to include qualified interconnection costs in the ITC-eligible basis.
With the upcoming change in administration, we may see additional IRA guidance released before January 20, 2025. Taxpayers are waiting on additional IRA guidance in a number of areas, including final regulations for the technology-neutral clean energy credits (Section 48E and its counterpart, Section 45Y for clean energy production) and regulations for the credit adders for domestic content and energy communities.