IRS Releases Final Energy Property Regulations Under Section 48 Investment Tax Credit
At A Glance
On December 4, 2024, the US Department of the Treasury (“Treasury”) and the Internal Revenue Service (“IRS”) issued final regulations, TD 10015, (the “Final Regulations”), which provide guidance on the definition of energy property and the rules applicable for the energy credit available under Section1 48 (the “ITC”) of the Internal Revenue Code of 1986, as amended (the “Code”). The Final Regulations, published in the Federal Register on December 12, 2024, update and clarify the definitions and rules contained in prior guidance for determining whether energy property is eligible for the ITC, and implement several amendments made by the Inflation Reduction Act of 2022 (the “IRA”).
Of the clarifications made by the Final Regulations, among the most helpful are modifications to the definition of qualified biogas property and the clarification for the rules to determine when multiple units of energy property are considered a single energy project, for purposes of complying with certain prevailing wage and apprenticeship (“PWA”) requirements and qualifying for domestic content and energy community tax credit adders. In addition, the Final Regulations address the recapture rules for failing to meet the PWA requirements.
Background
The ITC is generally equal to a percentage of the basis of each energy property placed in service during the taxable year. The percentage and the eligibility of the energy property depends on the type of energy property and the deadlines for beginning construction or placing the property in service. The IRA added new types of energy property, such as waste heat-to-power property and offshore wind facilities, and provided increased credit amounts (the “Bonus Credits”) for energy projects that meet certain requirements, such as the PWA, domestic content, or energy community requirements. The IRA contained new rules permitting the ITC to be transferred to unrelated taxpayers and for certain taxpayers to claim a cash payment in lieu of a tax credit. The IRA also allowed certain lower-output energy properties to include the cost of qualified interconnection property in their basis for the ITC.
The ITC is available for properties whose construction started on or before December 31, 2024. For properties that start construction after this date, the ITC is replaced with a similar technology-neutral tax credit under Section 48E.
Prior Guidance
Before issuing the Final Regulations, Treasury and the IRS issued proposed Treasury regulations (the “Proposed Regulations”) on various aspects of the ITC, such as the PWA requirements, credit recapture rules, the transfer of credits under Section 6418, and what qualifies as energy property for different technologies and arrangements.2 The Final Regulations address some of more than 350 comments received on the Proposed Regulations, making responsive modifications and clarifications. The Final Regulations also withdraw certain portions of the Proposed Regulations that are no longer relevant or consistent with the final rules.
I. Clarifications Regarding Certain Types of Energy Property
Waste Energy Recovery Property
The Final Regulations maintain the definition of waste energy recovery property (“WERP”) as property generating electricity solely from heat from buildings or equipment (with a capacity not exceeding 50 megawatts) if the primary purpose of such building or equipment is not the generation of electricity. Despite requests from commenters to include specific technologies—such as “pressure reduction” equipment and “carbon dioxide power system technology”—as examples of WERP, the Final Regulations did not adopt these suggestions. Instead, the Final Regulations retain a function-oriented approach, providing non-exhaustive examples of buildings and facilities where WERP may function, such as manufacturing plants, medical care facilities, and facilities on college campuses. The preamble to the Final Regulations explains that this approach aims to encompass nascent technologies without making the regulations quickly obsolete.
Energy Storage Technology
With respect to energy storage technology, Treasury and the IRS alleviated some taxpayer concerns by confirming that energy storage technology is eligible for the ITC if it satisfies the requirements of Section 48, even if it is co-located with or shared by a facility that is otherwise eligible for tax credits under Sections 45, 45V, or 48.
Moreover, in response to numerous taxpayer comments, Treasury and the IRS have agreed to drop the “end use” requirement from hydrogen energy storage property. In other words, in a departure from the Proposed Regulations, the Final Regulations do not adopt the requirement that hydrogen stored in hydrogen energy storage property be used solely for the production of energy, allowing for other applications such as fertilizer production without jeopardizing available ITCs for such energy property. The Final Regulations also clarify that hydrogen liquefaction equipment used in the process of preparing hydrogen for storage in hydrogen energy storage property may be considered an integral part of such energy property.
Generally consistent with the Proposed Regulations, the Final Regulations also confirm that modifications to energy storage property must result in a nameplate capacity increase of at least 5 kWh to qualify for the ITC. The Final Regulations confirm that this increase is measured relative to the nameplate capacity at the time of modification, not based on actual capacity. There are no limitations on the physical space occupied by the modified energy storage technology.
