On February 20 and February 21, 2024, the Internal Revenue Service (IRS) and the Department of the Treasury (Treasury) held a public hearing on proposed regulations concerning the definition of energy property and rules applicable to obtaining tax credits pursuant to the Inflation Reduction Act of 2022 (IRA). The IRA allows taxpayers to deduct a percentage of the cost of eligible renewable energy systems from their federal taxes through an Investment Tax Credit (ITC) and Production Tax Credit (PTC).

The public hearing sought comment on proposed regulations issued on November 17, 2023 (REG-132569-17; the “November 2023 Proposed Rules”) and corrected on February 16, 2024 (the “February 2024 Proposed Rules”) that would, among other things, clarify the ITC eligibility of power conditioning and transfer equipment like subsea export cables used in offshore wind projects; provide rules on the credit eligibility of standalone battery storage; and prescribe rules for including qualified interconnection costs in the basis of some lower-output energy properties. While these rules will almost certainly undergo further revisions before being made final, a taxpayer may rely on these proposed regulations with respect to property placed in service after December 31, 2022 and during a taxable year beginning on or before the date the final regulations are published in the Federal Register, as stated in the proposed rules.

A qualified project for the ITC includes energy storage technology, geothermal electricity, multiple solar and wind technologies, fuel cells, and biogas property, so long as the construction, reconstruction, or erection of the property is completed by the taxpayer, or the property is acquired by the taxpayer if the original use of the property commences with the taxpayer. ITC-eligible property consists of all the components of the energy property that would be included in a functionally interdependent unit of energy property, as well as property owned by the same taxpayer that is considered an “integral” part of such energy property. Certain interconnection property also qualifies for the ITC for facilities not exceeding five megawatts. Generally, eligible taxpayers can claim the ITC for qualifying energy property and may be eligible to claim an increased ITC if certain requirements are satisfied, including prevailing wage and apprenticeship requirements, certain domestic production requirements, and, if the project is sited in an “energy community,” an additional maximum adder of ten percentage points, as we have previously covered in a prior blog post.

The November 2023 Proposed Rules provided additional clarity on what property is considered “integral” to energy property. A detailed offshore wind facility example in the November 2023 Proposed Rules treats all offshore and onshore power conditioning and transfer equipment up to and including at the onshore substation where the project’s electricity is converted to electrical grid voltage as eligible for the ITC. This includes wind turbines; inter-array cables; the transformer and converter at the offshore substation; subsea export cables; and the converter, transformer, and switchgear at the onshore substation, but excludes transmission and distribution equipment. Other qualifying, “integral” property includes onsite roads used for equipment to operate and maintain the energy property, buildings that are essentially an item of machinery or equipment, and a building or structure that houses property that is integral to the activity of an energy property if the use of the structure is so closely related to the use of the housed energy property that the structure clearly can be expected to be replaced when the energy property it houses is replaced. Property not treated as “integral” includes fencing and roads primarily used for access to a site or employee parking.

The November 2023 Proposed Rules also adopted a technology-neutral definition for energy storage technology and provided a non-exclusive list of different types of energy storage technologies that qualify for the ITC. The IRA defines “energy storage technology” as property—other than property primarily used in the transportation of goods or individuals and that is not used to produce electricity—that receives, stores, and delivers energy for conversion to electricity and has a nameplate capacity of not less than five kilowatt hours. Thermal energy storage and hydrogen storage property are also considered energy storage technology. The proposed regulations specified that rechargeable electrochemical batteries (lithium ion, vanadium flow, sodium sulfur, and lead-acid), ultracapacitors, physical storage such as pumped storage hydropower, compressed air storage, flywheels, and reversible fuel cells qualify. ITC-eligible hydrogen energy storage property would be required to store hydrogen used solely for the production of energy and not for the production of end products, such as fertilizer. On the other hand, virtual batteries that shift demand to different points in time would not be considered energy storage technology, and property primarily used in the transportation of goods or individuals, such as batteries incorporated into motor vehicles, is excluded. The Treasury and the IRS requested comments as to how the exclusion for property primarily used in the transportation of goods or individuals should be defined and the specific types of property that should be covered by this exclusion.

Installation of interconnection property qualifies for the ITC only for smaller-output facilities not greater than five megawatts. The November 2023 Proposed Rules provided additional guidance on this qualified interconnection property, including the gloss that interconnection property is not to be taken into account when determining whether the associated project’s energy property satisfies the domestic production or energy community tax credit “adder” provisions. Additionally, if a larger energy project comprised of multiple discrete energy properties has a combined nameplate capacity over five megawatts, then each of the energy properties would nonetheless be eligible to include amounts paid or incurred by the taxpayer for qualified interconnection property if each separate energy property satisfies the five-megawatt limitation within the larger project.

Finally, the February 2024 Proposed Rules corrected the November 2023 Proposed Rules, noting that, as published, the November regulations would exclude from the definition of “qualified biogas property” any “gas upgrading equipment necessary to concentrate the gas into the appropriate mixture for injection into a pipeline through removal of other gases such as carbon dioxide, nitrogen, or oxygen.” A correction was needed to clarify that such gas upgrading equipment is considered energy property if it is an integral part of the biogas energy property.

The public comment period for the November 2023 Proposed Rules and the February 2024 Proposed Rules closes March 25, 2024, and comments can be submitted here. The SPR Blog will continue to track these developments and provide updates and analysis if additional guidance or rules are published or finalized.