Treasury Issues Final ITC Regulations

The U.S. Department of the Treasury recently released final regulations (Final Regulations) regarding the investment tax credit (ITC) pursuant to Section 48 of the Internal Revenue Code.  These Final Regulations finalize proposed regulations that were issued in November 2023 (Proposed Regulations) (our Legal Alert regarding the Proposed Regulations may be found here).  The Final Regulations are largely unchanged from the Proposed Regulations, with a few notable exception, including (i) clarification of certain types of “energy property” that qualifies for the ITC, (ii) changes to the rules related to when multiple energy properties will be treated as a single energy project, (iii) changes to the rules for calculating nameplate capacity of certain types of energy property,  and (iv) clarification of rules related to eligibility for the ITC of costs of qualified interconnection property paid or incurred in connection with energy property having a nameplate capacity of not greater than 5 MWac.  A summary of some of the notable provisions in the Final Regulations are summarized below.

Single Project Rules

Certain aspects of the ITC, including  the prevailing wage and apprenticeship rules, the energy community adder, and the domestic content bonus credit are applied to an “energy project,” which is defined in the statute to include multiple energy properties that are operated together as a single project.  The Proposed Regulations contained a potentially troubling provision that would treat multiple energy properties as a single energy project for these purposes if they were owned by a single taxpayer at any point during construction and if two or more of the following factors are present:

• The energy properties are constructed on contiguous pieces of land;
• The energy properties are described in a common power purchase, thermal energy, or other off-take agreement or agreements;
• The energy properties have a common intertie;
• The energy properties share a common substation, or thermal energy off-take point;
• The energy properties are described in one or more common environmental or other regulatory permits;
• The energy properties are constructed pursuant to a single master construction contract; or
• The construction of the energy properties are financed pursuant to the same loan agreement.

The mechanical two-factor test could lead to unexpected results.  For example, multiple phases of a project could be treated as a single project for prevailing wage and apprenticeship purposes even if the phases are financed through separate tax equity vehicles and are owned by different taxpayers when placed in service.

The Final Regulations change this rule in two significant ways. First, the Final Regulations provide that multiple energy properties are treated as a single project if four or more (rather than two or more) of the single-project factors are present.  Second, and perhaps more importantly, the Final Regulations allow a taxpayer to elect to apply the mechanical test either (i) at any point during construction, or (ii) during the taxable year in which the last energy property is placed in service.  This allows taxpayers to apply the single-project rules in a way that is more consistent with actual industry practice related to project development.  For example, if multiple phases of a project are owned by the same taxpayer during construction and four or more of the single-project factors are present, but the projects are financed through separate tax equity partnerships, a taxpayer may elect to apply the test for the year in which the projects are placed in service, when they are owned by separate taxpayers.

The Final Regulations also clarify that if an energy project includes multiple energy properties, the energy project is considered to be placed in service when the last energy property included in the energy project is placed in service.  This helps resolve a significant ambiguity in the Proposed Regulations regarding prevailing wage and apprenticeship, energy community, and domestic content rules that are dependent on the point in time that an energy project is placed in service.

Energy Property Definition

Many of the rules and definitions related to energy property were unchanged by the Final Regulations, with a few exceptions.

The Final Regulations add a new example that clarifies that all components of an energy property “up to the inverter” are “functionally interdependent” components of the energy property, and that the inverter and property up to and including the transformer are “integral” to the energy property, such that all of this property generally qualifies for the ITC.  This example provides helpful guidance to distinguish each individual energy property that may be treated as part of a single energy project pursuant to the above rules.  Because various ITC rules may be applied either on an energy project-wide basis or on an energy property-by-energy property basis, distinguishing between multiple energy properties included in a single energy project can be significant.

The Final Regulations also include definitional changes related to small wind energy property, qualified biogas property (including allowing certain flaring activities), thermal energy storge property, and hydrogen energy storage property. 

Interconnection Property for Projects with Output Capacity of 5 MWac or Less

The Final Regulations include a number of clarifying changes related to eligibility for the ITC of costs related to qualified interconnection property.  The Inflation Reduction Act allowed a taxpayer to claim the ITC for certain costs paid or incurred related to qualified interconnection property.  This special allowance, however, is available only with respect to an energy property that has a nameplate capacity of 5 MWac or less.  The Proposed Regulations made clear that this rule is applied on an energy property-by-energy property basis (rather than a project-wide basis) and that the cost of qualified interconnection property cost may qualify for the additional ITC even if the energy property is part of an energy project with an overall nameplate capacity of greater than 5 MWac.  The Final Regulations reiterate this by adding a new example in which a taxpayer that owns multiple energy properties that share a step-up transformer and are subject to a single interconnection agreement that allows for a maximum output of 10 MWac is allowed to take into account costs related to qualified interconnection property in calculating the ITC for both energy properties.  The Final Regulations also clarify that qualified interconnection property is not considered part of an energy property for purposes of the prevailing wage and apprenticeship rules. 

The Final Regulations also clarify that a taxpayer may be required to reduce costs paid or incurred for qualified interconnection property for purposes of the ITC (and potentially other purposes) if the taxpayer receives payments from the utility or third parties related to the qualified interconnection property.

Nameplate Capacity Calculation

Various provisions related to the ITC are based on the nameplate capacity of an energy property or energy project, as measured in alternating current.  With respect to electricity generation property that generates in direct current, the Final Regulations allow a taxpayer to choose to calculate nameplate capacity either (i) based on the sum of the nameplate capacity in direct current or (ii) based on the nameplate capacity of the first component of property that inverts the direct current electricity into alternating current.  For example, if a solar energy property is connected to an inverter, the nameplate capacity of the property may be measured using the nameplate capacity of the inverter if it is the first component of property attached to such property that inverts the direct current electricity into alternating current.  These nameplate capacity rules apply for purposes of calculating the less than 1 MWac exception to the prevailing wage and apprenticeship rules and the 5 MWac limitation for claiming ITC with respect to qualified interconnection property costs.

Applicability Dates

The Final Regulations have complicated applicability dates.  Final Treasury Regulations Sections 1.48-9 and 1.48-14 apply to property that is placed in service during a taxable year beginning after the date the Final Regulations are published in the Federal Register, final Treasury Regulations Section 1.48-13 apply to property that is placed in service in taxable years ending after, and the construction of which begins after, the date the Final Regulations are published in the Federal Register, and final Treasury Regulations Section 1.6418-5(f) apply to taxable years ending on or after the date the Final Regulations are published in the Federal Register. The Final Regulations are expected to be published in the Federal Register on December 12.  In addition, a taxpayer may elect to have the Final Regulations apply starting from earlier dates, but the taxpayer must apply the Final Regulations in their entirety and in a consistent manner.

Overall Takeaways

The Final Regulations were based on a particularly large volume of comments to the Proposed Regulations.  Helpfully the Final Regulations clarify a number of ambiguities and issues that developers and investors were encountering with the Proposed Regulations.  Most notably, the Final Regulations clarify the rules for identifying an “energy project” for purposes of the prevailing wage and apprenticeship rules, the energy community additional ITC, and the domestic content bonus credit.  The changes made to the Final Regulations will help avoid the unexpected results that the Proposed Regulations could have created in this regard.  The Final Regulations also provided helpful clarity around what property in a project may qualify for the ITC and the special rule that allows the cost of qualified interconnection property to qualify for the ITC.  In addition, the Final Regulations add clarity regarding the treatment of shared facilities.  Overall the Final Regulations should provide helpful clarity to developers and investors in ITC-qualified projects.