January 15, 2013
Tax Credit Alert
Author(s): Forrest Milder

This Nixon Peabody Alert discusses recent tax law changes resulting from the American Taxpayer Relief Act of 2012 (ATRA) that apply to renewables.

Change in the sunset for many (but not all) renewables. The act made a significant change to the production tax credit (PTC) and the investment tax credit (ITC) that applies to wind, geothermal that generates electricity, biomass, landfill gas, municipal solid waste, hydroelectric production, and marine and hydrokinetic energy.

Before ATRA, each of these technologies was eligible for a PTC or ITC only if the facility was placed in service by the end of 2013 (except wind, which had to be placed in service by the end of 2012, and geothermal, which can also qualify for a 10% credit beyond that date).

With long lead times, extensive requirements for approvals, and often long construction periods, having the credit depend on whether the facility is completed by a certain date made for a very high burden. Both developers and tax credit investors perceived these kinds of projects as much more difficult because of the risk that the credit could be lost by the time the project was completed.

ATRA addresses this issue head-on by changing the sunset provision to depend on when the facility begins construction, rather than when the facility is placed in service. Now, if one of the facilities described above begins construction by December 31, 2013, it will be eligible for the applicable PTC or the 30% investment tax credit. Obviously, this is a big change that should help developers trying to line up tax equity in the face of an extended approval process.

A few observations:

1. There is no legislative history or other guidance explaining what it means to “begin construction.”

2. Many practitioners have suggested that the IRS adopt the standards set by Treasury for the 1603 grants in lieu of tax credits program, i.e.:

   1. the test of beginning physical work before the end of 2013 (and then continue to work on the project thereafter), and
   2. the test of accruing at least 5% of the cost of the project before the end of 2013.
3. Of course, Treasury’s guidance for these renewable technologies had three sunset provisions—an applicant had to begin construction by December 31, 2011; submit a preliminary (or final) application before October 1, 2012; and then place the facility in service by December 31, 2012, for wind, and December 31, 2013, for geothermal that generates electricity [1] biomass, landfill gas, municipal solid waste, hydroelectric production, and marine and hydrokinetic energy. On the other hand, the new ATRA extension for these kinds of renewables only has one sunset: Construction must have begun by December 31, 2013, so it won’t be surprising if the IRS seeks to impose some other limitations on the definition of “begun construction.”
4. Accordingly, it may be better to wait until we hear something from the IRS. There are many possibilities—the IRS might require more than 5% be incurred in 2013, 5% plus diligently working to finish the project, that a particular project be identified before it is begun or the end of the year, or other variations. Until something is actually published by the IRS, it isn’t possible to determine what the standard might be. We’ll keep monitoring tax legislation and IRS regulations, looking for any rules or modifications to what we’ve seen so far.

Renewables that are still subject to the old rules. The tax credit rules for solar, fuel cells, small wind, microturbines, combined heat and power facilities, geothermal that generates heat, and geothermal that generates electricity, but that begins construction after 2013, continue to have the same placed-in-service tests as before ATRA. For example, solar facilities must still be placed in service by the end of 2016 to qualify for the 30% ITC. Industry groups are continuing to seek a “begun construction” rule here as well for those projects with very long lead times.

Section 1603 grants. No changes were made to the Section 1603 grant program for any renewable technology. In particular, no change was made in the sunsets for grants. As a result, to qualify for a grant, a renewable facility still has to meet the three sunset provisions described above, with the addition of a later placed-in-service date for solar, fuel cells, small wind, microturbines, geothermal that generates heat, and geothermal that generates electricity but begins construction after 2013, and combined heat and power. To qualify for a grant, each of these must be placed in service before 2017.

Sequestration. The sequestration rules, which OMB said would result in a 7.6% reduction in amounts paid under Section 1603, are still hanging over the industry. ATRA merely delays implementation by two months, from January 2, 2013, to March 1, 2013, leaving us wondering if the proposed percentage reduction in 1603 grant awards will still go into effect later this year. Again, industry groups are seeking an exemption for the Section 1603 grant program.

Technical fix: Facilities must be new. Most people didn’t realize that, when the American Recovery and Reinvestment Act of 2009 (ARRA) permitted PTC-eligible facilities to instead qualify for the ITC, and for any renewable facility to qualify for a 1603 grant, the legislation did not include the requirement that the facility be “new.” The ATRA legislation retroactively adds that requirement, dating back to ARRA. Of course, for this purpose, “new” generally means “80% new.” This means that a $10M wind project that uses $1.5M of used tower parts should still be considered new.

Other credits. Several other credits were also extended. The homeowner’s credit for energy-efficient homes (Section 25C of the Code), the credit for alternative fuel refueling property (Section 30C), the credit for two- or three-wheeled plug-in vehicles (Section 30D), and the business credits for energy-efficient homes (Section 45L) and appliances (Section 45M) all now include facilities placed in service in 2012 or 2013. Finally, in the case of residences, the reference to an efficiency standard has been updated from the International Energy Conservation Code of 2003 to the Code of 2006.

The credits for cellulosic biofuel, biodiesel, and renewable diesel are extended to apply to fuel production before January 1, 2014. Note that these credits and the corresponding extensions are based on the date of the production of the particular fuel, not the date that the facility is placed in service. In addition, cellulosic fuel is now called “second-generation biofuel,” and the definition is modified to include fuel derived from algae, cyanobacteria (a kind of bacteria that uses photosynthesis), and lemna (a kind of aquatic plant). Similar extensions are provided for the comparable alternative fuels excise tax credits in code sections 6426(d)(5) and (e)(3). Finally, there’s a one-year extension of the Indian coal credit, which is limited to certain facilities placed in service before 2006.

Bonus depreciation. ATRA extends “bonus depreciation” another year so the 50% bonus applies to property placed in service before January 1, 2014, and even January 1, 2015, for certain property. Second generation biofuels (described in the “Other credits” paragraph) have a similar 50% extender until the end of 2013. To illustrate, imagine a $1M facility that qualified for a 30% ITC to be claimed by its owner. The basis in that facility will be $850K (after reduction by half the amount of the $300K credit), and first-year depreciation will be the bonus, i.e., 50% of $850K (or $425K) plus regular 5-year accelerated depreciation, equal to 20% of the balance (or $85K), for a total first-year deduction of $510K. Note that the bonus rules automatically apply unless the taxpayer elects for them not to apply. Sometimes, particularly where there is a tax credit investor, having this much depreciation in one year can overwhelm the investor’s capital account and actually cause some deductions to be allocated to other partners or members, so the effect of bonus depreciation should be carefully monitored.

Special rules for certain utilities. Section 451(i) provides favorable tax rules for certain utilities that sell their property to implement FERC or a state restructuring policy. These rules are extended to apply to sales or other dispositions that occur before January 1, 2014.

1. There’s also a 10% grant for geothermal placed in service by December 31, 2016.
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