IRS Issues More Construction-Start Guidance

IRS issues more construction-start guidance

June 06, 2016 | By Keith Martin in Washington, DC

The Internal Revenue Service said in May that developers will have four years to complete a new wind farm or other renewable energy project and qualify for federal tax credits without having to prove that the construction work was continuous.

The four years will be measured from the end of the year in which construction starts on the project.

For example, if construction of a new wind farm started in 2013, then the project must be completed by the end of 2017.

If it takes longer, then the developer will have to prove that work after 2013 was continuous.

The IRS made the statement in the first of two new notices expected after Congress extended the deadlines to start construction of new renewable energy projects to qualify for
tax credits.

It is Notice 2016-31

The notice is causing pain for developers who did minimal physical work on projects at the site in 2012, 2013 or 2014 in order to claim their projects were underway ahead of earlier deadlines to start construction. They are now finding it hard to sell the development rights. 

A second notice is expected later and will focus on solar issues.

The first notice is focused mainly on wind, geothermal, biomass, landfill gas, incremental hydroelectric and ocean energy projects.

Developers of such projects must have the projects under construction by December 2016 to qualify for full tax credits.

Wind developers who start construction of their projects in any of the next three years after 2016 can qualify for tax credits at reduced levels. The levels are 80% for wind farms starting construction in 2017, 60% in 2018 and 40% in 2019.

There is no phase down of tax credits for geothermal, biomass, landfill gas, incremental hydroelectric or ocean energy projects. They must be under construction by December 2016 or they will not qualify for any tax credits, with one exception. Geothermal projects qualify for a permanent 10% investment tax credit no matter when work on the project is started.

There are two ways to start construction of a project.

One is by starting physical work of a significant nature. There is no fixed minimum quantity or dollar amount of work required to be considered “significant.” The IRS looks at the task. For an analysis of how much work is required and on what tasks, see the September 2014 NewsWire article, Additional Construction-Start Guidance

The other way to start construction is by “incurring” at least 5% of the eligible project cost by the deadline. Costs are not incurred merely by spending money. They only count once equipment or services are delivered, with one exception. A developer who pays for equipment at year end and takes delivery within 3 1/2 months after the payment can count the payment as incurred on the payment date. Delivery can be at the factory.

It is not enough merely to start construction. There must also be continuous work on the project after construction starts. Until now, the IRS has not made developers prove continuous work as long as the project is completed within two years after the construction-start deadline.

New Rules

The new notice takes a different approach.

Counsel will have to determine when construction of a project started. That sets a four-year clock running starting at the end of the year in which construction started. Thus, for example, if construction started in 2013, then the project must be completed by December 2017 or else the developer will have to prove continuous work.

Projects that were under construction on account of significant physical work and then run past the four-year mark to be completed must prove “continuous construction.” This may be impossible to do for many projects.

Projects that were under construction on account of the 5% test and then run past the four-year mark must prove “continuous efforts.” This is easier to do because development-type tasks qualify as part of the continuous efforts.

It is always a good idea to keep detailed records of what is being done on the project in case construction takes longer than expected. For practical lessons from the last two rushes to start construction, see the February 2016 NewsWire article, Another Race to Start Construction: Practical Advice.

The IRS repeated in the new notice that “preliminary activities” do not qualify as significant physical work. Examples of preliminary activities are securing financing, obtaining permits or doing test drilling at a geothermal site.

There can be a break in construction due to events outside the developer’s control. The IRS had given nine examples earlier of things that are considered outside the developer’s control. The new notice adds two more. The earlier list said that financing delays of “less than six months” can be excused. The new notice says simply “financing delays” without setting a time limit. The new notice adds “interconnection-related delays.” Many developers had asked in the past whether they can work backwards a year, for example, from when the utility will be ready to interconnect a project to start work in earnest on the site.

The new notice addresses three other issues.

