Tax Equity News

ITC recapture following a casualty event

Posted by David Burton

June 09, 2021

Posted in Power Renewable energy Solar Blog article

Solar and other renewable energy projects eligible for the investment tax credit (ITC) rarely suffer causalities; however, cautious taxpayers often seek to understand and be prepared for the ITC consequences of a potential project casualty. 

The ITC concern is the application of the "recapture" rules in section 50(a)(1) of the Internal Revenue Code as the result of a casualty.  Recapture means that the taxpayer has to increase its federal income tax liability in the year of the recapture event by the amount of the recaptured ITC.  Recapture occurs if a project or a portion thereof is sold, or otherwise disposed of, or removed from service (i.e., permanently ceases operating) in its first five years of operations.  If recapture occurs, some or all of the ITC has to be recaptured, based on the recapture schedule that declines by 20% a year.[1] 

The cost of recapture depends upon what portion of the project has been removed from service and what the taxpayer does about it:

  1. If only 20% or less of the value of the project has been removed from service, then the project should continue to qualify as originally placed in service and recapture should not occur.[2]  There is no obligation to replace the portion removed from service.
  2. If more than 20% of the value of the project is non-operative and it is not replaced within six months of the disposal of a portion of the project becoming non-operative, then recapture will likely apply to the non-operative portion of the project.[3]
  3. If more than 20% of the value of the project is non-operative and it is replaced within the six month period noted above, then the ITC on the replacement property reduces the recapture.  However, the ITC on the replacement property will likely be calculated based on the vintage of the "safe harbor equipment"[4] included as the replacement property and the placed in service date of the replacement property (i.e., somewhere between 10 and 26% depending upon the facts and circumstances[5]).[6] 

For instance, if a project with an eligible tax basis of US$100 that qualified for a 30% ITC (i.e., it "began construction" before 2020) was placed in service in 2021 and suffered a 25% casualty in 2021, the recapture amount would be US$7.50.Unless, the taxpayer had available to it "safe harbor" equipment the cost of which was incurred before 2020,[7] the ITC for replacement equipment added in 2021 (and within six months of the casualty event) would likely only be 26%.[8]Accordingly, the taxpayer would need to install replacement equipment with an eligible tax basis of US$28.85 to fully offset the recapture tax liability.

If more than 20% of the value of the project must be replaced but the taxpayer fails to replace the property within the six month window, the taxpayer may seek indemnification under its property and casualty insurance policy.  The questions are whether the insurance (i) includes coverage for lost tax benefits and (ii) is sized to compensate the taxpayer for the physical damage as well as the potential ITC recapture cost.  Some property and casualty insurers will agree to include coverage for specified lost tax benefits, such as ITC recapture, or alternatively there is a specialty tax insurance market that is versed in these issues.

[1] I.R.C. § 50(a)(1)(B): "(i) One full year after placed in service              100%

(ii) One full year after the close of the period described in clause (i)         80%

(iii) One full year after the close of the period described in clause (ii)       60%

(iv) One full year after the close of the period described in clause (iii)      40%

(v) One full year after the close of the period described in clause (iv)       20%"

[2] Rev. Rul. 94-31; PLR 200442014 (applying Rev. Rul. 94-31 to the potential replacement of a part of a synthetic fuel facility). 

[3] See Treas. Reg. § 1.47-3(h)(1).  Previously, there was not a time limit to acquire the replacement property for property destroyed by casualty, but the six month rule applies to disposition after April 18, 1969.  See Treas. Reg. § 1.47-3(c).  Also, the six month rule also applies to avoid recapture from dispositions generally (i.e., whether a sale or a casualty).  See Treas. Reg. § 1.47-3(h)(1).

[4] See Notice 2018-59 (establishing rules for determining when construction begins, including a safe harbor based on 5% of spending of the "total cost" of the project).

[5] See I.R.C. §§ 48(a)(2)(A), -(a)(6) (referencing "construction of which begins" for determining the ITC percentage available).

[6] See Rev. Rul. 88-96 (addressing a casualty event for general ITC property (i.e., not the ITC for solar) and holding recapture is not avoided by acquiring replacement property after the repeal of the general ITC).

[7] See I.R.C. §§ 48(a)(2)(A)(i), (a)(6)(A); Notice 2018-59, § 5.

[8] See I.R.C. § 48(a)(6)(A).


Tax Equity News reports on issues where renewable energy meets tax policy in the United States.



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