Summary
On December 4, 2024, the U.S. Department of the Treasury (Treasury) and the Internal Revenue Service (IRS) issued final regulations (the Final Regulations) regarding the investment tax credit (ITC) under Section 48 of the Internal Revenue Code of 1986, as amended (the Code) pursuant to changes authorized by the Inflation Reduction Act of 2022 (IRA). The Final Regulations provide updates to proposed regulations published on November 17, 2023, which we previously discussed here, including clarifications to energy project rules, prevailing wage requirements, energy storage property and recapture requirements.
Key Takeaways
The Final Regulations:
- clarify various definitions for energy property that qualify for ITCs, including thermal energy storage property, hydrogen energy storage property, and qualified biogas property;
- provide further guidance around prevailing wage and apprenticeship (PWA) requirements, including needed clarifications for energy properties that may be treated as one project;
- describe applicable tax principles with respect to qualified interconnection property and sale-leaseback or lease transactions; and
- clarify the impact of recapture on ITC amounts with respect to taxpayers and the basis of energy property when ITCs are transferred.
The Final Regulations have an effective date of December 12, 2024.
Energy Property
Thermal Energy Storage Property. The Final Regulations provide multiple clarifications with respect to the definition of thermal energy storage property. First, the Final Regulations exclude equipment that transforms other forms of energy into heat in the first instance as an eligible component of thermal energy storage property (e.g., a conventional gas boiler with an integrated storage tank would not generally be thermal energy storage property). Second, to address taxpayer questions relating to the “subsequent use” of transferred heat with respect to energy storage, the Final Regulations clarify that property that removes heat from, or adds heat to, a storage medium for subsequent use is property that is designed with the particular purpose of substantially altering the time profile of when heat added to or removed from such thermal storage medium can be used for heating or cooling of the interior of a residential or commercial building, and as a result may qualify as thermal energy storage property. Finally, the Final Regulations specify that thermal energy storage property includes a system that heats bricks to high temperatures that later use this stored energy to heat a building through the HVAC system, heat pump systems that store thermal energy in an underground tank, artificial pit, an aqueous solution, or a solid-liquid change material, and air-to-water heat pump systems with a water storage tank. However, if thermal energy storage property includes equipment that also serves a purpose in an HVAC system that is installed in connection with the thermal energy storage property, the taxpayer’s basis in the thermal energy storage property includes the total cost of the thermal energy storage property and HVAC system less the cost of an HVAC system without thermal storage capacity that would meet the same functional heating or cooling needs as the heat pump system with a storage medium, other than time shifting of heating or cooling.
Thermal Energy Storage Property Safe Harbor. The Final Regulations provide that an eligible thermal energy storage property will be deemed to have the purpose of substantially altering the time profile of when heat added to or removed from the thermal storage medium can be used to heat or cool the interior of a residential or commercial building if that thermal energy storage property is capable of storing energy that is sufficient to provide heating or cooling of the interior of such building for a minimum of one hour.
Hydrogen Energy Storage Property. The Final Regulations clarify that eligible hydrogen energy storage property includes above ground storage tanks, underground storage facilities, and compressors. Property that is an integral part of hydrogen energy storage property includes hydrogen liquefaction equipment and gathering and distribution lines within a hydrogen energy storage property.
Qualified Biogas Property. Qualified biogas property also includes any property that is part of such system that cleans or conditions such gas, including gas upgrading equipment to make the gas suitable for sale or productive use. The methane content requirement is measured at the point at which biogas exits the qualified biogas property. Further, while a qualified biogas property may not generally capture biogas for disposal via combustion, combustion in the form of flaring will not disqualify a qualified biogas property provided the primary purpose of the qualified biogas property is sale or productive use of biogas and any flaring is in compliance with law.
PWA Requirements
Transition Waiver of Penalty for PWA Requirements. The Final Regulations specify that for purposes of the transition waiver described under Treasury Regulations Section 1.45-7(c)(6)(iii), the penalty payment to cure a failure to satisfy the PWA requirements is waived with respect to a laborer or mechanic who performed work in the construction, alteration, or repair of an energy project on or after January 29, 2023, and prior to December 12, 2024, if the taxpayer relied on Notice 2022-61 or the proposed regulations to determine when the activities of any laborer or mechanic became subject to the PWA requirements, and such taxpayer makes the correction payments with respect to such laborer and mechanic within 180 days of December 12, 2024.
Yearly Determination of a Recapture Event. The Final Regulations clarify that if no alteration or repair work occurs in a taxable year during the five-year recapture period, the taxpayer is deemed to satisfy the PWA requirements with respect to each such taxable year such that there will be no recapture event.
Energy Project Definition. Final Regulations Section 1.48-13(d) provides a definition of “energy project” as one or more energy properties operated as part of a single project, for the following categories: 1) PWA requirements under Section 48(a)(9); 2) domestic content bonus credit amount under Section 48(a)(12); and 3) energy communities bonus credit amount under Section 48(a)(14).
- Multiple Energy Properties may be treated as one project. Subject to certain conditions, multiple energy properties may be treated as one energy project, if a single taxpayer (including as determined based on being related parties) owns all the properties, and four or more factors are met as set forth under the Final Regulations. These factors are:
- 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 is financed pursuant to the same loan agreement.
While this is less stringent than the test set forth in the proposed regulations, which only required two such factors to be met, it still may result in some unintended consequences and should be reviewed closely.
- Time of Determination and Applicable Placed in Service Date. A taxpayer may make the determination that multiple energy properties are an energy project either a) at any point during the construction of the multiple energy properties, or b) during the taxable year in which the last such energy property is placed in service. This is another welcome change from the proposed regulations, which applied the test if a single taxpayer owned the energy properties, and such factors were present at any time during construction. An energy project is considered placed in service on the date the last of the energy properties within such energy project is placed in service.
