On November 22, the IRS and Treasury published proposed regulations updating regulations under Section 48, the tax credit for investment in energy property. This insight describes the proposed rules on the definition of energy property. A later insight will discuss special rules for energy property; rules relating to the Section 48 prevailing wage and apprenticeship, domestic content, and energy community credit bonuses; and rules on recapture of Section 48 credits transferred under Section 6418. For information on proposed applicability dates, the deadline for submission of comments, and the public hearing date, see the PwC Insight Proposed regulations issued on Section 48 energy credit. For consideration: Much of the guidance included in the Section 48 proposed regulations regarding the definitions of energy property and excluded property, the treatment of “integral property,” and the used components rule, aligns with prior guidance. However, there are some clarifications and modifications to earlier provisions that would create both opportunities and challenges for taxpayers, depending on the specific technologies for which they will claim a credit. Taxpayers looking to qualify under technologies newly eligible under the Inflation Reduction Act of 2022 -- such as biogas -- will want to engage with operations personnel to differentiate between eligible and noneligible costs and evaluate how energy property and property integral to the functioning of the property will be owned.
For property placed in service after 2022, Section 48 provides an investment tax credit for a percentage (generally 6%, increased to 30% if prevailing wage and apprenticeship requirements are met) of the basis of energy property a taxpayer places in service during a tax year. The percentage may be increased by bonuses related to domestic content, location in an energy community, and location in a low income community. Property qualifies as “energy property” if it is of a certain type; the taxpayer completes the property’s construction, reconstruction, or erection or acquires it as the original user; depreciation or amortization is allowable; and it complies with performance and quality standards in effect at the time of acquisition that have been issued by Treasury after consulting with the Department of Energy. Types of property qualifying as energy property include (1) solar energy equipment used to generate electricity, heat or cool (or provide hot water for use in) a structure, provide solar process heat, or (for property that begins construction before 2025) provide lighting using fiber-optic distributed sunlight and electrochromic glass used to heat or cool, (2) equipment that produces, distributes, or uses energy derived from a geothermal deposit, (3) qualified fuel cell property, (4) microturbine property, (5) combined heat and power system property, (6) qualified small wind energy property, (7) equipment using the ground or ground water as a thermal energy source, (8) waste energy recovery property, (9) energy storage technology, (10) qualified biogas property, and (11) microgrid controllers. Energy property also includes amounts a taxpayer pays or incurs for qualified interconnection property that provides for the transmission or distribution of the electricity produced or is stored by an energy property (other than a microgrid controller) with a maximum net output of five MW or less. Qualified interconnection property is tangible property that is part of an addition, modification, or upgrade to a transmission or distribution system required at or beyond an energy project’s interconnection to the system. The taxpayer must either (1) construct, reconstruct, or erect the property or (2) pay or incur the cost of property for which a utility is the original user under an interconnection agreement. The amount paid or incurred must be properly chargeable to capital account. For property that begins construction before 2025, a taxpayer may elect to treat qualified property that is part of a qualified investment credit facility as energy property. A taxpayer may elect to treat qualified property that is part of a specified clean hydrogen facility placed in service after 2022 as energy property. A taxpayer generally may not claim both the Section 48 credit and a production credit relating to the same facility.
The proposed regulations provide general definitions of each type of energy property. Solar energy property includes electric generation equipment, solar process heat equipment, fiber-optic solar energy property, and electrochromic glass property (including windows that incorporate electrochromic glass), and includes parts related to the functioning of this equipment. Note: The proposed regulations define electrochromic glass as including not only the glass, glazing and control package, but also the installation components, such as flashing, framing, and sealants. Geothermal energy property is equipment used to produce, distribute, or use energy derived from a geothermal deposit, including equipment necessary to bring geothermal energy from a subterranean deposit to the surface (production equipment) and equipment that transports geothermal energy from a geothermal deposit to the site of ultimate use (distribution equipment). Observation: The proposed regulations expand the definition of geothermal production equipment from earlier rules, but still disallow costs incurred to drill failed or nonproducing wells. Qualified fuel cell property is a fuel cell power plant that has a nameplate capacity of at least 0.5 KW (one KW for a plant with a linear generator assembly) of electricity using an electrochemical or electromechanical process and an electricity-only generation efficiency greater than 30%. Qualified microturbine property is a stationary microturbine power plant that has a nameplate capacity of less than 2,000 KW and an electricity-only generation efficiency of not less than 26% under certain conditions. Combined heat and power system property is a system that uses the same energy source to generate electrical or mechanical shaft power combined with generating steam or other forms of useful thermal energy, and produces at least 20% of its total useful energy in the form of electrical or mechanical power and at least 20% of its total useful energy in the form of thermal energy that is not used to produce electrical or mechanical power. Qualified small wind energy property generates electricity using a wind turbine with a nameplate capacity of at least 100 KW. Geothermal heat pump equipment uses the ground, ground water, or other underground fluids as a thermal energy source to heat a structure or as a thermal energy sink to cool a structure. Waste energy recovery property generates electricity solely from heat from buildings or equipment that does not have a primary purpose of generating electricity. It specifically excludes property that qualifies as combined heat and power system property. Energy storage technology includes electrical, thermal, and hydrogen energy storage property. Electrical energy storage property receives, stores, and delivers energy for conversion to electricity and has a nameplate capacity of at least five KW/HR. Thermal energy storage property is directly connected to an HVAC system that removes heat from or adds heat to a storage medium for later use in heating or cooling a building. Hydrogen energy storage property stores hydrogen to be used solely as energy and has a nameplate capacity of at least five KW/HR. Qualified biogas property is a system that converts or concentrates biomass into a gas consisting of at least 52% methane by volume and captures the gas for sale or productive use rather than for combustion. Qualified property includes parts of the system that clean or condition the gas but excludes equipment to upgrade the gas by removing certain other gases. Observation: Determining the cost of equipment used to clean or condition the gas versus upgrade the gas may be challenging. The preamble to the proposed regulations states that upgrading equipment is not functionally interdependent with the biogas property and thus fails to meet the statutory requirement of converting biomass into biogas containing not less than 52% methane, while acknowledging the role of upgrade equipment in enabling injection of the biogas into a pipeline. The preamble requests comments on the distinction between cleaning and conditioning equipment versus upgrade equipment. Taxpayers should consider whether comments related to the integral nature of the upgrade equipment also may be helpful. Microgrid controllers monitor and control the energy resources and loads on a qualified microgrid (a system that can generate between four KW and 20 MW of electricity and is connected to but independent of the electrical grid). Observation: Taxpayers should be aware, not only of whether they meet the technology requirements to claim a Section 48 investment tax credit, but also of the costs eligible to include in their credit calculation. The proposed regulations define many components that are included in specific types of energy property and some components that are excluded. Noting that energy property technology still is evolving, the preamble to the proposed regulations acknowledges that the proposed regulations do not define all components of energy property and taxpayers may need to apply either a functional interdependence test or an integral to the property test to determine what costs are includible in the basis of their energy property.
