IRS issues solar construction-start guidance: Notice 2018-59

Author: Keith Martin Publication | June 22, 2018
IRS issues solar construction-start guidance: Notice 2018-59

Solar developers got long-awaited guidance from the Internal Revenue Service today about what must be done on future projects to be considered under construction in time to qualify for federal tax credits.

The IRS said, as expected, that the same general principles that apply to wind farms will also apply to solar.

The guidance also applies to fuel cells, small cogeneration facilities (called CHP projects), geothermal heat pumps and wind farms using small turbines of 100 kilowatts or less.

It is in Notice 2018-59.

Solar projects qualify for a 30% investment tax credit, but only if under construction by December 2019.

The tax credit drops to 26% for projects that start construction in 2020 and 22% for projects that start construction in 2021.

The other types of projects to which the guidance applies face varying deadlines.

There are two ways to start construction. One is by starting "physical work of a significant nature" at the project site or on equipment for the project at a factory. The other is by "incurring" at least 5% of the total project cost. With one exception, it is not enough merely to spend money. Costs are not considered incurred until equipment or services are delivered. The exception is a payment counts if the equipment or services are delivered within 3 1/2 months after payment.

The developer must also be able to prove continuous work on the project after the year in which construction starts, but not if the project is completed within four years.

Physical work

Physical work at a factory or by a construction contractor at the site must not start until a binding contract is in place to have the work done.

The IRS said it focuses on the nature of the work and not the quantity or cost. It said "there is no fixed minimum amount of work or monetary or percentage threshold required."

It gave a list of examples of types of physical work it considers significant.  

For solar, installation of "racks or other structures" to which solar panels will be affixed at the site is significant. Manufacture at a factory of "components, mounting equipment, support structures such as racks and rails, inverters, transformers" and "other power conditioning equipment" qualifies. Work at a factory on components does not count if the components are a type that the manufacturer normally keeps in inventory.

For fuel cell projects, installation of a fuel cell stack assembly is significant.

For geothermal, installation of "piping," flash tanks or heat exchangers is enough.

Preliminary activity, such as clearing a site or removing existing equipment, does not count.

The physical work must be on equipment that is "integral" to generating electricity.

The IRS said fences are not integral to generating electricity. Roads are integral, but only if they are needed to operate and maintain the power project. Roads that are primarily for access to the site or that are used primarily for employee or visitor vehicles are not integral. Buildings are not integral, but not all structures are considered buildings. For example, a structure that is basically a shell that will be removed when the equipment it houses is removed is considered part of the equipment.

5% test

The alternative is to "incur" at least 5% of the total project cost before the deadline.

Costs are usually "incurred" when equipment or services are delivered. However, a bare payment counts if the equipment or services are delivered within 3 1/2 months after the payment. Delivery can be at the factory. The equipment should not have to go back to the factory for further assembly. It should be integral to generating electricity.

Services count only at the point where all the services that the developer contracted to have done have been delivered.

The 3 1/2-month rule is a "method of accounting." Some developers may be unable to use it.

In cases where equipment, like a fence, is not integral to generating electricity, then its cost does not count toward the 5% test, but it is also ignored when adding up the total cost of the project.

Most developers try to incur at least 7% of the project cost in order to provide a safety margin in case there are cost overruns. The IRS said the developer will be out of luck if the costs incurred before the construction-start deadline end up being less than 5% of the final cost, unless the project can be broken into separate phases or units that can operate independently of each other. In that case, the developer can draw a circle that is 20 times the costs incurred before the construction deadline to see how many of the phases or units can fit inside. For example, suppose a project consists of five separate units, each of which costs $100X, cost overruns push the per-unit cost to $120X, and the developer incurred $25X before the deadline. Twenty times $25X is $500X. The final project cost is $600X. Four of the five units can be treated as under construction in time as the final cost of four units was $480X.

Continuous work

It is not enough to have started construction in time. There must also be continuous work on the project after the year in which construction started.

The IRS said it will not make developers prove continuous work on projects that are completed within four years.

If work on the project runs past four years, then the type of proof required depends on how construction started. Developers who relied on physical work to start construction must prove "continuous construction," meaning continuous physical work. Developers who relied on the 5% test need only prove "continuous efforts," which can involve steady work on developer-type tasks and arranging financing.

Breaks in continuous work for reasons that are outside the control of the developer are excused. Examples are severe weather conditions, natural disasters, delays in obtaining permits and interconnection-related delays. However, they do not extend the four years. They merely excuse failure to have worked continuously if proof must be provided because the project takes longer than four years to complete.

The US tax code requires any solar or fuel cell project on which a 30%, 26% or 22% tax credit will be claimed to be in service by the end of 2023. Thus, the continuous work requirement is relevant only for projects on which construction started before 2019. It is a good idea to keep weekly logs showing what was done on projects that qualify under the 5% test and start construction in 2018 in case proof of continuous work will be required.

For other tips, see "Another Rush to Start Construction: Practical Advice" in the February 2016 Project Finance NewsWire.


The IRS will not issue private letter rulings confirming that projects were under construction in time.

The IRS said that a developer who starts work in one year under the physical work test will not be able to buy more time to complete the project by restarting in a later year under the 5% test. However, this only applies to projects on which construction first starts after 2018. Thus, a project on which construction started in 2018 or before can restart later under the 5% test to buy more time.

Repowering of older projects may allow a developer to qualify for a tax credit on the repowered facility. The developer would have to spend enough on the repowering that the developer is considered to have built a new facility. This happens if the amount spent on improvements is at least four times the value of the used equipment retained from the old facility. The IRS said it will apply this "80-20 test" to each separate unit. Thus, one unit might be considered to have been so extensively rebuilt as to be considered brand new while other units at the same project do not qualify. Construction work on the repowering would have to start before the construction-start deadline.


Keith Martin

Keith Martin

Washington, DC