IRS offers partial clarity for future energy projects

The IRS released proposed regulations on May 29 (REG-119283-23) that provide significant comfort for future energy credit projects involving renewables like solar, wind, and geothermal, but the rules lack important clarity for projects that use combustion or gasification.

The proposed regulations address the new production tax credit (PTC) under Section 45Y and the new investment tax credit (ITC) under Section 48E. Sections 45Y and 48E were created by the Inflation Reduction Act to replace the existing Section 45 PTC and Section 48 ITC for projects that begin construction after 2024. The new credits differ from the existing credits in important ways.

Sections 45 and 48 provide credits for specific types of property meeting enumerated definitions. Section 45Y and 48E are meant to be “technology neutral,” and offer credits for any facility generating electricity with a greenhouse gas (GHG) emissions rate “not greater than zero.”

The new proposed regulations provide blanket qualification under the zero emissions standard for many existing renewable technologies, including, solar, wind, geothermal, hydro, waste heat and nuclear projects, as well as energy storage. The regulations also generally mirror current rules for important concepts like the definition of facility, the scope of qualifying property, the eligibility of refurbished projects, the prevailing wage and apprenticeship credits, and bonus credits for domestic content and energy communities.

The rules are much more complex for projects that involve combustion or gasification, such as combined heat and power (CHP), biogas, closed- or open-loop biomass, or municipal solid waste. The IRS outlined how the emissions rate would be calculated but asked for comments on many unresolved issues. The IRS has also not yet provided the annual table setting emissions rates for various technologies as required by the statute. Projects not covered by the table may need to apply to the Department of Energy (DOE) for a provisional emissions rate.

General rules

Like Section 48, Section 48E offers a credit of 30% of the basis of qualifying energy investments if prevailing wage and apprenticeship rules are met (or exceptions apply). The rules defining the scope of qualifying projects are slightly different under the two regimes. Section 48 generally relies on a more loosely defined concept of “property,” while Section 48E is available for “qualified facilities” or “energy storage technology.” Taxpayers placing in service qualified facilities with a capacity of no more than 5 megawatts can also claim the Section 48E credit with respect to “interconnection property,” generally defined as property needed to upgrade a transmission or distribution system that is required by a utility in order to accommodate the interconnection of a qualified facility. 

Like Section 45, Section 45Y provides a 1.5 cent per kilowatt hour credit (adjusted for inflation) of electricity produced in the 10 years after a qualifying facility is placed in service (as long as prevailing wage and apprenticeship rules are met or an exception applies). Section 45Y uses the same inflation adjustment factor as Section 45, and the credit rate reached 2.8 cents per kilowatt hour for 2023.

The rates for both credits drop to one-fifth the full amount if the prevailing wage and apprenticeship rules are not met unless the facility has less than 1 megawatt of capacity. The IRS released proposed regulations on these labor rules separately (see our prior story). Bonus credits of 10% each are available for facilities located in energy communities or meeting domestic sourcing requirements. Like with prevailing wages, guidance was issued separately on these rules (see our prior stores on domestic content and energy communities).

Both credits are eligible to be sold and transferred to an unrelated taxpayer under new Section 6418. Certain tax-exempt entities can also claim them as direct refundable payment under Section 6417 (see our prior stories on the final regulations for direct payments and credit transfers).

The credits under Sections 45Y and 48E will begin to phase out for construction beginning after 2032 (it could be earlier if certain nationwide emissions thresholds are reached). To qualify for either credit (apart from storage technology under Section 48E), the facilities producing electricity must have a GHG rate of “not greater than zero.”

Greenhouse gas emissions

The proposed regulations exclude several potential emissions sources from the calculation of the GHG emissions rate, including:

• Backup generators
• Step up transformers
• Project construction, including of the facility, any manufactured parts, or related infrastructure
• Routine maintenance

The proposed regulations create separate rules for calculating the GHG emissions rate for technologies that use combustion or gasification (“C&G facilities”). The IRS identified the following types of facilities that are “categorically” not C&G facilities and are deemed to qualify because the emissions rate is not greater than zero:

• Wind
• Hydropower
• Solar
• Geothermal
• Nuclear
• Waste energy recovery

WERP is property that generates electricity solely from heat from buildings or equipment if the primary purpose of the building or equipment is not the generation of electricity. 

The definition of C&G facilities encompasses technologies that use combustion or gasification either in the production of electricity itself or in the production of fuel used to make electricity. Fuel cells, for instance, could be considered C&G facilities if the hydrogen used to power the fuel cell is produced using combustion or gasification (or if the electricity used to produce hydrogen was made from combustion or gasification).

The GHG rate for C&G facilities is generally determined by applying section 211(o)(1)(H) of the Clean Air Act to calculate a lifecycle analysis (LCA), which includes both direct and indirect emissions. Offsetting activities that are not related to the production of electricity cannot be included. The proposed regulations go into some detail on the rules and scope for performing an LCA, but also identify many unresolved issues for which they solicit comments.

The IRS pledged to produce additional guidance on many aspects of the LCA analysis, and to provide an annual table required by the statute that sets GHG rates for specific categories of facilities. The IRS said it may have to provide different rates within categories based on different feedstocks. Taxpayers with a facility described in the table must generally use the rate in the table. Taxpayers with facilities not covered by the table may file a petition for a provisional emissions rate, which will require obtaining an emissions value from the DOE. The rules also include robust documentation and substantiation requirements. 

Qualifying property

The proposed regulations under Section 45Y and Section 48E provide nearly identical rules on the scope and definition a facility, even though many aspects of the rules vary in relevance for each credit. The types of property included in the scope of a qualified facility is more important for Section 48C, as the credit is calculated against the basis of property placed in service. The rules for determining whether aspects of a project represent separate facilities or a single facility, and when refurbishments and expansion are considered new facilities, are particularly important for determining the 10-year credit period under Section 45Y.

The regulations develop the concept of a “unit” of qualified facility to apply many of the rules for determining the scope of a facility. The unit of qualified facility includes all “functionally interdependent components,” meaning each component is dependent on the placing in service of the other components to produce electricity. A qualified facility also includes any property that is an “integral part” of the facility, defined as used directly in the intended function of the facility and essential to its completeness.

The proposed regulations expand on these definitions with special rules and examples that specifically list many types of property that can be included in the scope of a facility (and therefore the credit base for the Section 48E credit). This includes many types of specifically identified power conditioning equipment. Buildings are generally excluded unless the structure is essentially an item of machinery or equipment, or the use is of the structure is so closely related to the use of components that it will have to be replaced when the components are replaced. Fences will never qualify, but roads can qualify if they are considered integral to the intended function.

A retrofit of an existing facility will qualify as a new facility if the fair market value of the new property is at least 80% of the total value of the new and used components together. This codifies an existing 80/20 rule, and it can be applied on a facility “unit” basis. For purposes of Section 48E, the credit is only allowed on the new property. For purposes of Section 45Y, only the refurbished unit of qualified facility will be considered newly placed in service for the 10-year credit period.

The proposed regulations also allow for additional credits based on adding capacity to an existing facility or adding a new unit. For Section 45Y, the new 10-year credit period will only be allowed on the new unit or addition to capacity, which will be considered a separate qualified facility. The Section 48E credit will only be allowed to the extent of the increased amount of electricity produced at the facility by reason of the new unit or addition of capacity.

The Section 48E proposed regulations also define qualifying energy storage property, which includes thermal, electric, and hydrogen storage with an electrical or equivalent capacity of at least 5 kilowatt hours. The rules for interconnection property largely follow the Section 48 proposed regulations.