The Internal Revenue Service has issued three private letter rulings confirming that a 30% investment tax credit can be claimed on batteries that are installed as part of renewable energy projects.

The batteries must be positioned and operated in a way that they are considered part of the electric generating equipment.

Two of the rulings involved 32- and 36-megawatt batteries installed at merchant wind farms. One addressed batteries installed with rooftop solar systems. The US Department of the Treasury paid a cash grant on another battery installed at a large contracted wind farm.

The IRS has also declined to rule in some cases that pushed boundaries beyond the cases on which it has ruled.

The IRS is in the process of revisiting in what circumstances batteries qualify for investment tax credits. Tax credits can only be claimed on generating equipment. The issue is when is a battery considered part of the generating equipment. The IRS is sifting through 25 to 30 letters received in response to a request for comments. The issues are complicated and will probably take into 2017 to resolve.

IRS Rulings

In the first private ruling, a 32-megawatt lithium-ion battery installed at original construction of a merchant wind farm qualified for a tax credit as part of the generating equipment.

The battery is on the low side of the step-up transformer. Only 3% of the electricity stored each year on average was expected to come from the grid. The main function of the battery is to act like a knob on a motor to regulate the ramp rate at which wind electricity is fed into the grid. However, the plan was to use the battery also to provide frequency regulation services to the grid. Revenue from regulation services was expected to account for roughly 20% of total revenue of the wind farm.

The second private ruling dealt with a 36-megawatt advanced lead-acid battery installed at an existing merchant wind farm.

The wind company said about 15% of electricity on average used to charge the battery would come from the grid. The battery is on the low side of the step-up transformer. It is being used to provide various ancillary services to the grid. These services include spinning reserves, non-spinning reserves, voltage support, ramp control and black start. Revenue from ancillary services amounts to about 15% of total revenue of the project.

The third private ruling was issued to a solar rooftop company.

The company installs batteries on the same side of the inverter as the solar rooftop systems. The batteries have four possible uses: to store excess solar electricity from the rooftop solar system, store grid electricity at off-peak rates for use during peak hours, reduce demand charges and earn revenue by providing regulation services to the grid. The solar company said it was unable to represent that the batteries would be used mainly to store excess electricity from the rooftop systems. As a consequence, the IRS said the batteries qualify for investment tax credits, but it imposed a “75% cliff.”

A “75% cliff” means that at least 75% of the electricity stored in the year the battery is put in service must come from the solar equipment to be able to claim any investment tax credit. The actual tax credit is the percentage of solar electricity stored that year.

For example, if 80% of the electricity stored in the first 12 months after the battery is installed is solar electricity from the rooftop system, then a 24% investment tax credit — 80% of 30% — can be claimed on the battery. If the percentage drops in any of the next four years, then there is partial or full recapture of the unvested tax credits.

Investment tax credits vest ratably over five years. Thus, for example, if solar electricity accounts for only 75% of electricity stored in year two, then 5% (the 80% first-year use minus the 75% second-year use) of the unvested tax credit must be repaid to the US Treasury. The unvested credit in year two is 80% of the original 24% tax credit.

If the percentage drops below 75% in any of years two through five, then the entire unvested tax credit that year is recaptured.

The IRS told the two wind companies that there would not be a 75% cliff in their cases. After the solar rooftop ruling, the IRS warned that it might rethink whether a 75% cliff should also apply in the wind cases, but it never revised the wind rulings.

One problem with a 75% cliff is it is unadministrable. It does not work to make whether and how large a tax credit can be claimed in the tax year in which a solar system is placed in service depend on measurements that must be done over the 12 months after the battery is installed. The measurements could run well past the deadline for filing the tax return on which the tax credit is supposed to be claimed.

The IRS declined to rule that a 45-megawatt battery qualified that was physically distant from a solar project whose electricity it would store. A utility bought the electricity at the substation for the solar project and proposed to send it back to the solar company for storage in the battery. The electricity would have stepped up to transmission voltage in the meantime and then stepped down when it reached the battery. The battery would have been owned by the same project company that owned the solar project. The solar company proposed to collect a premium from the utility for the electricity for delivering a more firmed and shaped product.

Private letter rulings are not binding on the government, except for the taxpayers who received them.

Suggestions

Here are the main lessons to take away. An investment tax credit can be claimed currently on a battery, but in order for the battery to qualify, it must be considered part of a solar, wind, geothermal or other power plant that qualifies for tax credits. It should be on the low side of the step-up transformer or the same side of the inverter as a solar rooftop system. It should be owned by the same legal entity that owns the project. It should be used mainly to store electricity from the renewable power plant or solar rooftop system. In the case of a utility-scale power plant, it should be like a knob on a motor that regulates the ramp rate at which electricity from the power plant is fed into the grid.