Qualified Biogas Property
The Final Regulations address taxpayer concerns and provide significant changes to clarify the eligibility requirements for qualified biogas property.
Notably, the Final Regulations relax the application of the single-ownership rule requiring that all functionally interdependent components of a property must be owned by the same taxpayer for such property to be energy property. Specifically, the Final Regulations clarify that “waste feedstock collection systems,” “landfill gas collection systems,” and “mixing and pumping equipment” are “integral” property, as opposed to functionally interdependent property, and are therefore not subject to the single ownership rule. This is a welcome clarification, since such collection systems are commonly owned by landfill owners, not by the owners of biomass conversion facilities.
Moreover, the Proposed Regulations drew a distinction between “cleaning and conditioning equipment” and “upgrading equipment” and classified upgrading equipment as an integral part of an energy property. The Final Regulations, consistent with taxpayer recommendations, eliminate the distinction and provide more generally that gas upgrading equipment is cleaning and conditioning property, and therefore can be an energy property independent of any other conversion equipment. This clarification should also be welcomed by the industry as it affords taxpayers greater flexibility in planning around the 80/20 rule described below.
While the Code generally requires a qualified biogas property to capture biogas “for sale or productive use, and not for disposal via combustion,” the Final Regulations permit a de minimis amount of flaring. The preamble provides that, while a qualified biogas property generally may not capture biogas for disposal via combustion, combustion in the form of flaring will not disqualify a qualified biogas property, provided that the primary purpose is sale or productive use of biogas, and that any flaring complies with all relevant federal, state, regional, tribal, and local laws and regulations.
Lastly, the Final Regulations clarify that the minimum 52% methane content statutory requirement is measured at the point at which gas exits the qualified biogas property. In contrast, the Proposed Regulations focused instead on the point at which a taxpayer generally must determine whether it will convert the biogas fuel for sale or use it directly to generate heat or to fuel an electricity generation unit.
In the preamble to the Final Regulations, the IRS acknowledges that the point of measurement described in the Proposed Regulations was too early in the biogas production process, which could potentially frustrate compliance with the “sale or productive use” requirement. Thus, the Final Regulations update the test such that methane content is measured at the point at which the biogas exits the qualified biogas property. In addition, the preamble to the Final Regulations clarifies, through an example, that the methane content upon entry into a biogas property is not relevant in determining whether the property qualifies as a qualified biogas property.
II. Rules Relating to the Increased Credit Amount for Satisfying Certain Prevailing Wage and Apprenticeship Requirements and the Energy Project Rule
The Final Regulations provide guidance on the PWA requirements, the definition of energy projects, exceptions for projects under one megawatt, and the rules for recapture and reporting. As background, under the Code, bonus ITC amounts are available for projects that satisfy “domestic content” or “energy community” requirements.3 Taxpayers must satisfy the PWA requirements to be eligible for the full base ITC and Bonus Credits.4 For this purpose, qualification for Bonus Credits is tested at the level of an “energy project.”
A. Definition of Energy Project
An energy project is defined as property that qualifies for the energy credit based on its components, functionality, and compliance with statutory requirements. Components include equipment such as storage devices, power conditioning units, and transfer equipment integral to generating or utilizing energy. A unit of energy property is defined as all interdependent components operated together. This means, for example, that multiple solar panels connected to a single inverter (a device used to convert electricity) are considered part of a single unit of energy property. Multiple properties operated as part of a single project are treated as one energy project for purposes of applying Bonus Credits. The 80/20 rule allows a taxpayer to treat an energy property as originally placed in service even though it contains some used components. Specifically, the fair market value of the used components must not exceed 20% of the total value of the energy property. This rule is applied to each unit of energy property within an energy project.
In this regard, the Final Regulations revise the definition of energy project from the Proposed Regulations, which would have required taxpayers to treat multiple energy properties owned by a taxpayer (including certain related parties) as one energy project if they satisfy at least two of the following factors: (i) contiguity of land; (ii) common off-take agreement; (iii) common intertie; (iv) common substation or thermal energy off-take point; (v) common permits; (vi) common construction contract; or (vii) common loan agreement. The Final Regulations now require that four or more of these factors be present, and that the factors may be assessed—at the taxpayer’s choice—either at any point during construction, or during the taxable year the energy properties are placed in service. This is generally considered to be taxpayer-favorable, in that it will result in fewer energy properties being aggregated into a single “energy project” for purposes of applying Bonus Credits. Commentators had been concerned that, under the rules provided in the Proposed Regulations, properties would be aggregated in illogical ways that would inappropriately prevent taxpayers from qualifying for certain Bonus Credits.
