United States: IRS Sheds New Light On Solar Tax Credits, Leaves Energy Storage In The Dark

Jamie Jackson Hansen is a Associate in Holland & Knight's Denver office

Stephen J Humes is a Partner in Holland & Knight's New York office.

Mark C. Kalpin is Partner in Holland & Knight's Boston office

Seth R Belzley is a Partner in Holland & Knight's Denver office

The Internal Revenue Service (IRS) issued recent guidance regarding construction of commercial solar energy properties and other qualified energy properties for purposes of claiming the Investment Tax Credit (ITC), the key tax credit for solar energy projects, under Section 48 of the Internal Revenue Code.  Notice 2018-59, issued on June 22, 2018, provides a number of benefits for developers of commercial solar energy projects, including maximizing ITC amounts during a phase-out period and navigating a new import tariff, but leaves a rapidly growing component of the commercial solar industry—energy storage—with many unanswered questions on qualifying for the ITC.

Extension of the ITC

In 2015, Congress extended both the ITC and the Production Tax Credit (PTC), the wind energy industry's key tax credit. The ITC entitles the owner of solar "energy property" meeting the IRS's definition to a credit in the year the energy property is placed in service that is equal to a defined percentage of the owner's basis in the energy property.

The extension was welcome news to the solar industry, allowing a credit of 30 percent for projects that begin construction before Jan. 1, 2022. However, for projects beginning construction after this date, the credit percentage is phased down incrementally to 10 percent for projects placed in service after Jan. 1, 2024:

Date Construction Begins

Placed in Service Date

ITC Amount

Before 1/1/2020

Before 1/1/2024


1/1/2020 to 12/31/2020

Before 1/1/2024


1/1/2021 to 12/31/2021

Before 1/1/2024


Before 1/1/2022

On or after 1/1/2024


On or after 1/1/2022



Importance of Beginning Construction

When a solar energy project "began construction" is a key factor in the project's economics because the year in which a project started, together with the date it was placed in service, determines the amount of the ITC available to the energy property owner under the phase-out scheme. The IRS had previously issued guidance on this important issue for wind projects and the PTC in 2016 and 2017, but had not provided similar guidance on the ITC until now.

Under the new guidance, an energy property owner can establish when construction began in one of two ways: by performing work on the project meeting the requirements of the "Physical Work Test", or by incurring project costs qualifying for the "Five Percent Safe Harbor."

Under the Physical Work Test, an energy property owner can establish beginning of construction by starting "physical work of a significant nature." The IRS will look at the nature of the work performed on the property, rather than the amount or cost. There is no minimum amount of work or cost to meet the Physical Work Test requirements. 

Alternatively, under the Five Percent Safe Harbor, an energy property owner can alternatively establish beginning of construction by meeting a safe harbor requirement by paying or incurring 5 percent or more of the total cost of the energy property (including third-party construction costs), and making "continuous efforts to advance toward completion" of the property. The total cost of the energy property excludes the cost of land, as well as any property not "integral" to the energy property.

The energy property owner can claim start of construction based on the earlier of the dates on which either the Physical Work Test or Five Percent Safe Harbor was met. However, in both cases, the IRS imposes a "Continuity Requirement" that the owner make "continuous progress towards completion once construction has begun."

The new guidance provides greater certainty to developers and tax equity investors in the face of the declining ITC and new tariffs on imported solar panels and modules, which went into effect in February 2018 and will decline from 30 percent to 15 percent over four years, terminating in 2021. Developers can still claim the full 30 percent ITC and avoid tariff costs by beginning construction (as defined by the Physical Work Test or the Five Percent Safe Harbor) before the end of 2019, and by procuring solar panels and modules after expiration of the tariff in 2021 but before the 30 percent in-service deadline of Dec. 31, 2023, as long as the Continuity Requirement is met.

Unanswered Questions for Energy Storage Projects

Meeting the Physical Work Test or Five Percent Safe Harbor requires an understanding of what equipment, if purchased or installed, qualifies an energy project as having begun construction. For developers of solar facilities that utilize storage, the IRS's new notice does not shed light on what types of storage, if purchased or installed, would qualify for the "begin construction" requirement. Utilization of energy storage has grown substantially in recent years, and the Energy Information Administration reports that as of the end 2017, the U.S. had 664 MW of power and 742 MWh of energy in operational large-scale battery capacity. Energy storage is not limited to batteries, and can also take the form of flywheels, compressed air energy storage, thermal storage, or pumped hydropower storage.

The IRS is still catching up to the emerging industry's innovations. The IRS has defined solar "energy property" in its regulations as including "storage devices, power conditioning equipment, transfer equipment, and arts related to the functioning of those items." The regulations do not clarify what kind of storage equipment qualifies for the ITC, and under what circumstances, although the solar industry increasingly recognizes that energy storage paired with solar can enhance the market value of solar projects.

The IRS has provided limited guidance on a case-by-case basis in five private letter rulings over the past seven years (PLRs 201142005, 201208035, 201444025, 201426013, and 201809003) that suggest batteries are "storage devices" eligible for the ITC. However, these letter rulings address only battery storage, not other types of storage. Additionally, the IRS takes the view that "dual use" storage, capable of both transmitting energy to and storing energy from the grid, is only eligible for the ITC if, for a period of five years, at least 75 percent of the energy used on an annual basis to charge the storage device comes only from solar (or other qualifying) technology. The 75 percent requirement cannot be met by averaging, and even if the percentage of energy the storage device receives from solar technology exceeds 75 percent in all five years, if it dips below the benchmark of the first year percentage in the following four years the ITC amount claimed on the difference in percentage during those years is subject to claw back or recapture. The 75 percent rule stems from policy concerns surrounding energy arbitrage, but makes it difficult for a developer to determine at the time of construction whether storage equipment qualifies for the ITC.

In October 2015, the IRS issued Notice 2015-70 requesting comments on how to define qualified properties, including storage properties, for purposes of the Section 48 tax credit. In the notice, the IRS requested input on whether property such as storage devices and power conditioning equipment should be included in energy properties for purposes of the credit, and how the terms "storage devices" and "power conditioning equipment" should be defined.

The IRS has yet to act on the comments received in response to this request. In Notice 2018-59, the IRS states that energy property includes property "integral to the production of electricity" but not property "used for the transmission of electricity." The new notice provides examples of property that is "integral to" the energy property, the purchase, construction, or installation of which would meet the Physical Work Test or the Five Percent Safe Harbor. Absent from the notice is any guidance relating to energy storage equipment, although interestingly, power conditioning equipment—also included as a topic in the IRS's request for comments, together with storage—is listed.

The IRS notes that it will not issue private letter rulings regarding the notice, so additional guidance will not be available to developers planning storage components until the IRS takes action in a rulemaking.

Path Forward in the Transition to Storage

Energy storage has the capability to address the greatest drawback of renewable energy—its intermittency. While the extension of the ITC and the IRS's new guidance provide a clearer path forward for development of commercial solar facilities, the increasingly important storage complement to those facilities remains to be addressed. Each point of the new IRS guidance provides greater certainty for solar generation facilities, but raises more questions for combined solar generation and storage facilities that need to be addressed by the IRS before the window of opportunity closes on the ITC for this important segment of the industry.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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