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What Do I Need to Know About Repowering a Facility?

Published by Forrest D. Milder on Friday, August 4, 2017

Journal cover August 2017   Download PDF

Although renewable energy tax credits (RETCs), including investment tax credits (ITCs) and production tax credits (PTCs), are most commonly associated with newly constructed facilities, they can provide a great benefit to facilities in need of renovation as well. 

Here are some important considerations:

1. Does your repowering effort qualify for tax credits? RETCs for many kinds of technologies were phased out in recent years. Repowering a facility is subject to these rules, meaning that many facilities are no longer eligible for credits if they are renovated, regardless of whether they qualified for tax credits when previously placed in service.

Recognizing that there continue to be efforts to restore some of the now-expired credits for certain technologies, as of now, some technologies only qualify for RETCs if they began construction–or began renovation in the case of a repowering–before 2017. These technologies include biomass, anaerobic digestion, landfill gas, hydropower and hybrid solar lighting. This group also includes “small” wind, but it should continue to be eligible under the “general” wind rules. If the developments pass the before-2017 requirement, then they qualify for a 30 percent ITC or the full PTC. Another group is simply no longer eligible for credits. New construction and rehabilitation of fuel cells, microturbines, cogeneration and geothermal heat pumps are no longer eligible for RETCs if the construction or repowered facility is placed in service in 2017 or later.

This leaves solar, wind and geothermal electric. These technologies can commence construction or renovation of a new facility in 2017 and still qualify for credits, based on sliding scales. 

For wind, the percentages are as follows:

For solar electricity, solar water heating, solar space heating and cooling, and solar process heat, the percentages are as follows:

And finally, geothermal electricity qualified for a 30 percent credit or PTC if construction began before 2017, and a 10 percent credit thereafter.

So, the first step in determining whether your repowering effort is eligible for tax credits is finding the proper rule for your technology type and then determining if your renovation began by the appropriate date. Unless the law changes, this is going to limit repowering efforts that commence in 2017 to wind, solar and geothermal electricity, with the possibility that previously placed-in-service facilities based on biomass, anaerobic digestion, landfill gas, hydropower and hybrid solar lighting might have begun their renovation before the end of 2017 and still qualify for 30 percent ITC/full PTC.

2. Are you rehabilitating, or just fixing? The next step in your analysis is to determine whether you are spending enough on the new equipment to make the facility “new,” so that it qualifies for the credit. The test is applied by comparing the cost of the improvements to the total of the cost of the improvements and the fair market value of the existing facility. The resulting ratio of new expenditures to the sum must be at least 80 percent. This amount is computed as to each facility–e.g., each turbine, in the case of a wind project–and only the new equipment qualifies for credits. 

For example, suppose you have a wind project that consists of two old turbines, each with a fair market value of $200,000. Under the 80 percent test, you have to spend at least $800,000 on each renovation to qualify for the credit. It won’t work if you spend $700,000 on the one and $900,000 on the other; in that case, only the $900,000 renovation will qualify.

3. When did you begin the renovation? As noted earlier, the start of the renovation is very important. If it began last year, then many more technologies are eligible for RETCs. And on a going-forward basis, sooner is generally better than later. For example, as detailed in the tables above, the renovation of a wind project that began in 2017 will qualify for a 24 percent ITC, while a renovation that began in 2018 will only qualify for an 18 percent ITC. Such adverse rules don’t kick in until a few years from now for solar and starting with 2017, they never apply to geothermal electricity, which stays at 10 percent. 

4. How do we determine when the renovation began? For this purpose, we go back to the begun-construction tests that we have discussed several times. You will remember that there are two tests, the physical work test and the 5 percent safe harbor. While the 5 percent safe harbor provides mathematical comfort that the test has been passed, the IRS has provided a few illustrations that the mere pouring of foundations can be sufficient to show the start of physical work. Of course, this may not be useful in the context of a repowering and the developer may have to do something else to establish that an already-in-existence project is not being renovated. 

It is important to note that the begun-commencement test is computed differently from the one for the 80/20 test I described above. Here, the rule is applied to the whole project. For example, assume the facility consists of our two turbines from the previous example, with $200,000 of existing FMV and $800,000 of proposed work for each, and the developer accrues $100,000 of eligible costs on only Turbine 1 on Nov. 15, 2017. On these facts, we do the following math–total cost of new development is $800,000 plus $800,000, or $1.6 million. This amount multiplied by 5 percent is $80,000. Since the developer spent $100,000 in 2017, the project began construction in 2017, and it is eligible for a 24 percent ITC or 80 percent of the PTC. Note that the test is computed based on the amount expended for the new work and not anything expended for used equipment.

5. When does the project have to be finished? In addition to starting the project by a particular date, the IRS rules also require that the developer work on the project “continuously.” There are a large number of potential exceptions from the continuous-work requirement, ranging from work stoppages to weather to difficulties getting financing, but each of these requires substantial attention to detail and creates uncertainty. Fortunately, recent IRS notices give wind project developers a “safe harbor,” for which record-keeping is not required. If the wind project is finished by the end of the calendar year that is four years from the start of the renovation, then the developer will not have to demonstrate that it was “continuously” developing the project. For example, applying the same set of facts as we have used above, the repowering project began construction on Nov. 15, 2017, so the developer will have until the end of the calendar year that is four years later, or Dec. 31, 2021, to complete it. If the project is finished after that date, then the developer will have to produce evidence that it was working on the project continuously in order to qualify for the credit. So far, the IRS has not announced a solar rule comparable to the four-year rule that applies to wind, but it has reported many times that such a rule will be issued. Of course, with the far later sunset for the solar credit, there is far less pressure on the timing for publication of an appropriate rule.

Note also that the begun and finished rules can operate in opposition to one another. If the rehabilitation began earlier, then the project may qualify for a larger tax credit; on the other hand, the four-year period for completing the project will expire earlier, potentially accelerating the project timetable.

6. What should I be doing for recordkeeping? Plainly, it’s a good idea to be able to point to particular steps that constituted either “physical work” or the passing of the 5 percent safe harbor. However, remember that the IRS contends that a developer cannot do physical work and then change its mind to apply the 5 percent test in an effort to get a later date for complying with the four-year rule. Accordingly, some projects may face the difficulty of explaining how and whether what started as a major repair ultimately turned into a repowering. On the other hand, if the project was actually shut down, it should be a lot easier to identify when the developer “began construction” on its repowering project. To best establish that a repowering project has begun, it makes the most sense to have a contemporaneously prepared set of plans, a project budget and the ability to demonstrate that the requirements of the 5 percent safe harbor were met. 

Forrest David Milder is a partner with Nixon Peabody LLP. He has more than 30 years’ experience in tax-advantaged investments including the tax credits that apply to affordable housing, energy, new markets and historic rehabilitation, as well as the tax treatment of partnerships and LLCs, tax-exempt organizations, and structured financial products. He can be reached at (617) 345-1055 or [email protected]. 

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