Energy Tax Law Alert: IRS Updates "Beginning of Construction" Guidance

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The IRS has issued highly anticipated guidance updating the “beginning of construction” requirement for the production tax credit (PTC) under Section 45 of the Internal Revenue Code (the Code) and the investment tax credit (ITC) under Section 48 of the Code. Notice 2016-31 updates the IRS’s prior guidance to reflect the extension of the PTC and ITC that was enacted at the end of 2015, and also addresses a number of other issues taxpayers may encounter when determining whether they qualify for the PTC or ITC.

Notice 2016-31 addresses certain issues raised by the extension of the PTC and ITC that was enacted as part of the Protecting Americans from Tax Hikes Act of 2015 (the “PATH Act”). As we noted in our December 16, 2015, update, the legislation extended the availability of the PTC or ITC for wind facilities with respect to which construction begins before January 1, 2020, subject to a 20%-per-year reduction in the credit amount for facilities for which construction begins after December 31, 2016 (i.e., a 20% reduction for a facility the construction of which begins in 2017, a 40% reduction for a facility the construction of which begins in 2018, and a 60% reduction for a facility the construction of which begins in 2019). In the case of geothermal, landfill gas, trash, marine, and hydrokinetic facilities and certain closed-loop biomass, open-loop biomass, and qualified hydropower facilities, a taxpayer is eligible to claim the PTC or ITC if construction begins before January 1, 2017, with no phase-out.

In the case of solar facilities, the PATH Act extended the ITC for facilities beginning construction before January 1, 2022, providing a 30% credit for facilities beginning construction before 2020, a 26% credit for facilities beginning construction during 2020, and a 22% credit for facilities beginning construction during 2021. Notice 2016-31 indicates the Treasury Department and IRS will issue separate guidance to address the extension of the ITC for solar energy facilities.

Extension of Continuous Construction Test and Continuous Efforts Test

The IRS’s prior guidance provides that a taxpayer may begin construction by either (1) starting physical work of a significant nature (the “physical work test”) or (2) paying or incurring five percent or more of the total cost of facility (the “5% safe harbor”). Once construction begins, a taxpayer must maintain a continuous program of construction or make continuous efforts toward construction until the facility is placed in service. This requirement is commonly referred to as the “continuous construction” test in the case of projects satisfying the physical work test and as the “continuous efforts” test in the case of projects satisfying the 5% safe harbor (referred to collectively as the “Continuity Requirement” in Notice 2016-31).

In the prior guidance the IRS established a safe harbor (referred to as the “Continuity Safe Harbor” in Notice 2016-31) under which the Continuity Requirement would be deemed satisfied with respect to a project if the project were placed in service by a specified date. The new IRS notice extends that date, providing generally that if a taxpayer places a facility in service during a calendar year that is no more than four calendar years after the calendar year during which construction began, the facility will be considered to satisfy the Continuity Safe Harbor. Thus, as an example in Notice 2016-31 indicates, if construction begins on a facility on January 15, 2016, and the facility is placed in service by December 31, 2020, the facility will be considered to satisfy the Continuity Safe Harbor.

Related Issues and Additional Examples

The new IRS notice also addresses the following issues:

  • A taxpayer may not rely on the physical work test and the 5% safe harbor in alternating calendar years to satisfy the beginning of construction requirement or the Continuity Requirement. As an example, Notice 2016-31 provides that if a taxpayer performs physical work of a significant nature on a facility in 2015, and then pays or incurs 5% or more of the total cost of the facility in 2016, the Continuity Safe Harbor will be applied beginning in 2015, not in 2016.
  • The list of construction disruptions in Notice 2013-29 that will not be considered as indicating that a taxpayer failed to satisfy the Continuity Requirement is expanded to include the following new examples:
    • delays in obtaining permits or licenses from federal, state, local, or Indian tribal governments, including, but not limited to, delays in obtaining permits or licenses from the FERC, the EPA, the BLM, and the FAA;
    • interconnection-related delays, such as those relating to the completion of construction on a new transmission line or necessary transmission upgrades to resolve grid congestion issues that may be associated with a project’s planned interconnection;
    • delays in the manufacture of custom components; and
    • financing delays (now of an unspecified period—the phrase “of less than six months,” which was included in prior guidance, is not included in the new guidance).
  • Expanding on the types of activities that do and do not satisfy the physical work test, Notice 2016-31 includes the following examples:
    • Activities that satisfy the physical work test:n
      • for hydropower facilities, excavation for or construction of a penstock, power house, or retaining wall structure;
      • for biomass and trash facilities, site improvements (as opposed to site clearing) such as filling or compacting soil or installing stack piling; and
      • for geothermal facilities, physical activities that are undertaken at a project site after a valid discovery.
    • Preliminary activities that are not physical work of a significant nature:
      • conducting geologic mapping and modeling;
      • conducting surveys (now specifically including geophysical, gravity, magnetic, seismic and resistivity surveys);
      • performing activities to develop a geothermal deposit prior to valid discovery; and
      • removing existing turbines and towers, solar panels, or any components that will no longer be part of the facility.
  • The time at which the determination of whether multiple facilities are operated as part of a single project, and therefore are treated as a single facility for beginning of construction purposes, is in the calendar year during which the last of such facilities is placed in service.
  • Multiple facilities operated as part of a single project and treated as a single facility may be disaggregated and treated as multiple separate facilities for purposes of determining whether a particular facility satisfies the Continuity Safe Harbor, with any facilities that do not satisfy the safe harbor tested under a facts and circumstances test as to whether they satisfy the Continuity Requirement.
  • A “retrofitted” facility may qualify as originally placed in service for purposes of the PTC or ITC, even though it contains some used property, if the fair market value of the used property is not more than 20% of the facility’s total value (i.e., the cost of the new property plus the value of the used property) (referred to as the “80/20 Rule” in Notice 2016-31). The notice makes clear that only the cost of new property is taken into account in determining whether the 80/20 test is satisfied.
For summaries of past relevant changes in the law, see our alerts and updates from:

If you have questions about the new guidance, the PTC, the ITC, or related matters, please contact one of the key contributors.

Key Contributors

Kevin T. Pearson
Adam D. Schurle
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