There may be some cosmetic benefit if the battery is also treated for regulatory purposes as a generator rather than a transmission asset. However, the regulatory treatment does not determine ultimately whether the battery qualifies.

An investment tax credit cannot be claimed on a battery that is added to a power plant on which production tax credits will be claimed on the electricity output. Claiming tax credits on the electricity output while at the same time claiming a tax credit on part of the project cost would double up impermissibly on tax benefits.

Even though one of the three private rulings says otherwise, the IRS is unsure whether an investment tax credit can be claimed on improvements to existing facilities.

We think the law is clear: an investment tax credit can be claimed on later improvements assuming they are completed when the investment tax credit is available. After discussions with the IRS branch in Washington that handles these issues, the branch reported back that it agrees. However, when a solar company asked the branch to put the position in writing in a private letter ruling, the branch said the ruling request was too abstract. The IRS only rules on actual cases. The IRS position also seemed a little less clear after the ruling request was assigned to a new attorney in the branch who was not part of the discussions that preceded the ruling request.

There are two tax credits for solar projects: an investment tax credit under section 48 of the US tax code for solar equipment put to business use and a residential solar credit under section 25D of the US tax code for solar equipment purchased by a taxpayer for personal use in his or her residence. No rulings have been issued about batteries and the residential solar credit under section 25D. Eligibility is probably the same as for the investment tax credit. The battery must be used to store solar electricity.

Congress set deadlines in December 2015 for different types of renewable energy facilities to be under construction to qualify for investment tax credits. A battery that is an addition to an existing project must be under construction by the same deadlines.

It is rare to see a wind farm in 2016 on which an investment tax credit will be claimed. If given a choice between a tax credit tied to electricity output and one tied to project cost, wind companies choose the tax credit on electricity output. Turbine prices have been falling and efficiencies have been increasing. The only exception where an investment tax credit might be claimed is an offshore wind farm that has a very high capital cost.

Solar projects qualify only for investment tax credits. Unlike wind farms, they do not have a choice of claiming PTCs. Solar projects must be under construction by December 2019 to qualify for a 30% investment credit. Projects that start construction in 2020 qualify for a 26% credit. Projects that start construction in 2021 qualify for a 22% credit. After that, the credit falls to its permanent level of 10%. Any solar project on which greater than a 10% investment credit will be claimed must be in service by December 2023.

A battery added later to an existing solar project must also meet these deadlines.

There are two ways to start construction. One is by doing physical work of a significant nature at the project site or by starting work on the battery at the factory. There must be a binding contract in place with the battery vendor for the battery, or with another contractor for other work, before the work starts.

The other way to start construction is to “incur” at least 5% of the total cost before the construction-start deadline. Costs are not incurred merely by spending money. As a general rule, costs count only as equipment is delivered. Delivery can be at the factory. However, it may be possible to pay before the deadline and take delivery within 3 1/2 months after payment. (For more details, see articles in the February 2016 NewsWire and the June 2016 NewsWire.)

New Guidance?

The existing IRS regulations on what qualifies for investment tax credits date to 1982. The IRS is in the process of updating them.

Many comments were received about when energy storage facilities should qualify for investment tax credits. The issues are complicated and are unlikely to be resolved before 2017 at the earliest.

The Solar Energy Industries Association is urging the IRS to dispense with the 75% cliff and allow a full investment credit if the primary use of the battery is to store solar energy or the battery lets the taxpayer use solar energy when local utility service is not available. It also wants the IRS to allow different ownership of the battery and solar power plant.

At least one solar company proposed a functional use test. A battery would be considered part of the electric generating equipment — and, thus, qualify for an investment credit — if it performs a “generator function,” meaning it is on the solar side of the inverter and is used to store excess solar electricity or to regulate the ramp rate.

The IRS received 25 to 30 comment letters. It met over the summer with some groups that submitted comments. Two IRS attorneys have been assigned to work on the new regulations.

Meanwhile, the IRS said in a new notice in June that amounts that owners of standalone energy storage facilities pay utilities to connect to the grid do not have to be reported by the utilities as income. This will make interconnecting standalone storage projects less expensive. Utilities would otherwise have asked standalone storage owners to pay not only the cost of switchyard improvements and network upgrades to accommodate the storage project on the grid, but also a tax gross up that could have added significantly to the interconnection cost. The notice is Notice 2016-36.

The storage facility cannot be a customer of the utility for transmission services or for more than a minor amount of backup power.

Separately, a bill that would allow a 30% investment tax credit to be claimed on all types of energy storage — whether or not they are part of renewable energy facilities — is gradually picking up support in Congress. Tax credits would be available on the same schedule as the investment tax credit for solar. The bill is unlikely to be enacted in 2016. Its prospects in the next Congress in 2017 or 2018 depend on the outcome of the presidential and Congressional elections in November.