ASSURING 2024 QUALIFICATION FOR IRA ENERGY ITC & PTC PROJECTS
BEGINNING OF CONSTRUCTION
John Kapral JD, CPA, LLM
Approaching the end of 2024, you or your clients may have questions about energy, storage, or greenhouse gas mitigation projects that have commenced in 2024 but will be completed next year. The significance of this question is mainly for determining which IRA rules a project can qualify under, i.e., the pre-2025 Sections 45 PTC and 48 ITC rules or the post-2024 Sections 45Y PTC and 48E ITC rules. There are several important reasons for wanting to make the correct determination. First, the focus starting in 2025 will shift to producing clean electricity and property that generates clean (net zero emissions) energy on a technology-neutral basis. Consequently, some covered projects expire at the year-end of 2024, including those for electrochromic glass and the ITC for combined heat and power systems. In addition, given the expected post-election changes in energy policy starting in January 2025, there is uncertainty as to how the new rules are to be applied and even whether and to what extent these post-2024 rules will be modified or repealed.
To start the analysis, a body of administrative rulings and notices can be summed up in two tests to determine the “Beginning of Construction.” Assessing the Beginning of Construction for energy property is a fairly detailed factual process beyond just having a signed agreement, and so here are some guidelines from the referenced IRS publications.
The two ways to secure a 2024 Beginning of Construction qualification include meeting the “Physical Work Test,” which requires the work performed to relate directly to the energy property and not collateral or tangential construction work. This is a subjective test and so many taxpayers prefer opting for the alternative “5 Percent of Construction Test” because it is more definable. For this reason, the 5 Percent of Construction Test is considered a safe harbor. As with the Physical Work Test, it is the nature of the work performed that is directly related to the energy property that is considered when determining the amount of spend incurred as of 12/31/2024. This is the numerator of the test. The denominator is the total cost of the energy property used to determine whether the 5% test is met.
General Requirements of the “Beginning of Construction” Tests:
- Construction and costs must relate to the energy property
- Multiple energy properties that are operated as part of a single project are treated as a single energy
Property. - Energy property must be initially placed in service by the taxpayer. However, up to 20
percent of the capitalized cost of qualifying energy property may consist of used components (the 80/20 rule). - Transfers of energy property
- Excused Disruptions in a taxpayer’s continuous construction or continuous efforts tests
beyond the taxpayer’s control do not prevent a taxpayer from satisfying the Continuity Requirement. - Four-Year Test. The Continuity Test is deemed satisfied if the taxpayer places the energy property in service by the end of a calendar year that is no more than four calendar years after the calendar year during which construction began.
Physical Work Test:
- Continuity of Construction Test requires taxpayers to pursue a continuous program of construction
that involves continuing physical work of a significant nature. - Focuses on the nature of the work performed, not the amount of work or the cost.
- The test does not require the taxpayer to perform a fixed minimum amount of work or meet a monetary or percentage threshold.
- The physical work must relate to tangible property used as an integral part of the activity performed by the energy property.
- Integral items include transmission towers and other properties used to transmit electricity.
- Takes into account both on-site and off-site work that other persons perform for the taxpayer under a binding written contract (including a master contract) that is entered into prior to the manufacture, construction, or production of the energy property or components of energy property.
- Off-site physical work of a significant nature may include the manufacture of components, mounting equipment, support structures like racks and rails, inverters, and transformers (used in electrical generation that step up the voltage to less than 69 kilovolts), and other power conditioning equipment.
- The test does not take into account:
- preliminary activities, such as exploring, researching, planning, and designing; obtaining financing, permits, and licenses;
- mapping and modeling to access a resource;
- conducting geophysical, gravity, magnetic, seismic, and resistivity surveys or environmental and engineering studies;
- Clearing a site or excavating to change its contours (as opposed to excavating for a foundation) and removing existing properties and components that will not be part of the qualified energy property.
Five Percent Safe Harbor Test:
- Continuity of Activity Test requires taxpayers to make continuous efforts to advance towards completion of an energy property, such as paying or incurring additional amounts included in the total cost of the energy property, entering into binding written contracts for energy property components, obtaining necessary permits, and performing physical work of a significant nature.
- Construction of energy property begins when a taxpayer pays or incurs five percent of the total cost of the energy property.
- All costs properly included in the energy property’s depreciable basis are considered to determine whether the five-percent threshold is satisfied. However, as in the Physical Work Test the total cost of the energy property does not include the cost of land or any property that is not integral to the energy property.
If you or your clients have any questions about these “Beginning of Construction Tests,’ or alternatives for this year or next for your energy projects, we would be pleased to have one of our energy credits experts discuss them with you.
