Section 1603 of the American Recovery and Reinvestment Act of 2009, as amended (Section 1603), allows a taxpayer to elect to receive a cash grant payment, instead of claiming the 30% energy tax credit, with respect to an investment in certain renewable energy generation projects (so-called “specified energy property”). Generally, property qualifies as specified energy property if it would otherwise qualify for the Section 48 energy investment tax credit (ITC). The amount of the cash grant is 30% of the eligible basis of the property which qualifies for the ITC. The election to obtain the cash grant and forgo the ITC is made by application to Treasury. In general, Treasury is directed by the statute to pay out qualifying cash grants within 60 days after the application is complete and the project has been placed in service.

The amount of any Section 1603 cash grant payment is not includible in gross income. However, the tax basis of the property for purposes of depreciation deductions is reduced by one-half of the cash grant payment (as is also the case with the ITC). Like the ITC, all or a portion of the grant must be recaptured and paid back to Treasury in the event a specified disqualifying event occurs, such as a disposition of the project to an ineligible recipient or a change in the qualification or use of the property.

The Section 1603 cash grant program is available to applicants who place specified energy property in service during 2009, 2010 or 2011. Grant payments can be made for qualifying projects placed in service after 2011 if construction began during 2009, 2010 or 2011 and the property is placed in service by a specified date (December 31, 2016 for solar projects and December 31, 2012 for wind projects with respect to which the taxpayer has elected the ITC in lieu of the production tax credit). For more information about the cash grant program generally, see our summaries and alerts here and here.

Whether the taxpayer claims the ITC or elects the cash grant, the tax basis for the property determines the amount of the credit or grant. The Treasury Department has reviewed literally thousands of applications under the Section 1603 program and has paid out billions of dollars in grant money.  Congress encouraged a rapid application turn-around time and a 60-day payment deadline.  Due to the volume of applications, Treasury has had to evaluate whether a project is eligible for the grant, and whether the tax basis claimed by the taxpayer is accurate, in a much shorter period of time than is available to IRS auditors in the field examining returns on which the ITC has been claimed.

Most taxpayers and their advisors have been under the impression that once Treasury completes its review of a grant application and pays out a grant, the IRS does not have the authority to subsequently challenge on audit the qualification of the project as “specified energy property” or the amount of the tax basis on which the 30% grant was claimed. However, a recently issued IRS internal memorandum (available here) upsets this expectation. The IRS takes the position that the IRS may review in the course of an audit whether the amount of a Section 1603 payment was appropriate, and any portion of a Section 1603 payment that was “excessive” is required to be included in the grant recipient’s income.

In the memorandum, the IRS Chief Counsel responded to questions raised by IRS counsel and field agents concerning projects for which Section 1603 grant payments were made, but where the IRS determines on audit that all or a portion of the grant paid was not eligible for the grant. The key question raised was: “In the event the Service determines that a taxpayer’s project did not qualify for all or part of a section 1603 payment, is the excessive amount of the payment includible in the taxpayer’s gross income … notwithstanding … that section 1603 payments shall not be includible in the taxpayer’s gross income?” 

The IRS concluded that, notwithstanding the amount paid out by Treasury, only the portion of the grant claimed by the taxpayer that actually qualifies for the grant on the merits can be excluded from gross income. The excludable amount does not include the portion of any payment that a taxpayer receives under the Section 1603 program that exceeds the amount of the payment that applies to the cost of property that qualifies for the payment under section 1603. Thus, if the IRS determines, on examination, that a taxpayer’s property did not qualify for all or part of the payment that the taxpayer received under the Section 1603 program, the excess over the amount of the correctly determined Section 1603 payment is not excludible from the taxpayer’s gross income. The IRS also concluded that the excessive amount of a Section 1603 payment cannot be excluded from income under any other principle of tax law (e.g., as a non-taxable gift, contribution to capital).

As a corollary to the rule that “excessive” grant payments are income, the amount of the “excessive payment” that is includible in income does not reduce the taxpayer’s basis for the property for depreciation purposes.