First, the IRS said a developer who relied on physical work to start construction ― say in 2015 ― cannot now incur at least 5% of the costs in 2016 to buy more time to complete the project without having to prove continuous work.

Second, the agency is taking a more relaxed view of what happens if construction extends beyond the four-year mark. At worst if the developer cannot prove continuous work on the project, only the wind turbines that took more than four years to get into service will be denied tax credits. The rest of the project will qualify for tax credits without having to prove continuous work.


Finally, the notice addresses how to determine whether new tax credits can be claimed when wind turbines are repowered or retrofitted.

The tax credit extension opens a short window of opportunity for turbine manufacturers to make a vigorous push to upgrade turbines at older US wind farms.

In general, the owner must spend at least four times on the repowering the value of the equipment that the owner retains from the original project in order for the repowered turbines to qualify for new tax credits. This test is applied on a turbine-by-turbine basis, meaning that each turbine, pad and tower is considered a separate facility. Thus, if $300,000 in equipment value is retained from the original turbine, pad and tower, then at least $1.2 million must be spent on the upgrade to claim another 10 years of production tax credits on the electricity output or an investment tax credit on the new spending.

Construction of the repowering must start by the deadline to qualify for tax credits.

The 5% test requires incurring only 5% of the new spending, not the total project value.

The new notice gives the following example of how these rules work in practice. Suppose there is an existing wind farm with 13 turbines. Each of the turbines is more than 10 years old. The developer retrofits 11 of the 13 turbines and spends $1.4 million per “facility” ― turbine, pad and tower ― on the retrofits. It retains used components with a value of $300,000 at each facility. Thus, the new spending is more than four times the retained equipment value. The total spending on all 11 retrofits is $15.4 million. 

The developer treats the 11 retrofitted turbines as a single project with a total cost of $15.4 million.

Therefore, if the developer incurs at least $770,000 in costs by the deadline, then it will be considered to have started construction on the full repowering (5% x $15.4 million = $770,000). It does not have to show at least 5% in incurred costs for each individual turbine. 

No additional tax credits can be claimed on the two turbines that are not repowered.


Many wind companies and counsel set a low bar in 2012, 2013 or 2014 when they wanted to say projects were under construction in time to qualify for tax credits when faced with earlier deadlines that have since been extended.

It will be hard to walk that back now that the tables have turned. If a project was under construction in 2013 on account of physical work, then the company cannot give itself more time until 2020 to complete the project by now incurring 5% of the project cost. There are not many good options. Here are five.

One is to conclude that the company did not do enough on the project in the earlier year to qualify as “physical work of a significant nature.” This will almost certainly require a legal opinion to that effect to get financing. 

Alternatively, if the company did “physical work of a significant nature,” then get as many turbines in service as possible within four years after the end of the year it started work. At least their output will qualify for production tax credits even if the output from the remaining turbines does not.

The company could try to do enough to change the project so that it is no longer the same project on which work started in an earlier year. This will be hard. The only test the IRS has for assessing whether a project is a different project is something called an 80-20 test. This test looks at heavy spending to retrofit an existing project, and it does not work where a project has not been built yet. The only standard in this case is common sense. At a minimum, the company would have to change one or both of the site and the offtaker to have a different project.

Alternatively, a project would not have been treated as under construction in time as of the early date if the physical work was not actually used in the final project. However, the company cannot jettison the earlier work for tax reasons to buy more time to complete the project. There would have to be a clear non-tax reason why the work was not used.

Finally, it may be possible to break the project in two so that the work was considered to have started earlier on a small part, and treat the rest as a different project. However, the IRS will treat all the turbines as a single project if many of the following factors are present. All the turbines are owned by the same legal entity. They are on contiguous parcels of land. All the electricity is sold to a single offtaker under a single power purchase agreement. All the electricity moves to the grid through a common substation and intertie. There is a common set of permits for all the turbines. There is a common turbine supply agreement and balance-of-plant construction contract. All the turbines were financed under the same construction loan or tax equity transaction.