IRS Confirms that Batteries Qualify for the Energy Tax Credit But Imposes Limitations

A recent IRS ruling confirms that batteries used to store solar electricity qualify for the 30% energy tax credit. At the same time, it imposes significant limits on the amount of the available credit if the battery also stores electricity drawn from the utility grid.

In PLR 201308005, the taxpayer was a large solar developer that designed, financed, and installed residential and commercial solar PV systems on the roofs of buildings.   In most cases, taxpayer retained ownership of these systems and either leased them to the building owner or sold electricity from the system to the building owner under long-term power contracts. 

The typical system was a set of solar PV panels mounted on the roof of the building, wiring, and an inverter to convert the electricity from AC to DC.  Taxpayer was starting to include batteries with some systems.  These batteries allowed the taxpayer to store electricity from both the PV system and the grid during off-peak hours for use during peak hours or to supply electricity back to the grid during peak hours.

The taxpayer asked the IRS whether the batteries were solar energy property.  The IRS said “yes,” which meant that the taxpayer could claim a 30% energy tax credit for each battery. 

Unfortunately, the IRS didn’t stop there.  It went on to conclude that the credit was subject to a special recapture rule that applies to “dual-use property.”  Dual-use property is property that uses energy from both solar energy and non-solar energy sources.  (An example of dual-use property is a water tank that stores water heated by a solar thermal system and by a gas-fired water heater.)  The fact that the battery was able to store power from the grid appears to have been the dispositive fact leading the IRS to conclude that the battery was dual-use property.

Once the IRS concluded that the battery was dual-use property, two results necessarily followed.

First, the amount of the credit for the battery potentially became subject to a haircut and, in a worst case scenario, a complete elimination.  The haircut could occur because the amount of the credit for dual-use property is limited to the same proportion of the normal credit that the solar energy input bears to total energy inputs in the first year of service of the battery.  For example, assume that in year 1, 90% of the energy stored in the battery is from the rooftop PV system, while 10% is drawn from the grid.  Assume also that the cost of the battery is $100.  If the battery were not dual-use property, the amount of the credit would be $30 (30% of $100).  However, because the battery is dual-use property, the amount of the credit is limited to 90% of the normal credit, or $27 (90% of $30).

It gets worse.  Assume instead that in year 1, the stored electricity drawn from the rooftop PV system is less than 75% of the total energy stored by the battery.  In that case, the battery is not eligible for any energy tax credit.  This is referred to as the “75% cliff”.  In essence, if during year 1 the taxpayer is not careful and allows too much of the electricity stored in the battery to be drawn from the grid, no portion of the energy tax credit is available for the battery regardless of the battery’s mix of stored electricity in later years.

The second consequence of concluding that the battery is dual-use property is that a more onerous recapture rule applies to it.  The basic recapture rule that applies to single-use property is straightforward.  A taxpayer is allowed to keep 20% of the credit for each full year in which the property is actually in service.  Thus, a taxpayer who claims an energy tax credit in year 1 must add to its tax liability in year 2, 3, 4, or 5 a portion of the previously-claimed credit if in that subsequent year the property is longer being used in a qualifying manner.  For example, if a PV system ceases to qualify for the energy tax credit after three full years of service (because, for some reason, it is sold by the taxpayer to another person), 60% of the credit claimed by the taxpayer in year 1 has been earned and 40% must be recaptured in year 4.

In the case of dual-use property, however, a different recapture rule applies.  It has two thresholds that trigger a recapture event.  The first threshold occurs if the percentage of energy stored by the battery in a later year falls below the percentage established in year 1 but remains at or above 75% (for example, the percentage falls from 90% to 80%), then a proportional amount of the tax credit claimed in year 1 must be recaptured.

The second threshold occurs if the percentage of electricity stored by the battery from solar energy in a year after year 1 falls below 75%.  In that case, the taxpayer is required to recapture the full amount of the energy credit claimed in year 1 (to the extent the credit wasn’t already recaptured in a prior year). 

Note that in both cases, none of the recaptured energy tax credit can be “reclaimed” in a future year if, in that future year, the percentage of electricity stored by the battery from solar energy rises above the thresholds that triggered recapture.  The recapture that occurs as a result of falling below each of these two thresholds is permanent.

There are three main takeaways from this ruling.  First, while it is good news that the IRS has confirmed that a battery that is part of a rooftop PV system is eligible for the energy tax credit, the ability of the battery to draw and store electricity from the grid appears to mean that the battery qualifies as dual-use property. 

Second, if a battery qualifies as dual-use property, then its owner will need to determine how much stored energy is drawn from the grid and how much is drawn from the rooftop PV system during the five-year recapture period.

Finally, it will be helpful if the owner can manage the amount of stored electricity drawn from the grid relative to stored electricity drawn from the PV system during this five-year period (assuming it is possible to do).  The rules create a “lowest common denominator-type” approach in that the lowest percentage of solar energy-sourced electricity in any of these five years is the percentage that ultimately will determine the credit.  For example, if the highest percentage of stored electricity from solar energy is achieved in year 1 but falls to a lower percentage in a later year, some or all of the energy tax credit claimed in year 1 will have to be recaptured in that later year.  In contrast, if in year 1 there is a low percentage of stored electricity from solar energy but the percentage rises in a later year, the rules do not allow any of the credit “foregone” in year 1 to be claimed in that later year. 

Lead image: Approved concept via Shutterstock

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Kelly Kogan is a senior attorney whose practice straddles tax and project finance with particular emphasis on the renewable energy industry. She advises renewable energy clients on the tax aspects of cross-border transactions, including both inbound and outbound investment, financings, and reorganizations. She is also an expert in the use of REITs and master limited partnerships as potential funding sources for renewable energy projects. In addition to her counseling practice, Ms. Kogan advocates on behalf of clients before the U.S. Treasury Department and the IRS' National Office and service centers. Ms. Kogan's prior experience includes the Washington National Tax office of Deloitte Tax, LLP and the office of the IRS Chief Counsel, where she served as Special Counsel to the Deputy Associate Chief Counsel (International) and, prior to that, as an attorney-advisor in the Office of Associate Chief Counsel (International). In those positions, Ms. Kogan advised the IRS on the technical aspects of examinations in the international tax area, developed IRS litigating positions in various matters, and drafted and reviewed a broad range of regulatory and non-regulatory guidance.

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