For example, assume a taxpayer claims a grant payment of $300 on a project with a claimed tax basis of $1,000. Treasury pays the $300 grant to the taxpayer. Taxpayer’s basis for depreciation is reduced by one-half the grant amount, to $850. Absent a special disqualifying event, the grant money cannot be recaptured by Treasury. However, on the regular audit of the taxpayer’s return, the IRS examines and challenges the taxpayer’s claimed basis as excessive. The IRS determines that the taxpayer overstated its basis for the property and that the proper basis amount was $900, and the proper grant amount was $270. The taxpayer has an income inclusion of $30 (the “excessive payment”). In addition, the taxpayer’s basis re-adjusted: it is reduced from $1,000 to $865 ($1,000 less one-half of $270). Thus, the income inclusion is partially offset by a basis increase, but on a net basis, the economic loss caused by the adjustment on audit is still substantial.

What will surprise most taxpayers is not the IRS’ calculations, but the fact that the IRS has the authority on audit to challenge the amount of the taxpayer’s Section 1603 payment at all. By characterizing the portion of a grant payment that exceeds the allowable amount as an unreported item of gross income, the IRS essentially is asserting audit jurisdiction over every Section 1603 payment that Treasury has ever made. For taxpayers that have applied for and received a grant payment, the Treasury cannot recapture and require repayment of the grant money absent a disqualifying event. However, the IRS has another opportunity to review and challenge the taxpayer’s claim upon audit of the taxpayer’s return for the year the grant was paid. A significant portion of the economic benefit of the grant can be lost if the IRS determines on audit that all or a portion of the grant claimed exceeds the proper amount. 

One challenge that the IRS may make on audit is that the taxpayer’s project fails to qualify as “specified energy property.” Another more likely challenge is that the taxpayer has overstated the tax basis on which the 30% grant is calculated. Treasury apparently is concerned that taxpayers have attempted to game the Section 1603 system by claiming unrealistic and unsupported amounts as tax basis. Clearly, Treasury is concerned about potential taxpayer abuse in the Section 1603 program. This concern is reflected in the recently issued Treasury guidance describing how Treasury evaluates the tax basis for photovoltaic (PV) solar energy projects (discussed here). Treasury identified the opportunity to artificially step up basis through excessive developer premiums, transfers between related parties, sale-leasebacks, and in lessee “pass-through” lease transactions (also called “inverted leases”) where basis is deemed to be “fair market value.” Thus, if a lessor passes the Section 1603 payment through to a lessee and that payment to the lessee is based on an amount in excess of the true fair market value of the property, the lessee has received a partially excessive Section 1603 payment. These are the kinds of transactions which may be susceptible to greater IRS scrutiny on audit, with the potential for an unanticipated income inclusion and a reversal of a part of the overall economic benefit of the transaction.

Whether the taxpayer claims the ITC or the cash grant, the tax basis for the property determines the amount of the credit or grant. The Treasury Department is reviewing literally thousands of applications under the Section 1603 program and has to make a determination of tax basis in a much shorter period of time than is available to IRS auditors in the field. To assist taxpayers with preparing Section 1603 applications, Treasury has published and posted to its Section 1603 website an outline of the process used by the Section 1603 review team to evaluate basis and the principles that guide the process. Although these principles are published in the context of the cash grant, they are the same tax concepts used to determine tax basis for ITC purposes as well. Moreover, although the Treasury paper addresses solar PV properties, the guidance states that “the methods used to evaluate cost basis described herein apply to all types of properties.”

Basis

Basis is the amount of a taxpayer’s investment in property for tax purposes.  Basis is generally the cost of the property but also includes the capitalized portion of certain other costs related to buying or producing the property (e.g. permitting, engineering, and interest during construction). However, in certain circumstances, a taxpayer’s stated cost for an asset does not reflect the true economic cost of that asset to the taxpayer and will be ignored for purposes of determining the basis of the asset. For example, a stated cost may be inconsistent with the eligible property’s true basis “where a transaction is not conducted at arm’s-length by two economically self-interested parties or where a transaction is based upon ‘peculiar circumstances’ which influence the purchaser to agree to a price in excess of the property’s fair market value.”

