Understanding ‘safe harbor’ for extending your 30 percent solar ITC qualification

Just after the midnight hour of New Year’s Eve 2020, more than confetti will be abandoned on America’s sidewalks and parlors.  Somewhere around $130 million dollars of Investment Tax Credit (ITC) from that year’s anticipated Commercial & Industrial solar projects will fall out from any hope of reaching the proverbial pocket books of the nation’s infrastructure investors (assuming 2000MW of C&I and Community solar, and a $2/w installation cost).  On 1/1/20, the ITC drops to 26 percent, a first step to further decrease the following year. 

Except, if you plan, the IRS has created legal methods to freeze the 30 percent ITC for future projects terminating in 2020 or even a couple of years beyond. The process is called Safe Harbor.

Deciding to seize that opportunity is not a decision to be made flippantly; a slip-up in execution could cost, not just the difference in the ITC credit from one year to the next, but the entire credit consideration, not to mention the urgent professional services which immediately follow when the IRS comes knocking.

To map how to approach Safe Harbor, I attended the Solar Energy Industry Association tax conference in New York in February of this year, where I also caught up with a couple of nationally recognized tax experts. Greg Jenner of Stoel Rives LLP, and Lee Peterson of Cohn Reznick, both Washington D.C.-based, helped me with my understanding of the subject (Note: save for the direct quotes of the afore-mentioned gentlemen, everything I write here is derived from my personal journalistic investigation of Safe Harbor; you should consult legal and accounting expertise prior to making any decision involving this important IRS option).

Not your uncle’s safe harbor

To those solar industry veterans who recall the last time we had a Safe Harbor situation, in 2012, check yourselves from thinking this is déjà vu all over again and want to run from it.  Back then, the program (referred to as the “1603 Grant”) was run by a different department under the Treasury, and it left plenty of roadkill in the form of denied incentives, which they would electively “grant.” Because the program was not bound by IRS rules, and not subject to “due process,” Treasury interpreted how much of the 30 percent your project would get, with macabre wizardry. You took what you got.

“Not the case this time around” is the consensus from the experts at the SEIA panel on the subject.  The IRS is running the program; it is bound by its own program rules, which have specificity and a full range of due process.  For example, if you have an installation with outlier engineering costs which you can defend, then there is little concern about whether the entire 30 percent would be eligible under Safe Harbor.  That’s good news for the initiated.

Four years to complete a 2019 Safe Harbor project.

If you do opt for Safe Harbor, then the IRS gives you up to 48 months to put your project in service, a generous amount of time.  However, this comes with an obligation to demonstrate that you have continuously been working on said project from 2019 on. Safe Harbor legitimacy rests on this.   There is also a hard stop at the four-year mark. Stoel Rives’ Greg Jenner makes the point: “If you begin construction in 2019, and you place the facility in service before the end of the fourth year following your start date [in 2023], then you are automatically deemed to have met the continuity rule.  It’s only if you go beyond 2023 that you fall into the Facts and Circumstances [in review with the IRS], and at that point you have major problems beyond proving to the IRS that you exercised continuous construction.”  Specifically, you might suffer full disallowance of your ITC, plus penalties. 

Your sweat or your money

So how does a project qualify for Safe Harbor?  You have a choice of two options.

Sweat :“Beginning of Construction” with “Continuous work”

It is the more challenging methods of the two, because of the stringent documentation and process requirements.  However, it does allow one to hold on to the 2019 ITC rate if a project has been demonstrably started before the drop in ITC rate, and if said project remains under active construction without interruption through commissioning.   

There is no specific threshold, litmus test or magic number that determines if you have legitimately “started construction” on your project.  However in June 2018, the IRS released the document called IRS 2018-59 (https://www.irs.gov/pub/irs-drop/n-18-59.pdf) called “Beginning of Construction for the Investment Tax Credit Under Section 48”.  Section 5 of that document states that the taxpayer must make “continuous effort to advance towards completion of the energy property”.

