Final Regulations Issued Regarding Section 48 Investment Tax Credit
On December 12, 2024, the Internal Revenue Service (the “IRS”) and the Department of the Treasury (“Treasury”) published final regulations (the “final regulations”) regarding the energy credit under Section 48 of the Internal Revenue Code, commonly referred to as the investment tax credit (“ITC”). The ITC is a key incentive for investment in clean energy facilities and energy storage technology.
The final regulations provide guidance on amendments to Section 48 under the Inflation Reduction Act of 2022 (the “IRA”). In November 2023, IRS and Treasury released proposed and temporary regulations under Section 48, which we discussed here (the “proposed regulations”).
Section 48 provides an ITC in an amount generally equal to 30% of a taxpayer’s basis in “energy property” placed in service during the taxable year. Section 48 was originally enacted in 1962 and has been subject to a series of amendments over the years, including most recently by the IRA.
The IRA amended Section 48 in several important ways, including by making additional types of energy property eligible for the ITC and providing bonus credits for domestic content (discussed by us here), energy communities (discussed by us here), and low-income communities (discussed by us here). The IRA also decreased the starting ITC percentage (from 30% to 6%) and allowed taxpayers to be eligible for the 30% ITC only by satisfying certain “prevailing wage and apprenticeship requirements” (the “PWA requirements”) (discussed by us here) or qualifying for an exception.
The final regulations generally adopt the proposed regulations with the following key changes:
- revising the seven-factor test for determining whether multiple energy properties constitute a single “energy project” to require that at least four (rather than two) of the seven factors be present;
- clarifying that each “unit of energy property” of a solar energy property is determined up to the point of the inverter or load; and
- revising definitions of specific types of energy property, including with respect to hydrogen energy storage property and qualified biogas property.
These and other additional changes are discussed in more detail below.
Definition of “Energy Project”
The final regulations revise the definition of “energy project” to include all energy properties that are owned by a taxpayer (or a related person) and that satisfy four (rather than two) of the following seven factors:
- 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 offtake 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 is financed pursuant to the same loan agreement.
The final regulations also provide that the taxpayer may choose to assess the above listed factors, either (i) at any point during construction of the multiple energy properties, or (ii) during the taxable year in which the last of such energy property is placed in service. The final regulations also clarify that an energy project is placed in service on the date the last of the energy properties within the energy project is placed in service.
Baker Botts Tax Note: This rule for placement in service of energy projects, like all other rules for energy projects, applies only for purposes of the PWA requirements, the domestic content bonus credit, and the energy community bonus credit. The increase in the number of factors that must be satisfied (now four instead of two) is a helpful change because it reduces the possibility that a group of energy properties will inadvertently be treated as a single energy project and tested for PWA and bonus credit compliance as a group.
The IRS and Treasury declined to adopt a facts and circumstances approach used in long-standing begun construction guidance, reasoning that a taxpayer needs a greater degree of certainty in defining an “energy project” for purposes of the PWA requirements, the domestic content bonus credit, and the energy community bonus credit, than for defining a “single project” for purposes of establishing the beginning of construction. Relatedly, the final regulations remove the requirement in the proposed regulations requiring consistent treatment for begun construction purposes.
Baker Botts Tax Note: A taxpayer may rely on the physical work test or five percent safe harbor (discussed by us here) to establish the beginning of construction of multiple energy properties within a “single project.” The term “single project” is unique to long-standing begun construction guidance and is unrelated to, and likely broader than, the “energy project” concept under Section 48 and the final regulations. Beginning of construction is a concept important for a number of tax purposes, including establishing an energy property’s eligibility for the ITC (i.e., construction must begin on or before December 31, 2024). The “energy project” is relevant only for purposes of determining satisfaction of the PWA requirements and eligibility for the domestic content and energy community bonus credits.
“Unit of Energy Property” for Solar Energy Property
The final regulations adopt the proposed regulations in defining a “unit of energy property” as including all functionally interdependent components of property owned by the taxpayer that are operated together and can operate apart from other energy properties within a larger energy project.
As provided in the preamble to the final regulations, the IRS and Treasury are of the view that a “unit of energy property” for solar energy property is composed of all of the solar panels that are connected to a common inverter, which would be considered an integral part of the energy property, or, if a common inverter does not exist, all those solar panels that are connected to a common electrical load. The final regulations update an example to reflect this view.
Baker Botts Tax Note: “Energy property” is defined by statute to include amounts paid or incurred by the taxpayer for qualified interconnection property in connection with the installation of “energy property” that has a maximum net output of not greater than 5 megawatts (as measured in alternating current) (the “Five-Megawatt Limitation”). Because the Five-Megawatt Limitation applies to the energy property (and not the energy project), the ITC for qualified interconnection property may be available wherever the nameplate capacity of solar panels connected to a common inverter is 5 megawatts or less.
Types of Energy Property
The final regulations provide additional guidance on specific types of energy property, including geothermal heat pump (GHP) property, waste energy recovery property (WERP), hydrogen energy storage property, and qualified biogas property. Hydrogen energy storage property and qualified biogas property are each discussed in additional detail below.
