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Q&A: Grant Eligibility for Costs Incurred Prior to 2009

Published by Tony Grappone, Novogradac & Company LLP RETC Working Group on Saturday, January 1, 2011

Journal cover January 2011   Download PDF

Question: Are costs incurred in years prior to 2009 includable in eligible basis for a Section 1603 grant in lieu of energy tax credits?

Answer: Yes, but it depends on when construction began.

Background
Under Section 1603 of the American Recovery and Reinvestment Tax Act of 2009, the Treasury Department makes payments to eligible persons who place in service specified energy property and apply for such payments.  

In guidance released in March 2010, Treasury said: “Qualified property must originally be placed in service between January 1, 2009, and December 31, 2010, (regardless of when construction begins) or placed in service after 2010 and before the credit termination date if construction of the property begins between January 1, 2009, and December 31, 2010. Qualified property includes expansions of an existing property that is qualified property under section 45 or 48 of the IRC.”

The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 recently passed by Congress and signed into law by the president extended until December 31, 2011 the date by which construction must begin or qualified property must be placed in service.

The guidance also includes clarification that construction doesn’t begin until physical work of a significant nature occurs, and it specifically states that physical work of a significant nature does not include preliminary activities such as planning or designing, securing financing, exploring, researching, clearing the site, test drilling, or excavation to change the contour of the land (as distinguished from excavation for footings and foundations). This suggests that construction doesn’t begin until physical work of a more significant nature than these types of activities occurs.

The following two hypothetical fact patterns have been created to illustrate how to determine whether or not pre-2009 costs can be included in eligible basis for the Section 1603 grant. The first example illustrates pre-2009 costs which are not eligible.

Fact Pattern 1
ABC Energy (ABC) incurred costs for the development of their biomass facility during the years of 2007 to 2012. Costs incurred during years before 2009 included costs for the purchase and installation of plant and equipment. The facility is expected to be placed in service some time during 2012. Are all of the costs incurred from 2007 to 2012 includable in eligible basis for a Section 1603 grant payment?

Conclusions
Because this project began construction in a year earlier than 2009, and it is not expected to be placed in service before December 31, 2011, only those costs incurred in 2009 and later years will be eligible (assuming all other qualifications are met). If ABC was to place its qualifying energy facility in service by December 31, 2011, development costs incurred in any year (as long as they meet all other qualifications) would be includable in eligible basis for the Section 1603 grant payment.

Fact Pattern 2
Upon formation in July of 2008, XYZ Energy (XYZ) began preliminary planning for a wind energy project. Around that same time XYZ began incurring design and engineering costs with respect to services performed during predevelopment in order to obtain permits. For the next 12 months of the predevelopment phase of the project XYZ focused on obtaining permits. The project obtained its permits in the early part of 2010. At that point the developer begins having formal discussions with lenders and investors, running numbers, drafting documents, etc.; construction commences in November 2010 with the installation of a significant amount of equipment. The project is expected to be placed in service some time in 2011.

Conclusions
In this example, XYZ begins its predevelopment phase of the energy project and incurs costs prior to 2009. However, the question is: had physical work of a significant nature occurred before 2009? According to Treasury, construction doesn’t begin until physical work of a significant nature occurs. Using the logic explained in the guidance from Treasury, it seems that the preliminary activities that XYZ engaged in to obtain permits does not constitute physical work of a significant nature. Therefore, construction didn’t officially begin until 2010 when hard construction costs began. Therefore, assuming the project met all other qualifications, the costs incurred in 2008 would be includable in eligible basis for the Section 1603 grant.

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