The Final Regulations also clarify that an energy project is deemed placed in service when the final energy property within the energy project is placed in service. The Final Regulations do not adopt the comments that requested a facts-and-circumstances approach or that limited the definition of energy project to energy properties of the same type. The Final Regulations also do not adopt the rule in the Proposed Regulations that would have required consistent treatment as an energy project for beginning of construction purposes and for purposes of applying Bonus Credits.
B. Prevailing Wage and Apprenticeship Requirements – Transition Rule
The PWA requirements generally apply to the construction, alteration, or repair of an energy project, unless the project qualifies for an exception. In addition, the prevailing wage requirements (but not the apprenticeship requirements) continue to apply during the five-year period beginning on the date the project is placed in service during which taxpayers must document compliance with such requirements. Annual compliance reporting is mandatory, detailing payments made to workers and adherence to standards.
The Final Regulations adopt the position in the Proposed Regulations, providing a transition rule that exempts any work performed before January 29, 2023 (that is, the date that is 60 days after the publication of Notice 2022-61), from the PWA requirements, regardless of whether there is an applicable beginning-of-construction exception. The Final Regulations also provide a limited transition waiver for the penalty payment for a failure to satisfy the prevailing wage requirements for work performed between January 29, 2023 and June 25, 2024, if the taxpayer relied on Notice 2022-61 or the Proposed Regulations and makes the appropriate correction payments within 180 days of the publication of the Final Regulations. Taxpayers are permitted to use Notice 2022-61 for determining when construction begins for purposes of the labor hours requirement for the apprenticeship requirements.
C. Recapture Rules
If a taxpayer fails to meet the PWA requirements but identifies the issue during the five-year recapture period, the taxpayer can correct it by making required wage adjustments (i.e., paying back wages to affected workers) and penalties (i.e., paying a penalty equal to three times the wage shortfall per worker). Failing to rectify violations can lead to a recapture of increased credits. The Final Regulations clarify how these recapture rules apply to the increased credit amount for energy projects that do not satisfy the PWA requirements for the five-year period but do not cease to be investment credit property. In the event that a taxpayer transfers ITCs pursuant to Section 6418, the Final Regulations provide that if there is a recapture of the ITC due to a failure to meet the PWA requirements, the loss of credit is shared proportionally between the transferor and the transferee, based on the amount of credit actually claimed by the transferor and the transferee, and do not adopt the rule in the Proposed Regulations that would have caused the transferee to fully bear the recapture.
III. Rules Applicable to Energy Property
A. Retrofitted Energy Property (80/20 Rule)
The Final Regulations retain the 80/20 Rule for retrofitted energy property, which allows a taxpayer to treat an energy property as originally placed in service even though it contains some used components, as long as the fair market value of the used components is not more than 20% of the total value of the energy property. The Final Regulations also provide that the 80/20 Rule is applied to each unit of energy property within an energy project. All capital improvements and expenditures related to new components of the energy property are eligible for the ITC, as long as they satisfy the 80/20 Rule. Comments that suggested dropping or modifying the 80/20 Rule were not adopted in the Final Regulations, as the IRS believes that the rule is consistent with the statutory requirement of original use and provides flexibility and certainty for taxpayers.
B. Dual Use Rule
The Final Regulations slightly modify the rule for energy property that uses energy derived from both qualifying and non-qualifying sources (the “Dual Use Rule”). The Final Regulations provide that dual use property will qualify as energy property if its use of energy from non-qualifying sources does not exceed 50% of its total energy input during an annual measuring period. If the energy used from qualifying sources is between 50% and 100%, only a proportionate amount of the basis of the energy property will be eligible for the ITC. The Final Regulations also provide that the Dual Use Rule does not apply to energy storage technology placed in service after December 31, 2022, as such technology is added as a separate category of energy property by the IRA.