- Separate Reporting for Energy Properties Within an Energy Project. Multiple energy properties may be treated as a single energy project for specified purposes; however, this information must be separately reported for each energy property within an energy project on IRS Form 3468, Investment Credit, or any successor form thereto, and such form must be filed with the taxpayer’s timely filed U.S. federal income tax return for the taxable year in which the energy property is placed in service.
Nameplate Capacity for the One-Megawatt Exception. If an energy project is comprised of more than one energy property, the energy project’s maximum net output is calculated as the sum of the nameplate capacity of each energy property.
- Nameplate Capacity for Energy Properties That Generate in Direct Current. The Final Regulations clarify that for energy properties that generate electricity in direct current, the taxpayer may choose to determine the maximum net output (in alternating current) of each energy property that is part of the energy project by using the lesser of:
- the sum of the nameplate generating capacities within the unit of energy property in direct current, which is deemed to be the nameplate generating capacity of the unit of energy property in alternating current; or
- the nameplate capacity of the first component of property that inverts the direct current electricity into alternating current.
- Thermal Energy Storage Property and Other Property Generating or Distributing Thermal Energy. The One-Megawatt exception is determined by using the property’s maximum net output. The maximum net output is the maximum instantaneous rate of discharge and is determined based on the nameplate capacity of the equipment that generates or distributes thermal energy for productive use (including distributing the thermal energy from the storage medium). For purposes of determining the maximum net output of thermal energy storage property, if the nameplate capacity of the thermal energy storage is not available, the nameplate capacity of the equipment delivering thermal energy to the thermal energy storage may be used. Further, the maximum thermal output an entire project is capable of delivering at any given moment does not take into account the capacity of redundant equipment if such equipment is not operated when the system is at maximum output during normal operation. For thermal energy storage property and other energy property that generates or distributes thermal energy for a productive use, the maximum thermal output that the entire system is capable of delivering is considered to be the greater of the rate of cooling or the rate of heating of the aggregate of the nameplate capacity of the equipment distributing energy for productive use, including distributing the thermal energy from the thermal energy storage medium to the building or buildings. If such nameplate capacity is unavailable, in the case of thermal energy storage property only, the maximum thermal output may instead be considered to be the greater of the rate of cooling or the rate of heating of the aggregate of the nameplate capacity of all the equipment delivering energy to the thermal energy storage property in the project.
Qualified Interconnection Property
Qualified Interconnection Costs Included in Certain Lower-Output Energy Properties. If the qualified interconnection costs borne by the taxpayer are reduced by utility or non-utility payments, U.S. federal income tax principles may require the taxpayer to reduce the amounts of costs treated as paid or incurred to determine an ITC.
Qualified Interconnection Property and Sale-Leaseback or Lease Transactions. The Final Regulations specify that for purposes of determining the original use of interconnection property in the context of a sale-leaseback or lease transaction, the principles of Section 50(d)(4) must be taken into account, as applicable, with such original use determined on the date of the sale-leaseback or lease.
Five-Megawatt Limitation. The Final Regulations provide that the maximum net output of an energy property is measured only be nameplate generating capacity (in alternating current) of the unit of energy property, which does not include the nameplate capacity of any integral property, at the time the energy property is placed in service. The nameplate generating capacity of the unit of energy property is measured independently from any other energy properties that share the same integral property.
Recapture Requirements in Connection with ITC Transfers
Impact of Recapture Under Section 48(a)(10)(C). The transferee taxpayer is responsible for any amount of tax increased as a result of a recapture event under Treasury Regulations Section 1.48-13(c)(4), provided that if an eligible taxpayer retains any amount of an eligible credit determined with respect to an energy property directly held by the eligible taxpayer, the amount of such tax increase that the eligible taxpayer is responsible for is equal to the recapture amount multiplied by a fraction, with the numerator being the total credit amount that the eligible taxpayer retained, and the denominator of which is the total credit amount determined for the energy property. The amount of the tax increase that the transferee taxpayer is responsible for is equal to the recapture amount multiplied by a fraction, the numerator of which is the specified credit portion transferred to the transferee taxpayer, and the denominator of which is the total credit amount determined for the energy property.
Recapture on Basis of Energy Property Held by Eligible Taxpayer. The eligible taxpayer must increase the basis of the energy property (as of the first day of the taxable year in which the recapture event occurs) by an amount equal to the recapture amount provided to the eligible taxpayer by the transferee taxpayer pursuant to the notification required by the Final Regulations and the recapture amount on any credit amounts retained by the eligible taxpayer in accordance with Section 48(a)(10)(C) and Treasury Regulations Section 1.48-13(c)(4).
Effective Date
The Final Regulations are effective on December 12, 2024.
Treasury and the IRS further provide applicability dates for Final Regulations Sections 1.48-9(g), 1.48-13(f), 1.48-14(j) and 1.6418-5(j). Taxpayers may choose to apply Final Regulations Sections 1.48-9, 1.48-14 and 1.6418-5 with respect to property that is placed in service after December 31, 2022, and during a taxable year beginning on or before December 12, 2024, provided that taxpayers follow such sections in their entirety and in a consistent manner. Further, Final Regulations Section 1.48-13 applies to energy projects placed in service in taxable years ending after December 12, 2024, and the construction of which begins after December 12, 2024. Taxpayers may choose to apply Final Regulations Section 1.48-13 to energy projects placed in service in taxable years ending on or before December 12, 2024, and energy projects placed in service in taxable years ending after December 12, 2024, the construction of which begins before December 12, 2024, provided that taxpayers apply Final Regulations Section 1.48-13 in its entirety and in a consistent manner.
