July 10, 2024 | By Dorian Hunt, Head of Renewables

The Inflation Reduction Act (“IRA”) in 2022 introduced new Code Sections 48E and 45Y which provide for a largely technology agnostic approach to available federal tax credits, signaling a departure from the current regime which blesses certain specific technologies, such as wind and solar, as being credit eligible (don’t panic, wind and solar are still credit eligible, more below). These new incentives are generally available beginning in 2025. On June 3, 2024 the Treasury issued proposed regulations for Sections 48E and 45Y. For once, industry stakeholders have a relatively good bit of lead time to contemplate the forthcoming rules and plan accordingly. 

48E provides the framework for the new investment tax credit (“ITC”). 48E describes ITCs available for 3 major categories of projects 1) combustion and gasification (“C&G”) facilities 2) non-C&G facilities and 3) energy storage technologies. In this newsletter, I am going to focus on non-C&G facilities and will dive into the other two categories at a later date.  

Nothing of Him Doth Fade, But Suffer a Sea Change into Something Rich and Strange 

The big change in Section 48E hinges around the idea that a facility can be ITC-eligible provided that it is able to generate electricity and not produce greenhouse gas emissions in doing so. The statute itself departed from an explicit list of eligible technologies as the drafters apparently conceded that there are more things in heaven and earth than are dreamt of in [their] philosophy. The statute instead hinges on function (i.e. the generation of electricity) from any qualified facility. ITC stakeholders never spent much time thinking about the definition of a qualified facility unless they had made an election under Section 48(a)(5) to treat a Section 45 production tax credit (“PTC”) facility as ITC eligible. However, under the Section 48E regime, the definition becomes foundational. 

48E defines a qualified facility as that which a) is used for the generation of electricity b) is in service after 2024 and c) has an anticipated greenhouse gas emissions rate that is not greater than zero. As ITCs are based on cost, we must consider the definition of qualified property within a qualified facility. The definition of “qualified property” in Section 48E(b)(3) has parallels to the definition of “energy property” described in Section 48(a)(3). You’ll notice that those requirements don’t explicitly mention renewable energy or any particular variants thereof. However, in all cases with Section 48E, the lifecycle greenhouse gas emissions in connection qualified facilities must conform to certain standards. At long last, Section 48E fulfills the promise of broad performance and quality standards mentioned in Section 48(a)(3)(D). So, how do we cope as the ground moves beneath our feet? Do we just sit back and hope for the best? No! It is not in the stars to hold our destiny, but in ourselves. 

That Which is, Hath Been Before 

Section 48(a)(1) tells us that ITCs are calculated on the basis of energy property and Section 48(a)(3) tells us that energy property is equipment. Example 5 in Treas. Reg. Section 1.48-2(b)(7) supports this premise by describing a situation where a taxpayer buys a used project, makes additional capital expenditures, and claims an ITC on those additional capital expenditures. The Section 48 statute does not contain mentions of 1) units of energy property 2) functional interdependence 3) integral parts or 4) qualified facilities.  These terms first appeared in the ITC proposed regulations that were released in late 2023 (see my article on the “2023 ITC Proposed Regulations”. Many thoughtful readers voiced concerns with the premise introduced in those 2023 ITC Proposed Regulations (and maybe as far back as section 7.05 of IRS Notice 2018-59) that only through passage of the so-called 80/20 test (see Revenue Ruling 94-31 for a helpful example of this test in the context of a wind energy facility) could one claim ITCs on incremental capital expenditures applied to an existing ITC-eligible project. This is at odds with the language of the Section 48 statute itself which, again, says that energy property is eligible equipment. When the Bard said “what’s done cannot be undone”, I bet he was talking about Treasury Regulations contradicting statutes.   

Those 2023 ITC Proposed Regulations have not yet been finalized but Section 48E further cements the relevance of a qualified facility in the ITC context. So, let’s say we have a qualified facility that was previously placed into service and we incur additional capital expenditures in connection with that facility. How do we think about the amount of ITC that might be available? Well, the proposed regulations for 48E describe 3 possible scenarios: 1) a new unit of qualified facility 2) additions to the nameplate capacity of an existing unit of qualified facility or 3) a retrofit that must fulfill the requirements of the 80/20 test. The proposed regulations contain a number of examples demonstrating when each of these might apply and they should be read carefully because they suggest a departure from common ITC practice.  