C. Ownership Rules
The Final Regulations affirm the rule that a taxpayer must directly own at least a fractional interest in the entire unit of energy property to claim the ITC, and that no ITC may be claimed for ownership of one or more separate components of an energy property that do not constitute a unit of energy property. The Final Regulations also provide that related taxpayers are treated as one taxpayer for purposes of the ITC, and confirmed that the use of property owned by one taxpayer that is an integral part of an energy property owned by another taxpayer will not prevent the ITC from being claimed by the second taxpayer. The comments that argued for allowing separate ownership of components of energy property are not adopted in the Final Regulations, as the IRS believes that the statutory language and administrability concerns support the requirement of ownership of an entire energy property or energy project.
D. Lower-Output Energy Property and Qualified Interconnection Costs
The Final Regulations provide rules for the inclusion of qualified interconnection costs in the basis of energy property that has a maximum net output no greater than five megawatts (as measured in alternating current). Qualified interconnection costs are amounts paid or incurred by the taxpayer for qualified interconnection property, which is any tangible property that is part of an addition, modification, or upgrade to a transmission or distribution system that is required at or beyond the point at which the energy project interconnects to such system in order to accommodate such interconnection, the original use of which commences with a utility. The Final Regulations make several changes and clarifications from the Proposed Regulations regarding what constitute qualified interconnection costs.
The Final Regulations clarify that qualified interconnection property is not subject to the PWA requirements. However, qualified interconnection costs are eligible for the increased credit amount for energy projects that satisfy the PWA requirements, as well as for the domestic content bonus credit and the increased credit amount for energy projects located in an energy community, to the extent included in the basis of the energy property.
The Final Regulations clarify that qualified interconnection property is not subject to the PWA requirements. However, qualified interconnection costs are eligible for applicable Bonus Credits for energy projects that satisfy the PWA, domestic content, or energy community requirements, to the extent included in the basis of the energy property.
The Final Regulations retain the rule that the five-megawatt limitation is measured at the level of the energy property, not the energy project, and that multiple energy properties, each with a nameplate capacity of less than five megawatts, could utilize common interconnection agreements. However, the Final Regulations provide a method of measuring nameplate capacity for an energy property that generates electricity in direct current, such as solar panels. The taxpayer may choose to determine the maximum net output of the energy property (in alternating current) by using the lesser of: (i) the sum of the nameplate generating capacities within the unit of energy property in direct current, which is deemed the nameplate generating capacity of the unit of energy property in alternating current; or (ii) the nameplate capacity of the first component of property that inverts the direct current electricity generated into alternating current. This rule provides flexibility and accuracy for taxpayers while ensuring compliance with the statutory requirement of measuring the output in alternating current.
Applicability Dates
The Final Regulations have different applicability dates depending on the type of rules involved. The following is a summary of the applicability dates section of the Final Regulations.
The rules defining the types of energy property eligible for the Section 48 credit and the rules for determining the basis and the placed in service date of such property apply to property placed in service during a taxable year beginning after December 12, 2024. However, taxpayers may choose to apply these rules to property placed in service after December 31, 2022, and during a taxable year beginning on or before the date of publication, provided they apply the rules in their entirety and in a consistent manner.
The rules defining the term “energy project,” and the rules for the increased credit amount for satisfying the PWA requirements, apply to energy projects placed in service in taxable years ending after December 12, 2024, and the construction of which begins after this date. However, taxpayers may choose to apply these rules 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 this date, the construction of which begins before December 12, 2024, provided they apply the rules in their entirety and in a consistent manner.
The special rules applicable to the transfer of credits under Section 6418 apply to taxable years ending on or after April 30, 2024. However, taxpayers may choose to apply these rules to taxable years ending before April 30, 2024, provided they apply the rules in their entirety and in a consistent manner. The rules for the notification and impact of recapture for failure to comply with the PWA requirements apply to taxable years ending on or after the date of publication of the Final Regulations in the Federal Register.
1 References to “Section” refer to sections of the Code unless otherwise specified.
3 See our prior Legal Updates addressing domestic content requirements, “US Treasury to Propose Regulations on Domestic Content Bonus Credit,” and energy community requirements, “US Treasury to Propose Regulations on Energy Community Bonus Credit.”
4 See our prior Legal Update addressing PWA requirements, “Final Regulations Issued on Prevailing Wage and Apprenticeship Requirements under the Inflation Reduction Act.”