In order to ensure that a taxpayer’s claimed cost basis reflects the eligible property’s fair market value, basis is more closely scrutinized in cases involving related parties, related transactions, or other unusual circumstances. Similar to the authority of the IRS in the context of the ITC, in making cash payments under Section 1603, the Treasury Department has authority to decide that “an applicant has miscalculated or misrepresented the basis of its property.” However, the Treasury cannot simply deny an application because it disagrees with the taxpayer’s claimed basis. The courts have held that Treasury must pay a cash grant based on the correct basis amount. See ARRA Energy Co. I v. United States, 97 Fed. Cl. 12 (Fed. Cl. 2011) and our discussion of the case here.

The first step the Treasury review team takes to evaluate the claimed basis for solar photovoltaic (PV) properties is to compare the claimed basis to certain benchmarks. The benchmarks used by Treasury for solar PV cost basis are predicated on an open-market, arm’s-length transaction between two entirely unrelated parties with adverse economic interests, specifically with respect to setting the eligible property’s price.
 
Benchmarks considered by the Treasury review team are drawn and updated based  on publicly available information and analyses by various experts, data from existing Section 1603 applications and other confidential sources, and Treasury’s experience with solar PV properties. As of the first quarter of 2011, benchmark solar PV market expectations are as follows:

These prices reflect a high quality of equipment (modules, inverters, racking) installed by reputable companies across the United States and include profit. 

These are merely benchmarks – they are not safe harbors and they are not ceilings. Each system is different and its cost will be affected by technology choice, regional market differences and differences in size within the above categories. A property may have specific characteristics that increase (or decrease) eligible costs. Such factors are considered in evaluating how a given application’s basis compares with benchmark prices. 

If claimed basis is deemed consistent with benchmark prices, the Section 1603 review team typically focuses the remainder of its cost review on examining line items provided in the detailed cost breakdown to ensure that only eligible items have been included and that no costs have been inappropriately attributed to the property. If there are no ineligible items, the basis reflects only items appropriately attributable to the eligible property, and if there is adequate documentation to support that the costs reflect actual costs, the cost basis is accepted. 

The review team may ask the applicant to provide additional detail if a cost breakdown line item is defined too generally. If ineligible items are identified, they are removed, and the payment is based on the corrected amount. For example, although a project may necessitate a fence for security or a building for operations and maintenance, such costs are not eligible. 

Applications with a claimed basis that is materially higher than benchmarks will receive closer scrutiny. In addition to ensuring that only eligible costs are included, the review team looks at whether there are related transactions, related party considerations, or other unusual circumstances, such as:

1. Owner/applicant is related to the developer, installer, or supplier (collectively referred to as the “developer”). The developer may be a separate, legally-organized business, but there is common ownership/control. In such a case, a sale of the property by one related party to the other may not reflect an arm’s-length price.
2. Owner/applicant is a party to one or more related transactions with the developer such that economic interests in the specific transaction determining basis may not be adverse. For example, the owner/applicant purchased the energy property from the developer and leased the property back to the developer (sale-leaseback).

Where such circumstances are present, the review team evaluates whether the claimed basis is consistent with the property’s fair market value. (Fair market value is also relevant in the context of applications by lessees of leased property, where the parties have elected to pass through the ITC or cash grant to the lessee.) In this context, original manufacturer’s invoices/costs to the developer should be provided for major equipment, subsequent markups by the developer should be enumerated, and any markups by the owner identified. The owner may also submit a detailed and credible third-party appraisal (discussed below) demonstrating that the claimed basis is consistent with a market transaction between unrelated parties with adverse economic interests.

Ultimately, if the Section 1603 review team determines that the basis was not properly calculated or represented, the review team may adjust the basis on which a Section 1603 payment is made to a level consistent with the review team’s view of the property’s true cost, as informed by documentation provided by the applicant and other relevant information and analysis. This is no different than what might take place upon examination by the IRS if the applicant elected the ITC rather than the Section 1603 payment.

Fair Market Value

The IRS generally defines fair market value (FMV) as “the price at which property would change hands between a buyer and a seller, neither having to buy or sell, and both having reasonable knowledge of all necessary facts.”

