IRS Clarifies Rules for Starting Construction and Repowerings

IRS clarifies rules for starting construction and repowerings

December 15, 2016 | By Keith Martin in Washington, DC

The Internal Revenue Service made two changes today in how it will test whether wind farms and other renewable energy projects were under construction in time to qualify for federal tax credits.

It also answered a question some wind companies that plan to repower existing turbines had about how to calculate whether work on the repowering is extensive enough to cause the repowered turbines to be considered new.

Wind, geothermal, biomass, landfill gas, incremental hydroelectric and ocean energy projects must be under construction by the end of this year to qualify for 10 years of production tax credits at the full rate on the electricity output. Developers have the option of claiming a 30% investment tax credit instead in the year the project is completed.

There are two ways to start construction of a project. One is by "incurring" at least 5% of the total project cost by the construction-start deadline. The other is by starting "physical work of a significant nature" on foundations or turbine string roads at the project site or on equipment for the project at a factory. (For more detail on starting construction, see Another Race to Start Construction: Practical Advice and IRS Issues More Construction-Start Guidance.)

It is not enough merely to start construction in time; there must also be continuous work on the project after construction starts.

The IRS said in May that it will not make a developer prove continuous work on any project that is completed within four years after the year construction starts.

The change, while intended to be helpful to renewable energy developers, had the effect of making it impossible to sell or finance projects on which developers started construction ahead of past construction-start deadlines and that are not certain to be completed within the four-year window. The four years start to run from the past year when construction started. Some projects were under construction as early as 2011 or 2013.

It is possible in theory to prove continuous work on a project that takes longer to complete. However, the type of proof required depends on how construction started. Developers who relied on physical work must prove "continuous construction," which may be impossible to do. Developers who incurred at least 5% of project cost must prove only "continuous efforts," which include work on development-type tasks.

Four-Year Lookback Relief

The IRS made two changes in a new Notice 2017-04 today.

The notice can be found here.

First, developers will now have until four years after the year construction started or, if later, until December 31, 2018 to finish a project without having to prove continuous work.

Second, a developer who relied on physical work in a past year to start construction will now have the option to upgrade to the 5% test by incurring enough costs by the current construction-start deadline so that it is in a position to prove continuous efforts on the project.

Projects that are under construction by the end of 2016 qualify for tax credits at the full rate. Projects that start construction in any of the next three years qualify for tax credits at reduced rates. The reduced rates are 80% for projects that start construction in 2017, 60% in 2018 and 40% in 2019.

Upgrading to the 5% test in 2016 for a project under which physical work started ahead of an earlier construction-start deadline will buy a new four-year window -- through the end of 2020 -- to complete work.


The new IRS notice also addressed an issue that has come up in wind farms that the existing owners are repowering.

A project owner can qualify for tax credits on a repowered wind turbine if two things are true.

One is the repowering "project" must be under construction by the deadline to qualify for tax credits. The "project" is the group of turbines at a single wind farm that will be repowered.

If this is true, then the developer must test "facility" by "facility" whether the repowering was so extensive to treat a repowered turbine as essentially brand new. Each turbine, pad and tower is treated like a separate power plant or "facility." A wind facility must be new to qualify for tax credits. The IRS uses an 80-20 test to determine whether it is new. The spending on the repowered facility must be at least four times the value of the used parts retained from the old turbine, pad and tower. The value of the used parts is their depreciated replacement cost. The developer must determine how much the used parts would cost new today and then adjust for the used condition.

Many companies planning repowerings have ordered equipment this year from turbine vendors in order to incur at least 5% of the cost of the planned repowerings.

The IRS said in May that the only costs that can count toward the 5% test are spending on "new property," and "only expenditures paid or incurred that relate to new construction should be taken into account for purposes of the" 5% test.

The IRS clarified today that any costs that go into the depreciable basis of the repowered turbines can be counted. Thus, indirect costs, like employee salaries for time spent working on the repowering or outside consultant fees to negotiate turbine contracts count. The intention is for such costs to count for both the 5% and 80-20 tests, a Treasury source said.