On June 22, 2018, the Internal Revenue Service (the "IRS") issued Notice 2018-59, which provides long-awaited guidance on when construction of energy property will have begun for purposes of the Investment Tax Credit ("ITC") under section 48 of the Internal Revenue Code (the "Code").
The guidance is similar in many respects to the beginning of construction guidance issued for wind facilities and other facilities that are eligible for the PTC under section 45 of the Code or the ITC in lieu of the PTC (the "Prior Guidance"). Although the rules in Notice 2018-59 should be familiar to those who have worked with the Prior Guidance, this client alert covers the applicable rules in detail. Furthermore, this client alert will focus on solar PV projects, though Notice 2018-59 also applies to solar hot water, fiber-optic solar, geothermal, fuel cell, qualified microturbine, CHP, small wind, and geothermal heat pump property.
At the end of this client alert, we provide a brief overview of the strategies for beginning construction on solar projects that we expect to be widely used.
The applicable percentage for the ITC for a solar project depends on when construction on the property begins and when the project is placed in service. The percentage is 30% if construction begins before 2020, 26% if construction begins in 2020, and 22% if construction begins in 2021, in each case, as long as the property is placed in service before 2024. If construction begins after 2021, or if the property is placed in service after 2023, the percentage is 10%. Notice 2018-59 includes a useful chart covering the applicable dates for solar and other relevant projects.
Two Methods for Beginning Construction
Notice 2018-59 provides two methods by which a taxpayer can satisfy the beginning of construction requirement: (i) starting physical work of a significant nature (the "Physical Work Test") or (ii) incurring 5% or more of the costs of the facility (the "5% Safe Harbor"). Both methods require that a taxpayer make continuous progress toward completion once construction has begun (the "Continuity Requirement").
Although a taxpayer may satisfy both methods of establishing the beginning of construction, construction will be deemed to have begun on the date the taxpayer first satisfies one of the two methods. Notice 2018-59 provides that this rule applies "to energy property the construction of which begins, as determined under the earlier of either the Physical Work Test or the 5% Safe Harbor, after December 31, 2018." Unfortunately, the effective date rule is inconsistent with an example in Notice 2018-59, which applies the alternate method rule to a taxpayer that satisfies the Physical Work Test in 2018 and the 5% Safe Harbor in 2019. Accordingly, it appears that either the effective date rule or the example is incorrect.
Physical Work Test
The Physical Work Test requires that a taxpayer begin physical work of a significant nature.
No Fixed Minimum. Note that the test requires that the taxpayer "begin" (as opposed to complete or make substantial progress toward the completion of) physical work of a significant nature. As Notice 2018-59 states, (i) the Physical Work Test focuses on the nature of the work performed, not the amount or the cost and (ii) assuming that physical work performed is of a significant nature, there is no fixed minimum amount of work or monetary or percentage threshold required to satisfy the Physical Work Test. This is consistent with the Prior Guidance and with public statements from IRS and Treasury officials with respect to the wind guidance. Work Under Binding Written Contract. Work performed by the taxpayer and work performed for the taxpayer by other persons under a binding written contract that is entered into before the manufacture, construction, or production of the property is taken into account to determine whether construction has begun. On-Site and Off-Site Work. Both off-site and on-site work may be taken into account. Generally, off-site physical work of a significant nature may include the manufacture of components, mounting equipment, support structures such as racks and rails, inverters, and transformers and other power conditioning equipment. If a manufacturer produces components of property for multiple energy properties, a reasonable method must be used...