The proposed regulations provide that energy property includes (1) units of energy property and (2) property owned by the taxpayer that is an integral part of an energy property. “Unit of energy property” means all functionally interdependent components of property owned by the taxpayer that operate together and are able to operate apart from other energy properties within a larger energy project. In general, a component is functionally interdependent if placing the component in service is dependent on placing in service each other component for the energy property to be able to generate or store electricity, thermal energy, or hydrogen, or to perform the intended function of the energy property. A unit of energy property must meet all the requirements for energy property (type, constructed or acquired, depreciable, and standards). Property owned by a taxpayer is an integral part of an energy property owned by the same taxpayer if it is used directly in, and is essential to the completeness of, the intended function of the energy property. An integral part may be shared by more than one energy property or by an energy property and a Section 45 qualified facility, in which case the basis of the integral part must be allocated to each property. The integral part may be at a different location than the energy property. The proposed regulations identify power conditioning equipment (such as transformers, inverters, converters, switches, circuit breakers, and arrestors) and transfer equipment (such as wires, cables, combiner boxes, current transformers, and circuit breakers and fuses) used to perform the intended function of an energy property as integral parts. Onsite roads used for equipment to operate and maintain energy property is an integral part, however roads used primarily for access to the site or for employee or visitor vehicles and fences do not qualify. Generally, buildings are not integral parts of an energy property. However, structures that are essentially an item of machinery or equipment, or that house integral parts and clearly can be expected to be replaced when the housed property is replaced, are not treated as buildings. Observation: Taxpayers who own both energy property and integral property may include the basis of both the energy property and the integral property in their Section 48 tax credit calculation. However, taxpayers who own integral property, but not the energy property to which it is integral, are not entitled to a Section 48 tax credit.
The proposed regulations provide that power purchase agreements, goodwill, going concern value, and renewable energy certificates are not energy property. Electrical transmission equipment, equipment beyond the electrical transmission stage, and additions or modifications to an existing energy property (except for certain modifications to energy storage property and used components of certain retrofits) also are excluded. Energy property generally does not include any property that is part of a qualified facility for which production is allowed as a Section 45 credit for the current or a prior tax year.
The proposed regulations provide that qualified interconnection property is not taken into account in determining whether an energy property satisfies the requirements for the domestic content or energy community credit bonuses. The proposed regulations specify that the maximum net output of an energy property for purposes of applying the five-MW limitation is measured solely by the nameplate generating capacity of the unit of energy property when placed in service. Observation: The preamble to the proposed regulations notes that the interconnection provisions do not apply to microgrid controllers, electrochromic glass, fiber optic solar energy, geothermal property, and biogas equipment.
The proposed regulations provide that a taxpayer constructs, reconstructs, or erects energy property if the work is performed by the taxpayer or by another party to the taxpayer’s specifications. “Acquisition of energy property” is defined as a transaction by which a taxpayer obtains rights and obligations relating to the property, including title (unless the taxpayer is a lessee) and physical possession or control. Used components included in a unit of energy property are treated as originally placed in service by a taxpayer if the fair market value of the used components is no more than 20% of the total value of the unit of energy property. Only the cost of the new components qualifies for the Section 48 credit. “Costs” include all costs properly included in the depreciable basis of the new components.
The proposed regulations provide that depreciation or amortization of a property is “allowable” if the basis is recoverable using a method of depreciation, including bonus depreciation. Depreciation is not allowable if a taxpayer recovers the basis of the property through an expensing provision such as Section 179.
The proposed regulations define “time of acquisition” for purposes of determining if property meets applicable performance and quality standards as the date a taxpayer enters into a binding contract to acquire the property or, for constructed property, the earlier of the date the taxpayer begins construction or enters into a binding contract with another person to construct the property. The proposed regulations identify applicable performance and quality standards for small wind energy property and electrochromic glass property. The standards for small wind energy property are provided in guidance published in the Internal Revenue Bulletin.