IRS Extends Continuity Safe Harbor for Beginning of Construction

The IRS today issued Notice 2020-41, which modifies prior notices regarding the beginning-of-construction requirement for qualifying for the production tax credit under Section 45 of the Code (“PTC”) and the investment tax credit under Section 48 of the Code (“ITC”). Both tax credits are subject to phase-out based on the year in which construction of the facility, in the case of the PTC, or the energy property, in the case of the ITC, begins.

Prior IRS notices provide that construction of a project is considered to have begun for PTC or ITC qualification purposes when either (i) physical work of a significant nature begins with respect to the project (the “physical work test”) or (ii) the taxpayer pays or incurs 5% of the total cost of energy property included in the project (the “5% safe harbor”). In addition, the taxpayer must satisfy a continuity requirement. Under this continuity requirement, if beginning of construction is established using the physical work test, the taxpayer must thereafter maintain a continuous program of construction. If construction begins under the 5% safe harbor, the taxpayer must make continuous efforts to advance towards completion of the energy property. Generally the continuity requirement must be established by showing actual continual physical work or continual efforts toward completion of a project, as applicable. Prior IRS notices provided a safe harbor, however, under which the continuity requirement would be deemed satisfied if a project is placed in service no later than the end of the fourth calendar year following the year in which construction began.

Due to COVID-19 and related delays, a number of developers and investors have expressed concern that projects that were originally intended to be completed by the end of 2020 may extend into 2021. Depending on the circumstances, this could have caused a project that otherwise would have qualified for the four-year continuity safe harbor to fail to qualify, in which case the taxpayer would be required to show continuous construction or continuous efforts, as applicable, under a facts and circumstances determination. The IRS responded to this concern in Notice 2020-41 by extending the continuity safe harbor for an additional year for projects that began construction in 2016 or 2017. Under the revised safe harbor, the continuity safe harbor will be satisfied if a project is placed in service by the end of the fifth calendar year after the year in which physical work began or the 5% safe harbor was satisfied. This is a particularly welcome modification to developers of wind facilities the construction of which began in 2016 (to qualify for the full PTC) and with respect to which the four-year continuity safe harbor otherwise would have expired at the end of 2020. Those facilities generally may now qualify for the continuity safe harbor if they are placed in service before the end of 2021. This revised continuity safe harbor only applies if the taxpayer met the physical work test or the 5% safe harbor in 2016 or 2017 with respect to the applicable project. If a taxpayer satisfied either test in 2018 or 2019, the four-year continuity safe harbor still applies.

IRS Notice 2020-41 also addresses the application of the “3½ month rule” in light of COVID-19 and related delays. Generally, for a cost related to the purchase of property to be considered “incurred” by an accrual method taxpayer in a particular year (and therefore taken into account for purposes of applying the 5% safe harbor), the property must be provided to the taxpayer by the end of the year. Under the 3½ month rule, however, an otherwise eligible accrual method taxpayer may treat the date of payment as the date a cost is incurred if the taxpayer reasonably expects the property to be provided within 3½ months after the date of payment. A number of developers relied on this rule for purposes of beginning construction of solar and other projects in 2019, before the amount of the ITC was reduced.

IRS Notice 2020-41 confirms that if a taxpayer was eligible to use the 3½ month rule and reasonably expected property to be provided within the required time frame when payment was made, the taxpayer may treat the date of payment as the date the cost was incurred even if the property is not received within 3½ months after the date of payment. In addition, to provide certainty and assurance, the notice also provides that for payments made on or after September 16, 2019, a taxpayer will be deemed to have had a reasonable expectation that the services or property would be provided within 3½ months after the date of payment in any case in which the services or property are actually provided on or before October 15, 2020. This safe harbor may provide welcome relief to taxpayers that have not received property that was paid for at the end of 2019 as a result of COVID-19 related delays. Notwithstanding the 3½ month rule safe harbor, the 3½ month rule may still be satisfied even if the services or property are provided after October 15, 2020 if the expectation at the time of payment was reasonable.