So there are two key standards that must be addressed: “substantially started work” and maintaining a status of “continuity of effort”.  If you have the fortitude to digest IRS documents without falling to their soporific effect, then you should probably read 2018-59 in its entirety (or make certain your attorney does).  

The lack of distinct clarity about what constitutes the beginning of construction means that the burden is on you, the party claiming the ITC, to prove to the IRS the substance of the work, both that which falls before and after 2020.  Lee Peterson provides insight about the Safe Harbor “work” method: “It’s a good solution but it’s not perfect. I have the ‘important talk’ with a client: If you can stand in front of the US Tax Court judge with the IRS sitting at the table to your right, and look him in the eye and convince [him or her] that it was legitimately continuous, knowing that both the judge and the IRS are sophisticated and have heard every explanation before, and if you can support your position with receipts and documents, then you should sleep comfortably.  If you can’t, understand that your tax credit calculations could be altered or denied.” In the end, the sagest overarching advice shared by Peterson is to “be diligent, regular and consistent with documenting indicia of continuity”.  There’s your guideline.

A shimmer of clarity does come from the “customized equipment” rule, again defined in IRS-2018-59.   This says that if you are asking a manufacturer to build equipment that is unique and special for the project specifically being safe-harbored, then that work can qualify as part of the construction effort.  But the component must have “design specifications that are outside the manufacturer’s spec’s”, says Greg Jenner.  The IRS provides the example of an inverter having particular and unique attributes, where the construction labor involved with delivering the product could be included under “beginning of work” or, perhaps, continuity of work.

Based on what I heard at the SEIA discussion, project developers and EPC’s that intend to use the “work” method should begin their work and its documentation well before they get to the deep end of 2019; it will avoid raising IRS eyebrows needlessly.  When you claim a 30 percent ITC in 2021, you’ll have to credibly document the timing. Pouring a rack footing in your party suit at 5pm on New Year’s Eve probably lacks that needed credibility, even if you hold on to your hardware store receipts.

Money: “Five percent…the bright line”

The IRS also provides the opportunity to hold on to the 30 percent ITC if you invest five percent of the eventual project cost by midnight of December 31, 2019.   If you have the option to choose your Safe Harbor strategy, then here are two strong reasons you might want to consider this method.

“Five percent is the bright line”, says Lee Peterson, and it does seem like a fairly straightforward, value-based definition.  But the next question might be “Five percent of what?” or, what is permissible as a definition of cost?  If you have any doubt about what represents the defensible contract cost of a renewable energy installation, then you should probably seek counsel for your Safe Harbor projects.   

Another reason this method might be softer on your ulcers, per Greg Jenner, is “it’s a lot easier to prove ‘continuous effort’ than ‘continuous work’.  All the stuff that goes toward development, from obtaining a PPA to obtaining an interconnection agreement, the financial and contract structuring and negotiations that one does when developing a project, that qualifies under ‘continuous effort’ but does not qualify for continuous work”. 

Project timing determines method

If you put a shovel into the ground in 2019 and want Safe Harbor, then you will need to demonstrate construction work without interruption until the system is placed into service. Actively finding an alternative financing solution while your construction team is on hiatus in the middle of 2020 will not qualify. If interruption for engineering, legal work, permit work or other project-structural reason is expected, experts advise against using the Work method.  In contrast, “if you buy panels or other components in 2019, using the 5 percent rule, continuity is presumed.” says Peterson, “It gives everyone involved most comfort.” 

In terms of the timing of component purchase to qualify, here are two pieces of good news. 

  1. Unlike for the “work” method, you can wait until the last moment to buy your components.   Cashflow considerations, technology improvements, or technology releases might compel you to do so, and the panel of experts at the SEIA conference agreed that a 12/31/2019 component purchase qualifies for Safe Harbor.
  2. You can delay delivery of said components for up to three-and-a-half months into 2020, which will be a welcome relief for those projects without warehousing solutions (Caution is called for when using that delivery delay if you’re an accrual method tax payer).  

