On December 15, 2016, the Internal Revenue Service (the “IRS”) issued Notice 2017-04 (the “Notice”), which clarifies earlier guidance with respect to safe harbors available for determining when construction of a facility has begun such that the taxpayer is eligible for the renewable electricity production tax credit (“PTC”) or to elect the investment tax credit (“ITC”) in lieu of the PTC.

1. Background

In December 2015, Congress extended the PTC under Section 45 of the Internal Revenue Code of 1986, as amended (the “Code”), for two years with respect to certain facilities (e.g., biomass facilities, geothermal facilities and certain hydropower facilities) the construction of which begins before January 1, 2017, and wind facilities the construction of which begins before January 1, 2020. The same legislation also instituted a phase-out of the PTC for wind facilities. Under this phase-out, for wind facilities that commence construction during 2017, the amount of the PTC will be reduced by 20%. For wind facilities that commence construction during 2018, the amount of the PTC will be reduced by 40%. For wind facilities that commence construction during 2019, the amount of the PTC will be reduced by 60%. We discussed these extensions and limitations along with other impacts of the legislation on renewable energy tax credits in a prior client update, which can be found here.

Under Section 48 of the Code, a taxpayer may elect the ITC in lieu of the PTC with respect to these facilities. To be eligible for the PTC (or the ITC), construction of the qualifying facility must begin before the appropriate date (the “Commencement of Construction Requirement”). In Notice 2013-29, the IRS provided two alternative tests under which a taxpayer may meet the Commencement of Construction Requirement: the “Physical Work Test” and the “Five Percent Safe Harbor.” In either case, the taxpayer must make continuous progress towards completion of the facility (the “Continuity Requirement”). Notice 2013-29 was the subject of a prior client update we issued on April 17, 2013, which can be found here.

In Notice 2013-60, the IRS provided a safe harbor (the “Continuity Safe Harbor”) under which a taxpayer is deemed to meet the Continuity Requirement if the facility was placed into service before January 1, 2016. If the taxpayer does not qualify for the Continuity Safe Harbor, whether the taxpayer meets the Continuity Requirement will be based on the relevant facts and circumstances. Notice 2013-60 was the subject of a prior client update we issued on October 2, 2013, which can be found here.

In Notice 2015-25 and as a result of the Congressional extension of the PTC, the IRS extended the Continuity Safe Harbor by one year to include facilities placed into service before January 1, 2017 if construction began before January 1, 2015.

In May 2016, the IRS released Notice 2016-31, which extended the Continuity Safe Harbor to four years from the end of the year in which construction began. Under Notice 2016-31, a taxpayer who begins construction, as measured under either the Physical Work Test or the Five Percent Safe Harbor, will be deemed to meet the Continuity Requirement if the facility is placed into service by the later of (1) a calendar year that is no more than four calendar years after the year during which construction began or (2) December 31, 2016. Notice 2016-31 also prohibited a taxpayer from effectively extending the Continuity Safe Harbor period by using the Physical Work Test in one year then using the Five Percent Safe Harbor in a following year with respect to the same facility. In addition, Notice 2016-31 provided guidance as to when facilities containing used property were qualified facilities and how the Five Percent Safe Harbor applied to such facilities. Under that guidance, a facility may be a qualified facility if the fair market value of such used property is not more than 20 percent of the facility’s total value, which is the cost of the new property plus the value of the old property (the “80/20 Rule”). However, only the expenditures paid or incurred with respect to new construction used to retrofit the facility count towards satisfying the Five Percent Safe Harbor. A more complete discussion of Notice 2016-31 can be found in our June 16, 2016 client update, which is available here.

2. Notice 2017-4 Extends the Continuity Safe Harbor

The Notice extends the Continuity Safe Harbor to allow a taxpayer to satisfy the Continuity Safe Harbor if the taxpayer places the facility into service by the later of (1) four years from the end of the year in which construction began and (2) December 31, 2018. Under this rule, taxpayers have two more years to complete projects unlike the earlier guidance in Notice 2016-31, which set the latter deadline at December 31, 2016. While this extension has little impact on projects begun recently, it may help taxpayers who began construction on a qualifying facility several years ago but with respect to which the construction had been interrupted or delayed. For example, under Notice 2016-31, qualifying facilities construction of which began in 2012 or earlier would not qualify for the Continuity Safe Harbor unless completed on or before December 31, 2016. Now, projects begun in 2013 or earlier years can qualify for the Continuity Safe Harbor if placed in service before December 31, 2018.

3. Notice 2017-4 Permits Use of the Different Safe Harbors in Alternating Years in Certain Cases

Notice 2016-31 prohibited taxpayers from relying on the Physical Work Test in one year and the Five Percent Safe Harbor in the following year to satisfy the Continuity Requirement. After issuing Notice 2016-31, IRS officials publicly indicated that the IRS may reconsider this rule. Rather than reconsider the rule in full, the Notice applies this prohibition prospectively only as of June 6, 2016, the date on which Notice 2016-31 was published in the Internal Revenue Bulletin. The prospective application of this rule implies that taxpayers that satisfied the Physical Work Test prior to 2016 and then subsequently satisfied the Five Percent Safe Harbor before June 6, 2016 (or vice versa) could benefit from the Notice by using the latter date to start the four-year period to satisfy the Continuity Safe Harbor. For example, if a taxpayer began construction January 1, 2015 under the Physical Work Test but cannot place the facility into service until after December 31, 2019, then the taxpayer cannot meet the Continuity Safe Harbor (i.e., because the placed-in-service date is more than four years since commencing construction and after December 31, 2018). However, if under the Five Percent Safe Harbor, the taxpayer began construction on January 1, 2016, then the taxpayer may qualify for the Continuity Safe Harbor because the placed-in-service date is within four years of commencing construction.

4. Notice 2017-4 Clarifies the Treatment of Retrofitted Facilities & the 80/20 Rule

Under Notice 2013-29, the Five Percent Safe Harbor is applied by taking into account all costs properly included in the depreciable basis of the facility. The Notice clarifies that, with respect to determining whether a retrofitted facility can meet the 80/20 Rule, the costs of the new property to be taken into account includes all costs properly included in the depreciable basis of the new property, thereby including indirect costs that may be capitalized into the tax basis of the facility. This clarification aligns the application of the 80/20 Rule with the calculation of costs to determine whether the Five Percent Safe Harbor has been met.