The IRS released favorable final regulations (TD 10024) on new technology-neutral energy credits on Jan. 7, but key questions remain over the qualification for projects involving combustion or gasification.
The final regulations address the new production tax credit (PTC) under Section 45Y and the new investment tax credit (ITC) under Section 48E, which apply for projects placed in service after Dec. 31, 2024. The new credits were created by the Inflation Reduction Act to replace the existing Section 45 PTC and Section 48 ITC, which are generally not available for projects that begin construction after 2024. Projects that begin construction in 2024 or earlier but are placed in service in 2025 or later are eligible for either credit regime.
The new credits differ from the old credits in important ways. Sections 45 and 48 offer 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.” There is significant overlap between the technologies that will qualify under the new and old regimes, but there are also differences, particular for the treatment of technologies that that use combustion or gasification, like biogas and combined heat and power (CHP).
The final 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 rules are much more complex for projects that involve combustion or gasification. The IRS provided details on how emissions rates should be calculated, but has 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 for a provisional emissions rate.
In addition to the emissions standard, the Section 45Y and 48E credits differ from credits under Sections 45 and 48 in areas involving the scope of qualifying property, the treatment of refurbished facilities, and dual use property. The final regulations also make several favorable changes from the proposed regulations, including:
- Allowing the full costs of additions to capacity to be creditable for an ITC
- Creating an incremental cost rule for property with qualifying and nonqualifying uses
- Removing an end-use requirement for hydrogen storage
Grant Thornton Insight
Taxpayers with projects using renewables like solar, wind, and geothermal to generate electricity will largely be able to rely on familiar rules to claim credits under Section 45Y or 48E, but they should evaluate some of the more nuanced differences from the credits under Section 45 and 48. Taxpayers with CHP or biogas projects that will begin construction after 2024 may need to perform a complex life-cycle analysis to see if they qualify, which could involve requesting a provisional emissions rate if the technology is not addressed in the forthcoming table from the IRS. The final regulations are generally applicable for projects placed in service in 2025 or later.
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 3 cents per kilowatt hour for 2024 (2.9 cents under Section 45 if placed in service before 2023).
Grant Thornton Insight
The use of the term “facility” for Section 48E harmonizes the ITC regime with the PTC regime, which has always relied on this definition. The definitions around the scope of property that can be included in the Section 48E credit basis is fairly consistent with the final regulations recently released under Section 48, with some important distinctions discussed later.
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 final regulations provide rules for determining capacity. The IRS released proposed regulations on the prevailing wage and apprenticeship 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 stories on domestic content and energy communities).
Grant Thornton Insight
The IRS denied requests to provide aggregation rules similar to those in Section 48 for purposes of the domestic content and energy community bonus credits under Section 45Y and Section 48E. The IRS said an aggregation rule was appropriate for Section 48 because it uses the concept of an energy “project,” while Sections 45Y and 48E refer to “facilities.” The final regulations provide that interconnection property is not included in the determination of eligibility for bonus credits, but that the bonus credits still apply to those costs.
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.”
Grant Thornton Insight
Because the qualification standards are generally identical for both Section 48E and 45Y, any qualifying facility that generates electricity will qualify for either credit. The Section 45 and 48 credits also had significant overlapping eligibility, and taxpayers could elect to claim the Section 48 credit in lieu of the Section 45 credit, but there were some categories of Section 48 property that previously did not qualify under Section 45, including biogas, CHP, waste energy recovery, and fuel cells (as well as solar before the enactment of the IRA).
Greenhouse gas emissions
The final regulations create separate rules for calculating the GHG emissions rate for technologies that use combustion or gasification (C&G facilities) and technologies that do not. Both C&G and non-C&G technologies can generally exclude potential emissions sources that are not involved in the production of electricity, including:
- Back-up generators
- Step-up transformers
- Project construction, including of the facility, manufactured parts, or related infrastructure
- Routine maintenance, including emissions from vehicles to access property
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
- Marine and hydrokinetic
- Geothermal
- Nuclear fission or fusion energy
Waste energy recovery property (WERP) can also be deemed to automatically qualify if it does not involve a C&G process or if it uses any of the above as an energy source. 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.
Grant Thornton Insight
The IRS acknowledged that some of these renewable technologies could have ancillary emissions, such as degassing emissions from hydropower or emissions from underground reservoirs in geothermal operations, but determined that these emissions were not directly produced by the transformation of an input energy source into electricity and could be ignored. The replacement of Sections 45 and 48 with Sections 45Y and 48E will not significantly alter the basic qualification standards for renewable technologies like wind, solar and geothermal. There are some differences, however, in the scope of qualifying property and facilities, the inclusion of property with dual uses, and the ability to credit additional investments in an existing facility, discussed later.