Let’s break each of these down. For #1, a unit of qualified facility is defined in proposed regulation 1.48E-2(b)(2) as “all functionally interdependent components of property … owned by the taxpayer that are operated together and that can operate apart from other property to produce electricity”. This meaning will take different forms depending on the type of facility we are dealing with (e.g. solar, wind). In the context of wind, Revenue Ruling 94-31 tells us a pad, pole and turbine operating together to produce electricity is a qualified facility. In the context of a solar facility, it’s been a topic of discussion as to what constitutes a qualified facility since the IRA brought back the PTC for solar in Section 45(c)(1)(E). Is a solar facility a string of panels and an inverter? Is it a block of strings? Is it a collection of blocks? Is it a collection of blocks and a generating step-up transformer? Proposed regulation 1.48E-3(a)(7) when read in conjunction with proposed regulation 1.48E-2(b)(2) implies that a solar qualified facility is a string of panels and an inverter (this is relevant here but also in the discussion of qualified interconnection costs below). Therefore, a sensible read may say that the addition of a string of panels and an inverter is a unit of qualified facility and therefore the basis of such might generate an ITC under Section 48E when it is placed into service. How does this differ from #2 (the addition of capacity to an existing unit of qualified facility)? 

The addition of capacity scenario in #2 is reminiscent of the capacity additions commonly used in the context of hydropower installations in Section 45(c)(8)(A)(i) and Section 45Q(b)(2) in the context of the installation of additional carbon capture equipment. Proposed regulation 1.48E(b)(3)(ii) provides that we have additional capacity installations when we replace, in whole or in part, components of property (including integral property like a substation) that increases the nameplate capacity of a qualified facility. Generally (there is a special rule for projects that have been decommissioned and then placed back into service), the amount of ITC eligible basis we might calculate when placing those capacity additions in service is the cost of such additions (the “qualified investment”) multiplied by a ratio the numerator of which is the incremental generating capacity (e.g. new megawatts) and the denominator of which is the total generating capacity after the additions. As an example, say you replace some panels at a solar qualified facility and it brings the nameplate capacity of that solar qualified facility from 2 MW to 3 MW at a cost of $1 million. Assuming all those costs are a qualified investment, the amount of ITC-eligible basis would be equal to $333,333 = $1 million * ((2 MW – 3 MW)/3 MW). The additional capacity will be treated as a new qualified facility.  

Scenario #3 is concerned with retrofits and passing the 80/20 test. Assume the same facts outlined in scenario #2 and further assume that the value of the retained components is $234,000. In that case, the $1 million of new spend would pass the 80/20 because 81% = $1 million/($1 million + $234,000). How does this differ from scenario #2? Well, if you pass the 80/20 and $1 million is all qualified investment, the ITC-eligible basis is $1 million instead of $333,000.  

Praising What Is Lost Makes the Remembrance Dear 

It’s also important to note that as we transition to Section 48E, we lose incentives for some technologies such as qualified biogas that were incorporated into Section 48 as part of the IRA. Again, 48E only allows for ITCs on qualified facilities (which, among other things, must produce electricity) and energy storage technology. A qualified biogas facility that produces electricity may qualify under some circumstances but the requirements are more limited than the relatively broad “productive use” requirement for qualified biogas under Section 48(c)(7)(A)(ii). While we’re on the topic of biogas I also want to point out that the additionality concerns of Section 45V (see my commentary on green hydrogen) are alive and well in the proposed regulations. That is, proposed regulations suggest that if you burn renewable natural gas (“RNG”) that was otherwise destined for a productive use, burning that RNG would result in deemed emissions equal to that of traditional natural gas. To put it another way, the proposed regulations discourage diversion of resources and instead insist on the creation of new resources. Having said that, the Treasury has asked for help across 13 questions in the proposed regulations to help put together a framework that is sensitive to commercial considerations. As the comment period persists, hopefully we’ll receive more clarity on where these particular rules might end up.  