The review team does not prepare appraisals for energy property. Rather, the review team evaluates appraisals provided by applicants and prepared by independent, certified appraisers with expertise in solar PV properties. There are three broad and interrelated methods that are used in valuation efforts: the cost approach, market approach, and income approach.

Cost Approach. The cost approach is based on the actual cost to build the property. This approach should clearly show the cost buildup, including hard costs, soft costs, and profit. Because the Section 1603 program only applies to energy property placed in service after December 2008, properties are new, and the actual costs should be readily available.  As cost data for PV systems is increasingly timely and available, this approach tends to be the most concrete and supportable analysis and is favored by the review team. 

Treasury’s Section 1603 review team will accept a cost approach that includes only eligible property and a markup (“developer’s premium”) that is consistent with industry standards and with the scope of work for which the markup is received. While appropriate markups are case-specific and can depend on the ultimate transaction price, Treasury has found that appropriate markups typically fall in the range of 10 to 20 percent of actual cost to build. This 10 to 20 percent guideline is not a safe harbor or a ceiling. A cost approach that includes a markup should explicitly address the appropriateness of the selected markup in light of the activity, capital investment, and risk for which that markup is compensating.

Market Approach. The market approach is based on sales of comparable properties. The Treasury paper suggests that “thousands of solar PV properties have been installed in the last two years, and market data are readily available.” 

Income Approach. The income approach is based on the discounted value of future cash flows generated by and appropriately allocable to the eligible property. Numerous assumptions must be made, including forecasts of all relevant project revenue and cost streams, cost of capital (debt and equity), rates of inflation and taxes, number of periods of income, and residual value. Treasury has found this to be the “least reliable” method of valuation given the number of variables that are subject to speculation and open to debate. However, the reliability varies with the quality of the data and assumptions. Projects with contracted power purchase agreements (PPAs) and contracted sales of environmental attributes (e.g., SRECs) have concrete cash flows on which to base an income approach. Assumptions must still be made, however, about revenues expected to be generated after the PPA expires and residual value. For purposes of Section 1603, a credible income approach to valuation will consist of a detailed spreadsheet model showing annual revenue and expenses over the term of the contract with a reasonable residual value at contract termination.

• Inflation rates should be supported by credible sources.
• Discount rates should reflect an appropriate risk premium above the risk-free rate.
• Speculative revenue (i.e., revenue that is not specifically contracted and guaranteed by a credit-worthy customer) will be closely scrutinized and must be well-supported and documented. Projected revenue beyond contracted periods should be based on conservative, publicly-available data.
• All expenses must be included, both annual ordinary operating expenses and major maintenance (e.g., inverter replacement).
• All depreciation, taxes, and other considerations should be incorporated into the model.

These and all other assumptions should be well-reasoned and sufficiently documented, and should reflect market expectations. Moreover, the income approach should explicitly address the allocation of the estimated discounted cash flows to the eligible property.

Requirements for 100% Bonus Depreciation

Under the revenue procedure, “qualified property” is eligible for the 100% first year depreciation deduction if the property meets all of the following requirements:

Qualified Property. The property is “qualified property” – generally property eligible for MACRS depreciation deductions under section 168 of the Code that is acquired or constructed and placed in service in or after 2008, and was not subject to a written binding contract entered into before 2008 (i.e., the property would otherwise qualify for the 50% first year bonus depreciation deduction)

Acquisition. The property is “acquired” after September 8, 2010, and before January 1, 2012 (before January 1, 2013 in the case of certain long-lived property and certain aircraft). For 100% bonus purposes, a taxpayer “acquires” qualified property when the taxpayer pays or incurs the cost of the property. Qualified property that a taxpayer manufactures, constructs, or produces is treated as “acquired” for these purposes when the taxpayer begins constructing, manufacturing, or producing that property. As summarized in our prior alert on when construction begins, construction generally is considered to begin when physical work of a significant nature is first undertaken or the taxpayer has incurred a sufficient amount of project costs to satisfy a safe harbor. 