C&C facilities
The final regulations introduce complex rules for determining the GHG emissions rate for C&G facilities. 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).
C&G facilities must generally determine their GHG emissions rate by performing a lifecycle analysis (LCA) of both direct and indirect emissions, including emissions at all stages of fuel and feedstock production and distribution. The regulations provide extensive requirements for an LCA, which must include broader changes in commodity markets, such as emissions from land-use changes and the consequences of commodity production. The LCA must evaluate the emissions over a time horizon of 30 years.
Offsets and offsetting activities, such as renewable energy certificates, cannot be used to reduce emissions. The LCA can, however, consider alternate fates and avoided emissions, such as emissions that would have occurred from alternative uses or disposition of the feedstock used in the C&C facility.
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Because C&G facilities without carbon capture will generally by their nature produce emissions, qualification will largely hinge on whether the emissions of the facility are essentially a net savings against a baseline that assumes emissions from alternative uses or disposition of the feedstock. For instance, combusting methane to generate electricity will generally create carbon emissions, but could still qualify as net zero if can be established that the methane or the source for the methane otherwise would have created emissions through atmospheric release or flaring. The assumptions of how feedstock would alternatively be used will be critical, and could change over time based on evolving industry standards, regulatory restrictions on release, and changing behavior based on the credits themselves.
The preamble to the final regulations goes into extensive detail on many complex issues of how the LCA should apply, including the assumptions about alternative uses based on regulatory requirements and industry practices; differentiating primary products, co-products, by-products, and waste products; and the market effects of the credits themselves to change some of these factors.
The IRS is required to produce an annual table that sets forth CHG emissions rates for types or categories of facilities. The IRS said it “cannot commit to a specific timeline for publication of the first annual table” due to the time and effort required. Taxpayers with facilities that are not covered by the annual table may petition for a “provisions emissions rate.” This may require working with the Department of Energy to obtain an emissions value. An emissions value can also be determined by using the most recent version and LCA model or model that have been designated by the IRS.
Grant Thornton Insight
The qualification standards under Sections 45Y and 48E are very different from those under Sections 45 and 48, particularly for C&G technologies like CHP, biogas, biomass, and landfill gas. Microgrid controllers and electrochromic glass, which currently qualify under Section 48, will generally not qualify at all under either Section 45Y or 48E if construction begins after 2024. Biogas projects will be treated much differently, as the current Section 48 credit is provided for facilities that produce methane rather than electricity. Sections 45Y and 48E only provide a credit if electricity is produced from any methane meeting the GHG standards. The description of the LCA in the preamble and final regulations provide insight into which projects may qualify going forward, but full clarity will not be available until the annual table is published and the IRS finishes guidance on areas not covered by the final regulations. The preamble does offer some hints at types of qualifying projects while describing regulatory decisions. For instance, the preamble mentions that “certain woody biomass-derived feedstock” like pelletized biomass “require significant energy inputs,” making qualification “unlikely.” The preamble also suggests that natural gas facilities are “unlikely” to have zero emissions unless they blend natural gas with other feedstock with negative emissions.
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 scope of property included in a facility is more important for Section 48E, as the credit is calculated against the basis of property, while Section 45Y is dependent only on the amount of electricity produced. 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 the rules for determining the scope of a qualified 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 or generate 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 distinction between a functionally interdependent component and integral property can be important for various reasons, although both can be included in the cost basis for calculating the Section 48E credit. For example, only functionally interdependent property is included for purposes of the 80/20 rules described below.
Grant Thornton Insight
Taxpayers must own the unit of qualified facility in order to claim a credit. The IRS rejected requests to allow taxpayers to claim a credit for owning mere components or integral parts of another taxpayer’s qualified facility.
The final regulations provide additional clarification around the definitions of “functionally interdependent” and “integral” with expanded 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 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.
Grant Thornton Insight
These final regulations contain less explicit information on the scope of qualifying property than the recent final regulations under Section 48, largely because Section 48E is open-ended while Section 48 specifically defines each category of qualifying property. The IRS acknowledged in the preamble that many technologies could qualify under either credit, and because they share overlapping concepts, the IRS expects similar components to be eligible under either credit. The IRS, however, rejected calls to fully incorporate many of the Section 48 rules on specific qualifying components because it said Section 48E is technology-neutral and so the analysis of what qualifies will need to be fact-specific.
In a major break from the Section 48 rules, the IRS declined to include a rule for allocating the cost of “dual use” property to the credit basis for Section 48E. The preamble to the final regulations maintains that these dual-use rules were necessary only to determine if energy storage property could be included in a Section 48 credit. Because energy storage property separately qualifies under Section 48E, the IRS said that dual use rules are unnecessary.