Whenever we talk about ITCs, we should be thinking about recapture of ITCs. There are a few different things that can cause recapture under Section 50 such as ownership transfers, tax exempt use, or a project ceasing to be energy property (after 20 years of doing this I am not sure what that means). Under 48E, we now have performance standards that can trigger recapture. If at any point during the 5 year post placed in service recapture period a 48E qualified facility has a greenhouse gas emissions rate that exceeds 10 grams of CO2e for every kWh, that would trigger recapture. Generally, the proposed regulations provide that a taxpayer must provide sufficient documentation to substantiate the CO2e produced in connection with each kWh. However, some technologies that do not produce electricity through C&G have been whitelisted as being deemed to satisfy this requirement: 1) wind 2) hydropower, 3) marine and hydrokinetic 4) solar 5) geothermal (again, only electricity-generating) 6) nuclear fission 7) nuclear fusion (!) and 8) certain waste energy recovery property. If your technology is not on this list, be prepared to do some work to substantiate the CO2e per kWh. 

All’s Well That Ends Well . . . 

. . . as long as our unit of qualified facility has a nameplate capacity below 5 MW. 48E and the accompanying proposed regulations continue the opportunity for taxpayer costs of interconnection property to, in some cases, be ITC-eligible. The proposed regulations attempt to clarify how to navigate this opportunity that reiterate much of what was already communicated in the Section 48 ITC proposed regulations. Crucial to the determination of this threshold is the unit of qualified facility to which the threshold applies. Engineering considerations may drive a tax planning opportunity to maximize the amount ITC-eligible interconnection costs. 

Interconnection property is often shared among qualified facilities. The proposed regulations provide numerous examples discussing how to think about the availability of ITCs in cases where some assets are shared between multiple qualified facilities. Effectively what it boils down to is that (and this is in line with the 2023 ITC Proposed Regulations) if you own a qualified facility and a portion (or all) of the property that is deemed integral to the operation of the qualified facility, you can claim ITC on the cost the qualified facility and its integral property. However, if you only own a portion (or all) of the integral property and none of the qualified facility itself, then there is no opportunity to claim an ITC on that integral property alone (see my article on the ITC proposed regulations). 

Odd Old Ends 

We have often had to deal with the gradual reduction of available incentives for renewable energy technologies or “phase outs” as they’re called. In the past, phase out schedules were largely static in that the specific milestones based on cardinal calendar years. However, under 48E we have rolling phase outs that are partially dynamic in that they begin on the later of 2032 or when the nation’s greenhouse gas emissions from the production of electricity is equal to or less than 25% of what that corresponding figure was in 2022. So, nothing is going to begin to phase out under 2032 at the earliest. However, after that point, project stakeholders need to be on their toes to understand and anticipate when the collection of available incentives might be diminished. Whether a phase out applies is a function of when a qualified facility starts construction, so keep your definitions of the 5% safe harbor and physical work of a significant nature handy.  

Can you have a phase out without having a phase in? I think you can, but I’d personally be disturbed by the lack of symmetry. The phase in here is with respect to domestic content and direct payments under Section 6417. Section 48E(g)(12) carries on the proud tradition first established by Section 48(a)(13) that limits the amount of direct pay a qualified facility might enjoy if it does not fulfill the requirements for “domestic content” (here’s a link to my other article on that topic) 

48E(d)(1) provides that 48E credits can be generated against qualified progress expenditures as described in Treas. Reg. § 1.46-5, however, as provided in Section 6418(g)(4), credits from progress expenditures are not eligible to be sold under Section 6418. So, when considering the possibility of potentially accelerating the receipt of 48E credits by taking advantage of the inherited qualified progress expenditure option, consider how this might limit your monetization options. 

Brevity is the Soul of Wit 

If you have a project whose construction begins before January 1, 2025 and it’s placed into service after December 31, 2024 it can take the old-fashioned Section 48 ITC or take the ITC that will be available under Section 48E.  

Our Revels Are Now Ended 

Like it or not, Section 48E is the framework we’ll need to live in as we think about ITCs going forward. The technology agnostic tendency of the statute and the proposed regulations are encouraging and inclusive, but much work remains to be done, particularly around the right way to determine lifecycle greenhouse gas emissions across different use cases. The proposed regulations in particular provide rich detail around potential implementations and open the door for discussion across a number of key topics. There’s still a lot to talk about, which I will address in subsequent newsletters such as C&G facilities and energy storage technology under 48E and, of course, 45Y. However, bear in mind that the nature of proposed regulations is that they are tentative and the final regulations, whenever they may be issued, do not necessarily have to comport with the words and concepts we have today.