IRS Releases Final Regulations Under Section 48 of the Code

The Internal Revenue Service (“IRS”) and Department of the Treasury last week released final regulations (the “Final Regulations”) relating to investment tax credits under Section 48 of the (the “ITC”) of the Internal Revenue Code (the “Code”).  The release of the Final Regulations follows the issuance of proposed regulations in November 2023 (the “Proposed Regulations”), which we described here.  The Final Regulations are available here.

The Final Regulations largely adopt the Proposed Regulations, with a few exceptions.  Mandatory applicability dates differ slightly between the various provisions of the proposed regulations, and the regulations provide some flexibility for taxpayers to apply them to projects that are already under construction or in service.

The following provides a summary of several key points from the Final Regulations, including changes from the Proposed Regulations and areas where the Treasury Department and the IRS declined to make any changes that had been requested by some commenters.

The Final Regulations for the ITC

The Final Regulations contain a few key differences and confirmations from the Proposed Regulations, including:

• Qualified Interconnection Property.
  • The Final Regulations retain the rule from the Proposed Regulations that the 5 MW (AC) limitation for qualified interconnection property is measured at the level of the energy property—rather than at the energy project level.
  • The Final Regulations no longer require that reimbursements from a utility must be accounted for when determining ITC-eligible interconnection costs. Instead, the effect of reimbursements on ITC-eligibility is subject to general income tax principles and, accordingly, there may be some situations where reimbursement for interconnection costs may cause some interconnection costs to not be eligible for the ITC.
  • The Final Regulations confirm that interconnection property is not subject to the prevailing wage and apprenticeship requirements, and is not taken into account in determining whether an energy property satisfies the requirements for the domestic content or energy community bonus credits.

• Revisions to Single Project Determination.
  • In response to taxpayer concerns regarding the single project rule set forth in the Proposed Regulations, the Final Regulations contain several changes to provide taxpayers additional flexibility.  First, rather than implementing an “ownership plus two factors” test for multiple energy properties to be treated as a single energy project under the Proposed Regulations, the Final Regulations now require “ownership plus four factors.”  This should provide taxpayers with some relief for projects that were truly not single projects in the ordinary sense but would have been treated as a single project under the “ownership plus two factors” scheme of the Proposed Regulations.  Second, the single energy project analysis may be assessed, at the taxpayer’s option, at any point during construction of the energy properties or during the taxable year the energy properties are placed in service.  This will clearly help taxpayers to separate projects that are developed as one in early stages but are broken up and ultimately sold to unrelated taxpayers.  Finally, the Final Regulations decline to adopt the “consistent treatment” rule contained in the Proposed Regulations that required multiple energy properties to be treated as a single energy project for purposes of the prevailing wage and apprenticeship requirements, domestic content bonus credit amount and energy community bonus credit amount if such energy properties were treated as a single energy project for beginning of construction purposes. 
  • Many commenters suggested that different types of energy property should not be susceptible to aggregation as a single energy project.  For example, if solar and storage are combined as a single energy project, several commenters noted that it was not fair to test the combined property for eligibility for the domestic content adder.  These commenters noted that in many cases the solar may qualify for the adder on a standalone basis, but when the analysis required a combination of solar and storage then neither energy property would qualify for the adder.  The IRS and Treasury declined to adopt this request and, accordingly, multiple types of energy property technology are tested together for purposes of the single energy project determination, including application of the domestic content adder. 
  • In line with the above, the Final Regulations also clarify that an energy project will be deemed placed in service when the last energy property within the energy project is placed in service. This is a helpful clarification in connection with adders, including the energy community adder, eligibility for which is generally determined on the placed in service date for the energy project.

• 80/20 Rule.  The IRS and Treasury received multiple comments to the application of the 80/20 rule, which generally outlines the requirements for retrofits of energy property for purposes of obtaining the ITC for the retrofit costs.  Among the most impactful decisions, IRS and Treasury determined that energy property generally does not include equipment that is an addition or modification to existing energy property unless the rigorous 80/20 test is satisfied.

• Changes to Qualified Biogas Property. With respect to qualified biogas property, the Final Regulations clarify that gas upgrading equipment constitutes cleaning and conditioning property since such upgrading equipment is used interchangeably with cleaning and conditioning equipment that may be needed to make the biogas suitable for sale or productive use.  As such, under the Final Regulations, gas upgrading equipment that is used to make the gas suitable for sale or productive use constitutes qualified biogas property eligible for the ITC.  In addition, the Final Regulations clarify that combustion in the form of flaring will not disqualify a qualified biogas property from being eligible for the ITC, provided that the primary purpose of such qualified biogas property is sale or productive use of biogas and any flaring complies with all relevant laws and regulations.  The Final Regulations also provide flexibility with respect to qualified biogas property ownership requirements.  Because of the unique ownership structures in the biogas industry, in many cases the owners of the biogas production facility do not also own the associated waste feedstock collection system or landfill gas collection system.  The Proposed Regulations essentially required that a taxpayer had to own both the biogas production facility and the associated collection systems; the Final Regulations change this rule by permitting separate ownership of these collection systems (which would not, if owned by a taxpayer unrelated to the owner of the conversion system, be eligible for the ITC).    

• Calculation of Maximum Net Output for the 1 MW (AC) Exception to Application of the Prevailing Wage and Apprenticeship Requirements for the 30% ITC. The Final Regulations provide a new rule for energy properties that generate electricity in direct current.  Under this new rule, a taxpayer may choose to determine the maximum net output of each energy property that is part of the energy project (in alternating current) by using the lesser of (1) the sum of the nameplate generating capacities within the unit of energy property in direct current, or (2) the nameplate capacity of the first component of property that inverts the direct current electricity into alternating current.  However, in other respects the Final Regulations adopt the 1 MW (AC) exception as set forth in the Proposed Regulations.  For example, the IRS and Treasury declined to adopt taxpayer comments that electrochromic glass property, fiber-optic solar energy property, and microgrid controllers should be eligible for the 1 MW (AC) exception notwithstanding that such property does not generate electrical or thermal energy.  Accordingly, all of these properties must satisfy the prevailing wage and apprenticeship requirements to be eligible for the 30% ITC.

In addition, the preamble to the Final Regulations includes confirmation regarding a handful of significant questions from commenters, including:

• Confirmation that energy storage technology is eligible for the ITC if it satisfies the requirements under Section 48 of the Code, even if the energy storage technology is co-located with or shared by a facility that is otherwise eligible for the tax credits under Sections 45, 45V, or 48 of the Code.

• Confirmation that Treasury Regulations Sections 1.45-7, 1.45-8 and 1.45-12, regarding the prevailing wage and apprenticeship requirements, are generally incorporated for the ITC by cross-reference.

The Foley team will continue to monitor developments related to the Final Regulations and the ITC.  Please reach out to Adam Schurle or Tori Roessler if you have any questions.