Grant Thornton Insight
This position is at odds with the final regulations recently issued under Section 48, which also now includes energy storage property as eligible for a stand-alone credit. The IRS still codified dual use rules in the final Section 48 regulations for property that uses energy derived from both qualifying and nonqualifying sources, such as HVAC or electrical components. Under the Section 48 dual use rules, taxpayers may allocate a proportional amount of the cost to the credit as long as the qualifying use is at least 50%.
The Section 48E regulations instead import only the incremental cost rule from the Section 48 regulations, which applies to property or equipment that is also used for a purpose other than the intended function of the energy property, like a roof holding solar panels. Under this rule, only the incremental cost of the component over the cost of a version that would be needed for a nonqualifying use can be included in the credit base.
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. Under the final regulations, storage for hydrogen will qualify without regard to the end use of the hydrogen. The rules for interconnection property largely follow the Section 48 proposed regulations.
Grant Thornton Insight
Taxpayers must generally choose between claiming a Section 45Y or 48E credit. There are also provisions preventing taxpayers from claiming most other energy credits for the same facility for which a credit is claimed under Section 48E and 45Y. The determination of which credit is more valuable can depend on a variety of factors, including financing costs and cash flow. There also may be opportunities to claim multiple credits for some types of projects. Taxpayers could claim a Section 48E credit on energy storage at a Section 45Y facility, for example. Taxpayers can also claim a Section 48E credit for an addition to capacity under the incremental production rules even if the taxpayer claimed the Section 45Y credit when the facility was first placed in service.
Additions and retrofits
There are two separate rules that allow for additional credits after a property is placed in service, an 80/20 rule and an incremental production rule. Each applies to both Section 48E and Section 45Y facilities, though in different ways.
The 80/20 rule essentially codifies a series of rulings for both Section 45 and Section 48. Under this rule, 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 fair market value of the new and used components together. The analysis includes only functionally interdependent property and not integral property (though new integral property can be included in the credit if the 80/20 rule is satisfied). For Section 45Y, meeting the 80/20 rule allows the facility to restart the 10-year clock for the credit on the entire unit of the facility. For Section 48E, meeting 80/20 rule results in taking an additional credit based on the new expenditures.
The incremental production rule was created by new statutory language in Sections 45Y and 48E and marks an important difference between the old credit regime in Sections 45 and 48. Under the final regulations, any new unit or any addition of capacity to an existing unit is credit-eligible. For Section 45Y, the additional capacity is considered newly placed in service and eligible for a full 10-year credit period, but only with respect to the additional capacity. The regulations include rules for determining the amount of increased capacity, and the rules allow for the restarting of a decommissioned facility to be considered an addition to capacity.
The final regulations remove an unfavorable rule in the proposed regulations that would have limited the credit under Section 48E for creating additional capacity to only a proportional share of the cost based on the new and old capacity. The final regulations provide that the entire cost of any additions to or replacements of qualified property is eligible for additional Section 48E credit as long as there is any increase in capacity. There is no minimum capital expenditure required, and the additional capacity can come from simply increasing efficiency.
Grant Thornton Insight
The final rules align more closely to a position many taxpayers had taken under the old Section 48 rules, arguing that any additional incremental investment in Section 48 “property” is credit-eligible in years after a project is placed in service. These arguments were generally based on a Section 48 framework that relied on the concept of “property” rather than “facility,” and the position relied on somewhat contradictory guidance. The preamble to the Section 48E regulations explicitly rejected calls to apply this kind of position in the context of 80/20 rule, but the final version of the incremental production rule essentially achieves the same result as long as some increase in capacity can be demonstrated. If so, any further investment in tangible property that is functionally interdependent or integral to the qualifying facility will essentially be credit-eligible. The 80/20 rule under Section 48E would only be a helpful alternative when new equipment does not increase capacity.
Next steps
The proposed regulations will be critical for any projects beginning construction after 2024. Projects beginning construction in 2024 and earlier can also choose to use the new rules if the project will be placed in service after 2024. The rules will significantly alter the qualification standards for C&G facilities, and could affect the amount of credit or credit options for other types of facilities. Certain projects may not qualify under the new rules, and taxpayers should carefully consider the rules for establishing that construction began before the end of the 2024.
Republicans have criticized some of the energy credits and could target them in order to pay for other tax priorities. There is a significant amount of renewable energy investment going into Republican districts, however, and many Republicans have indicated they will fight to preserve the credits. If changes do come, they are most likely to be effective only for projects beginning construction after some prospective future date. Taxpayers considering energy projects should monitor the legislative process.
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