Hydrogen Energy Storage Property
The proposed regulations had specified that qualifying hydrogen energy storage property must store hydrogen that is solely used for the production of energy and not for the production of end products, such as fertilizer, or for transportation, such as in a hydrogen fuel cell vehicle (known as the “end use requirement”). Comments submitted by hydrogen industry members on the end use requirement stressed that such a rule would be extremely difficult to administer since, in most cases, the seller of hydrogen does not know or control the use made of the hydrogen it sells. After consideration of these comments, to the relief of industry members, the IRS and Treasury removed the end use requirement. This means that investment in hydrogen storage equipment will be eligible for the ITC regardless of the use made of the hydrogen once sold. Moreover, the statute does not restrict hydrogen storage equipment eligible for the ITC to equipment that stores hydrogen produced using low-carbon techniques such as green or blue hydrogen. Thus, neither the production method for the stored hydrogen nor the subsequent use that is made of the stored hydrogen affects the availability of the ITC for the hydrogen storage equipment.
The final regulations also provide additional clarity on the definition of hydrogen energy storage property, i.e., the components of storage property the cost of which will be eligible for the ITC. Whereas the proposed regulations stated that hydrogen energy storage property includes, but is not limited to, a hydrogen compressor and associated storage tank and an underground storage facility and associated compressors, the final regulations have expanded the definition to include liquefaction equipment and gathering and distribution lines (pipes) within a hydrogen energy storage property. Clarification that liquefaction equipment is eligible for the credit is especially important to the industry since liquefaction equipment can be a significant cost of a hydrogen facility.
Commenters had also requested clarity as to whether mobile carriers of hydrogen, such as cryogenic tankers, could be considered hydrogen storage property. The IRS and Treasury declined to add such equipment to the definition, citing to the statutory exclusion of property primarily used in the transportation of goods or individuals, and stating that “pipelines, trailers, and railcars are property primarily used in the transportation of goods.”
The proposed regulations did not speak directly to whether property that stores hydrogen carriers, such as ammonia and methanol, qualifies as energy storage property but the preamble to the proposed regulations stated that “the type of storage medium (for example, physical based or material based), is not limited,” perhaps suggesting that storage of property that itself stores hydrogen, such as ammonia or methanol, could qualify as hydrogen energy storage property. However, in the final regulations, the IRS and Treasury declined to designate ammonia, methanol or other hydrogen carriers, or equipment that stores ammonia or methanol as hydrogen storage energy property, noting that Section 48(c)(6)(A)(i) specifically references only hydrogen, not compounds containing hydrogen.
Baker Botts Tax Note: The revisions implemented in the final hydrogen energy storage regulations are a win for the hydrogen industry in that they dropped the end use requirement and added liquefaction equipment to the definition of hydrogen energy storage property. The hydrogen industry is anxiously waiting for the final regulations on the Section 45V clean hydrogen production tax credit, which Treasury has said it will promulgate before the end of 2024. Treasury’s responsiveness to the hydrogen industry’s comments in the final hydrogen energy storage property regulations may be reason for cautious optimism that the final Section 45V regulations will be similarly responsive to industry’s comments on the proposed regulations.
Qualified Biogas Property
The final regulations regarding qualified biogas property contain several important changes from the proposed regulations. First, the proposed regulations had contained examples of “functionally interdependent” components of a qualified biogas property, including, but not limited to, a waste feedstock collection system, a landfill gas collection system, and mixing or pumping equipment. This meant that a single taxpayer had to own, and originally place in service, these components to be eligible for the ITC. Commenters objected that such a requirement was inconsistent with the way that ownership of renewable natural gas projects is typically structured. The final regulations addressed this concern by adopting a function-oriented definition of qualified biogas property, and listing waste feedstock collection systems, landfill gas collection systems, and mixing or pumping equipment instead as property “integral” to qualified biogas property, so that a taxpayer is not denied the credit for failure to own and originally place in service such property.
Second, the final regulations have confirmed that gas upgrading equipment is considered to be cleaning and conditioning equipment that is treated as qualified biogas property. As originally issued, the proposed regulations had not allowed upgrading equipment to be qualifying property. After strident objection from the biogas industry, the proposed regulations were modified but questions remained as to how the issue would be resolved in the final regulations. In the preamble, Treasury acknowledges that upgrading equipment may be necessary to make biogas suitable for sale or use and is therefore eligible for the ITC as qualified biogas property.
The final regulations also provide additional rules on flaring and the point of measurement for qualified biogas property.
Miscellaneous Changes or Clarifications
Below is a list of some additional changes or clarifications in the final regulations:
- Direct Current Nameplate Capacity. The final regulations provide a method of measuring nameplate capacity for an energy property that generates electricity in direct current.
- Retrofitted Energy Property and the 80/20 Rule. The final regulations retain the 80/20 rule from the proposed regulations.
- Ownership of All Components of a Unit of Energy Property. The final regulations retain the rule in the proposed regulations that a taxpayer must directly own at least a fractional interest in the entire unit of energy property (and not just a component of the energy property).
We will continue to monitor the Inflation Reduction Act guidance initiatives from the IRS and Treasury and will provide further updates as guidance is released. In the meantime, Baker Botts would be pleased to assist you in your analysis of the Inflation Reduction Act and other clean energy tax incentive matters.
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