In Notice 2017-04, the IRS updates and clarifies guidance under Section 45 (renewable electricity production tax credit) and Section 48 (energy investment tax credit) regarding the date by which facilities must begin construction to qualify for the credits.

Background

The Protecting Americans from Tax Hikes Act of 2015 (PATH Act) extended by two years the date by which construction of a qualified facility, as described in Section 45(d), must begin. Under the PATH Act, a taxpayer claiming the renewable electricity production tax credit under Section 45 (PTC), or the energy investment tax credit under Section 48 (ITC) in lieu of the PTC, with respect to a facility must begin construction before January 1, 2017, or before January 1, 2020, in the case of wind facilities. The PATH Act also provided for a phase-out of the credits for facilities on which construction begins after December 31, 2016.

The five IRS notices that preceded Notice 2017-04 provide background. Notice 2013-29 permits taxpayers to establish that construction has begun by either: (i) starting "physical work of a significant nature" (the Physical Work Test) or (ii) meeting a safe harbor by paying or incurring 5% or more of the total cost of the facility (the 5% Safe Harbor). Notice 2013-29 also establishes the Continuous Construction Test, stating that the IRS may determine that the Physical Work Test is not satisfied if the taxpayer fails to maintain a continuous program of construction. The safe harbor provided in Notice 2013-29 also is only available if the taxpayer maintains continuous efforts to advance completion of construction (the Continuous Efforts Test).

Notice 2013-60 provides that a facility placed in service before January 1, 2016 will be considered to satisfy the Continuous Construction Test and the Continuous Efforts Test (the Continuity Safe Harbor). Notice 2014-46 clarifies that there is no statutory requirement that the taxpayer placing a facility in service be the taxpayer that began construction, explaining that a partially or fully developed facility generally may be transferred to unrelated taxpayers without losing its qualification under the Physical Work Test or the 5% Safe Harbor. Notice 2015-25 described a one-year extension of the credit.

Notice 2016-31 puts a four-year limit on construction and provides that if a taxpayer places a facility in service during a calendar year that is no more than four calendar years after the calendar year during which construction of the facility began, the facility will be considered to satisfy the Continuity Safe Harbor. Notice 2016-31 also clarifies that a taxpayer may not rely on the Physical Work Test and the 5% Safe Harbor in alternating calendar years to satisfy the beginning of construction requirement or the continuity requirement. Additionally, Notice 2016-31 clarifies that when the 5% Safe Harbor is applied to an existing facility that is being retrofitted, only expenditures paid or incurred that relate to new construction should be taken into account. This is tested under the "80/20 rule" where the fair market value of the used property is not more than 20% of the facility's total value (the cost of the new property plus the value of the used property). This rule is applied to each individual facility comprising the single project.

For additional details on these underlying notices, see: Tax Alert 2013-790 and Tax Alert 2013-852 (Notice 2013-29); Tax Alert 2013-1822 (Notice 2013-60); Tax Alert 2014-1453 (Notice 2014-46); Tax Alert 2015-552 (Notice 2015-25); Tax Alert 2016-848 (Notice 2016-31); and Tax Alert 2014-1790 (consolidated analysis of the first three notices).

Additional updates and clarifications in Notice 2017-04

Under prior notices, the Continuity Safe Harbor was satisfied if the taxpayer placed the facility in service by the later of (1) a calendar year that is no more than four calendar years after the calendar year during which construction of the facility began or (2) December 31, 2016. Notice 2017-04 provides that the Continuity Safe Harbor will be satisfied if the facility is placed in service by the later of (1) a calendar year that is no more than four calendar years after the calendar year during which construction of the facility began or (2) December 31, 2018.

Notice 2017-04 delayed the effect of the rule in Notice 2016-31 that provides that a taxpayer may not rely on the Physical Work Test and the 5% Safe Harbor in alternating calendar years to satisfy the physical work test or the continuity requirement. Notice 2017-04 provides that this rule applies only to facilities on which construction begins after June 6, 2016 (the date on which Notice 2016-31 was published in the Federal Register).

Notice 2017-04 also clarified the application of the 80/20 rule. The Notice provides that, in applying the rule, the cost of new property (the 80 in the 80/20) includes all costs properly included in the depreciable basis of the new property. Thus, it does not include the cost of land or any property not integral to the facility.

Finally, the IRS reiterated that it will not issue private letter rulings to taxpayers on the application of this guidance or the application of the beginning-of-construction requirement under Sections 45(d) and 48(a)(5).

Implications

The principal change made by Notice 2017-04 is the extension of the Continuity Safe Harbor for facilities placed in service between December 31, 2016, and December 31, 2018. Under Notice 2016-31, those facilities would have satisfied the Continuity Safe Harbor only if they were placed in service during the five-calendar-year period beginning with the calendar year in which construction began. Thus, facilities on which construction began in 2013 would satisfy the Continuity Safe Harbor only if placed in service before the end of 2017. Now, all facilities on which construction began in 2013 (or any earlier year) will satisfy the Continuity Safe Harbor if placed in service before the end of 2018. As under Notice 2016-31, facilities on which construction begins after 2013 will satisfy the Continuity Safe Harbor if they are placed in service during the five-calendar-year period beginning with the calendar year in which construction begins.

Taxpayers should also note that Notice 2017-04 retains the rule providing that a taxpayer may not rely on the Physical Work Test and the 5% Safe Harbor in alternating calendar years to satisfy the physical work test or the continuity requirement for new construction. Taxpayers are reminded that, if they rely on the 5% Safe Harbor, they should be aware that the rule gives added significance to the Physical Work Test by starting the running of the Continuity Safe Harbor in the first year in which either of those tests is satisfied. In Tax Alert 2016-848, we explained that a taxpayer that began physical work in 2015 has only until December 31, 2019, to place property in service, even if the 5% Safe Harbor is not satisfied until 2016. Notice 2017-04 provides that the rule applies only to facilities on which construction begins after June 6, 2016. We note that Notice 2017-04 does not explicitly state that the physical work performed in 2015 can be disregarded in determining when the five-calendar-year period begins. We assume, however, that the specific situation described in Tax Alert 2016-848 is not intended to be subject to the rule. To update the example in Tax Alert 2016-848 under the current rule, a taxpayer that began physical work after June 6, 2016, and before the end of 2016 has only until December 31, 2021, to place the property in service, even if the 5% Safe Harbor is not satisfied until 2017.

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