The 26% ITC Clock Is Ticking. Is Your Project Safe Harbored?

It may only be September, but now is the time to make sure your current or potential solar project can capture the current 26% solar investment tax credit (ITC). Unless Congress and the administration intercede, the solar ITC will step down from 26% to 22% on January 1, 2021. If you’re going to build a $100,000,000 project and bring it online before the end of 2023, capturing the 2020 safe harbor brings $4 million to your bottom line.

To capture 26% credit, your solar projects must either be placed in service by the end of 2020 or satisfy the Internal Revenue Service (IRS) safe harbor provisions. These complex IRS provisions allow developers to put a stake in the ground by the end of 2020 and, under certain conditions, receive the 26% ITC if the project is completed by the end of 2023.

The following is a simple overview of the IRS' safe harbor provisions for solar projects and some strategies for compliance. It is not legal advice, so please consult your tax adviser to ensure that your safe harbor plan is informed by them.

What Is the IRS’ Safe Harbor Provision for Solar Energy Projects?

Under certain conditions, broadly termed “continuous construction” and the “5% rule,” the ITC’s safe harbor provisions allow solar projects to capture the 26% credit, despite the project not being placed in service by the end of 2020. 

In the first approach, the asset owner must demonstrate that it has begun physical construction and that the construction is continuous. In the second approach, asset owners must spend 5% of the project’s total costs by the end of 2020. Let’s briefly explore these options.

The 5% Rule

With the 5% rule, the project owner must purchase (and actually spend the money) a minimum of 5% of the total cost of the solar property by December 31, 2020. Depending on when payment is made (and no later than 11:59 p.m., December 31), the buyer must take possession of the property by about April 10, 2021. For example, the developer could purchase enough solar modules to meet the 5% cost threshold of the total estimated property cost. As a rough guide, if solar modules are 30% of the total cost of a project, you could buy approximately 15% of the total amount of modules and hit the 5% threshold.

It’s important to note that the asset owner must take title of the equipment by the April 2021 deadline. It is not enough to simply purchase enough modules to meet the 5% provision and then later have them manufactured and delivered to the job site when convenient. The asset owner must have physical and clearly identifiable possession.

However, “possession” doesn’t have to be at the buyer’s location; the buyer can take possession anywhere in the world. Demonstrating that physical possession can be as simple as storing the modules in a dedicated warehouse or a private, padlocked shipping container with a rental agreement in your name. More complicated would be having a dedicated section of the factory's shipping warehouse. In this case, some demarcation and label would be needed, as well as other protections. The concept is to ensure that the goods belong to the buyer and unavailable to anybody else.

To establish compliance with the 5% rule, project developers may wish to contract with a quality assurance provider (that’s CEA, of course) to independently document and verify the equipment has been purchased, manufactured, properly identified, and exclusively stored for later use by the asset owner. This typically calls for an on-site inspection at the production facility and sometimes at the storage facility as well. Evidence usually includes the eyewitness account, review of the documentation, and detailed photos. 

Continuous Construction

The other way to preserve 2020’s 26% ITC for a project being built in 2021 or later is to satisfy the continuous construction clause. Rather than purchase 5% of the total expected equipment costs, you could start substantial “construction” at the project site by paving roads, grading the land for future single-axis trackers, or installing foundations. 

With this provision, there is no specific amount of money that has to be spent, so there can be minimal capital costs. You can also qualify for continuous construction that takes place away from the project site, including, for example, at a factory that is producing equipment for you. For this to qualify, the equipment must be clearly identified as built for you—and not taken from stock.

We’ve see examples of equipment constructed (and not necessarily finished construction) for transformers, tanks for transformers, inverter components, and mounting system components. In each case, the parts have been made for a particular buyer, and there is traceability, which is often a physical identification that the item “belongs” to the buyer. Evidence may include an inspection of the project site for on-site construction and inspection at the producer of the component that is produced off-site.

As with the 5% path, evidence usually includes the eyewitness account, review of the documentation, and detailed photos. In addition to providing the IRS with the evidence, the buyer will also likely have to provide a document to the IRS certifying that the buyer believes they have met the requirements for safe harbor. It would be prudent to define this document with your counsel in advance of the inspection.

Independent Safe Harbor Verification

In order to validate continuous construction compliance or the 5% safe harbor provisions and reduce the risk of the IRS disqualifying the 26% ITC, tax attorneys and advisers often utilize an independent quality assurance company to provide clear evidence and documentation of your 5% equipment purchases, land preparation, and the building of specialized equipment.

Due to the international supply chains and the race to procure the right amount of solar equipment before January 1, 2021, your safe harbor audit team should already be on the ground and familiar with various suppliers in multiple countries. Based on activities for the 2019 safe harbor program, you can expect the need to have auditors on-site during Q4 2020, and especially during the last few weeks of the year. 

In addition to being able to document, photograph, and verify the serial numbers of your purchased equipment, independent verification services should also be able to provide asset owners with recommendations for secure warehousing.

Satisfying the IRS’ safe harbor provisions can be extremely complicated and there are many other regulations and requirements. For more information about independently verifying your ITC safe harbor provisions for 2020, contact CEA’s supply chain management team.