But let’s say you, an EPC or contractor, do not yet have a specific project with an inked contract, only prospects; and let’s say you are willing to take a chance by investing in panels that you will assign in 2020 to one or more specific project(s). Will that qualify under “continuous effort”?  

“There is some uncertainty about that” says Greg Jenner.  “As a developer you can acquire components pursuant to the ‘Master Contract’ rule without a specific project in mind, and then later on allocate those components to a specific project, whether or not you owned that project at the time you entered into the Master Contract.” The IRS defined Master Contract in prior guidance; it’s essentially the tax payer’s agreement with the developer/EPC/contractor.  Again, Greg Jenner: “But it’s also clear that if you are trying to transfer purely ‘personal property’, meaning Safe Harbor components, without any intangibles like PPA, site rights, leases, just to transfer panels, that’s not going to work.   It’s an anti-abuse rule. I think there is going to be a lot of [IRS] scrutiny on these transfers.” 

If you are a wholesaler reading this, you’re head-scratching right now as you evaluate if you can help your customers by warehousing some 2019 products.  Learn early in the current year what you can and cannot do; get a tax advisor who is going to help you structure these transactions.   

To harbor or not to harbor? 

The buyer of the solar plant, the taxpayer, is the one to answer the question, in the end.  However, in the vast majority of instances the buyer will be the least informed, if not totally uninformed, frequently relying on contractors/developers to inform them, to a fault.  Any developer of a project that might straddle or start after the 2019/2020 gong should debrief the taxpayer on the safe harbor option, and advise outside counsel.

No matter their role, at the deep end of 2019 there will be folks with a brand-new contract in their hands asking themselves how they should decide whether to Safe Harbor, using either method.   If the concern is entirely financial, then here is a question process you may find useful.

Assuming two-dollars per watt as an installed system price, the value of the tax-credit loss to the buyer is approximately $0.08 (eight cents).  To the developer/contractor, it’s approximately a four percent price difference. Do you believe that in the time that separates the end of this year and the time your eventual project will require the delivery of those components, your cost on those same elements might drop by more than eight cents on a per-watt basis? 

I called three panel manufacturers with varied countries of fabrication, and none thought an eight cent price drop likely. It would represent a 20 percent drop in current pricing, grosso modo, and there is not enough production efficiency gain or technological breakthrough to mine in the next year for that price drop (One might say that they would have no incentive to state otherwise, but their reasoning has merit). Panels aside, you would have to make the cumulative projections for drops in steel prices, inverter prices, labor prices, transportation prices and all other factors that make up your material costs to determine if you were better off locking-in the 30 percent, or letting fly off with the December 31st calendar page.

There are other questions to ask that go beyond cash-flow projections: What is the taxpayer’s anticipated need to put tax dollars to use at the higher rate, and in what year? What is the cost of capital associated with floating the component purchase until solar savings begin? If using the five percent method, how will the product hold impact the warranty?  

To the point

In the majority of cases, a successful solar sale relies on being able to prove optimal cashflow improvement from the investment. Do the math. If the savings analysis pivots even slightly on an eight-cent increase in tax payer adjusted cost, then this issue really requires close attention, and you should get knowledgeable advice.  If there is still a comfortable positive cash-flow position after the drop, and all stake-holders are comfortable with foregoing the additional ITC, then come 12/31 drop the sharp pencil, don the pointy hat, and let the 30 percent go with the confetti. 

Author’s note: A bill to extend the ITC for solar projects, and add storage projects to it as well has been introduced in the U.S. congress. It remains to be seen if it will pass. 

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Philippe Hartley packages commercial financing on behalf of the leading C-PACE funders and tax equity providers in the US. He is the Managing Director of CleanFinancing. Reach him at ph@cleanfinancing.com.

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