IRS Refreshes and Codifies Energy Property Tax Credit Guidance in Proposed Section 48 Regulations

November 21, 2023

On Nov. 17, 2023, the IRS and Treasury Department released a series of proposed regulations for the Section 48 investment tax credit (ITC) that the energy market has anticipated for nearly a decade. These proposed rules represent the first update to these regulations since 1987, and they provide important instructions reflective of new ITC statutes under the Inflation Reduction Act of 2022, incorporate previous legislative changes to the ITC and formally adopt pieces of cumulative administrative guidance that have been used in market energy practices for many years. This alert summarizes the key points of the proposed regulations.

Specifically, this alert will give an overview of (i) guidance on what qualifies as energy property eligible for the ITC, (ii) codification of the “80/20 Rule” for retrofitted energy property and other ITC rules, and (iii) administrative rules related to the increased credit amount for ITC projects meeting the prevailing wage and apprenticeship requirements enacted by the Inflation Reduction Act.

Energy Property Definitions

The new rules at proposed Reg. Section 1.48-9 offer guidance for determining if certain items qualify for the ITC. In all cases, the key measure to identify all components of ITC-eligible property is whether that equipment is both necessary for the energy project to function and either functionally interdependent on the other components or an essential part of the energy property. Components that rely on the other components to allow the property to work properly for its goal, like the ability to store energy, are functionally interdependent. Essential parts of energy property are those that directly serve a key purpose, such as operation and maintenance roads or undersea cables for wind facilities.

In some cases, the proposed regulations provide the first specific definitions for pieces of energy property that have been undefined but eligible for decades (for example, solar process heat, fiber-optic solar property, combined heat and power system property, qualified fuel cell property and qualified microturbine property). In other cases, the proposed regulations provide the first descriptive guidance for newly eligible energy property (for example, electrochromic glass, energy storage technology, microgrid controllers and biogas property). Some highlighted definitions are as follows.

  • Solar Energy Property: Several definitions have been updated to align with eligible property under the Internal Revenue Code. For example, solar process heat equipment that uses solar energy to create steam at high temperatures for industrial or commercial use is definitively established as eligible in the regulations, removing a confusing exclusion regulation that had been defunct for four decades.
  • Energy Storage Property: Electrical energy storage property, thermal energy storage property and hydrogen energy storage property receive their first definitions since their inclusion as stand-alone energy properties in the Inflation Reduction Act.
  • Qualified Biogas Property: Systems that take biomass and turn it into a gas that is at least 52% methane and then collect and sell or use this gas (instead of burning) are eligible for the ITC. However, in a surprising decision, the proposed regulations state that “gas upgrading equipment necessary to concentrate the gas into the appropriate mixture for injection into a pipeline through removal of other gases such as carbon dioxide, nitrogen, or oxygen is not included in qualified biogas property.” (Emphasis added.)

The 80/20 Rule and Other Codified Energy Property Rules

Certain rules established in IRS notices and established through energy industry usage have been formally incorporated into proposed Reg. Section 1.48-14. Significant among these is the “80/20 Rule” for claiming an ITC on repowered/retrofitted projects, which has been established primarily in IRS notices to date. This rule allows a property to be deemed originally placed in service even though it contains some used property as long as the fair market value of the used property is not more than 20% of the project’s new total value.

The proposed regulations also set a definition of “placed in service” for Section 48 that replaces the retracted Section 46 regulations that taxpayers and practitioners have relied on for years. The definition is as expected and establishes that energy property is placed in service in the taxable year that is the earlier of when the period for depreciation for the property begins, or the taxable year in which it is placed in a state of readiness and availability for a trade or business or in the production of income.

Additional formal adoptions are rules concerning multiple ownership of energy property, when interconnection costs can be eligible for the ITC, and how to determine what incremental costs can be included in an ITC claim (for example, identifying appropriate costs for specialized roofing to benefit solar energy property).

Prevailing Wage and Apprenticeship Requirements Applied to the ITC

Proposed Reg. Section 1.48-13 also addresses the application of the Inflation Reduction Act’s prevailing wage and apprenticeship requirements to specific ITC scenarios regarding the alteration or repair of projects and the recapture period. The requirement to engage apprenticeship labor in construction of energy property ends when ITC property is placed in service and does not apply in the five-year recapture period during which owners are restricted from selling or taking energy property offline. However, workers engaged in construction, maintenance and repair work on projects during the same recapture period still must be paid the prevailing wage, or the ITC may be reduced from 30% to the base amount of 6%. Taxpayers that claim the 30% ITC must provide information about the payment of prevailing wages with all tax returns filed during the recapture period.

These proposed regulations also clarify that nameplate capacity is the determining facet of meeting the 1 MW exception from following prevailing wage and apprenticeship rules. The rules establish measurements to translate this metric to electrical energy storage property, hydrogen energy storage property, clean hydrogen production facilities and qualified biogas property. Property that does not store or generate electricity or thermal energy is not eligible for the 1 MW exception, leaving all electrochromic glass property, fiber-optic solar energy property and microgrid controller projects subject to prevailing wage and apprenticeship requirements.

Notice and Comment on the Proposed Regulations

The proposed and temporary regulations will be formally published in the Federal Register on Nov. 22, 2023. The IRS and Treasury will accept comments until 60 days after this publishing date. Interested parties are invited to submit written comments to the IRS before final regulations are issued. Taxpayers are permitted to rely on these proposed regulations until final regulations are issued, although the specific proposed regulations have different beginning dates for reliance over the past few years.

McGuireWoods lawyers are experienced in energy, project finance and tax equity structures, and will continue to monitor these regulations and issue updated alerts as the regulations evolve. Do not hesitate to reach out if you would like to discuss any of the above information.

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