Thus, projects where construction began before September 9, 2010 are not eligible for 100% bonus depreciation. (Certain components of such projects may be eligible, as noted below.) Projects where construction began after September 8, 2010 satisfy the acquisition requirement (and can qualify for 100% bonus so long as there is no binding contract dated before 2008). Projects to acquire qualified property pursuant to written binding contracts entered into after September 8, 2010 are deemed to meet the acquisition requirement.

Placed In Service. The taxpayer places the qualified property in service after September 8, 2010, and before January 1, 2012 (before January 1, 2013 in the case of certain long-lived property and certain aircraft). Existing regulations apply to determine date the property is deemed “placed in service” for tax purposes.

Original Use. The original use of the qualified property commences with the taxpayer after September 8, 2010. Existing regulations apply to determine date the property is deemed “placed in service” for tax purposes. The lessor in sale-leaseback is treated as the original user of the property so long as the lessee sells and leases the property back within 90 days after the property becomes commercially operational (placed in service).

Election for Certain Components

Congress gave permission to Treasury to issue rules “similar to” (and not necessarily identical to) those in existing regulations. Many developers were hoping Treasury would take a more taxpayer-friendly position on the acquisition date for self-constructed property. 
For projects that were started before September 9, 2010, some advocated for allowing 100% bonus for at least those costs that were incurred after that date. The revenue procedure does not adopt that position, but does provide a limited exception for certain components.

If a taxpayer begins the manufacture, construction, or production of a project before September 9, 2010, the taxpayer may elect to treat any purchased or self-constructed component of the project as eligible for 100% bonus depreciation deduction, so long as the component is qualified property and is itself acquired or self-constructed by the taxpayer after September 8, 2010, and before January 1, 2012 (before January 1, 2013 in the case of certain long-lived property and certain aircraft).

50% Bonus Election

To minimize disputes regarding whether a taxpayer acquired or placed in service

qualified property after September 8, 2010, the revenue procedure allows a taxpayer to elect to claim the 50%, instead of the 100% first year bonus depreciation for all qualified property that is in the same class of property and placed in service by the taxpayer in its taxable year that includes September 9, 2010. For example, if a calendar-year taxpayer for its taxable year ending December 31, 2010, placed in service 5-year property before September 9, 2010, and other 5-year property after September 8, 2010, the taxpayer may elect to claim the 50% bonus for all of its 5-year property that is qualified property and placed in service during the 2010 taxable year.

Section 168(k)(1) and (5) provide that the depreciation deduction for the first year that any “qualified property” is placed in service includes an allowance equal to either 50% or 100% of the adjusted basis of the property.  Property can qualify for the 50% bonus depreciation if it is acquired after December 31, 2007 and before January 1, 2013 (January 1, 2014 for aircraft and certain long-term-production-period property).   Property can qualify for a 100% allowance if it is acquired after September 8, 2010 and before January 1, 2012 (January 1, 2013 for aircraft and certain long-term-production-period property). The 50% and 100% bonus depreciation allowances are referred to herein as “Bonus Depreciation.”  

Bonus Depreciation is in addition to the amount otherwise allowable as a depreciation deduction for the year the property is placed in service and for any later tax year.[3]  The otherwise allowable depreciation deductions for the first year and later years are determined by reducing the adjusted basis of the qualified property by the Bonus Depreciation.  Thus, before computing the amount otherwise allowable as a depreciation deduction for the year the property is placed in service and for later tax years, the adjusted basis of the property must be reduced by the Bonus Depreciation.[4] 

Example.  On September 1, 2010, a calendar year taxpayer acquires and places in service qualified property that costs $1,000, and it is 5-year property subject to the half-year convention and the 200% double-declining balance method.  The taxpayer is allowed 50% Bonus Depreciation for the 2010 taxable year in the amount of $500.  The remaining $500 of cost is deductible under the rules applicable to 5-year property.  Thus, 20%, or $100, is also allowed as a depreciation deduction in 2010.  The total depreciation deduction for 2010 is $600.  The remaining $400 cost is recovered under the otherwise applicable rules for computing depreciation.[5]  Had the taxpayer acquired and placed in service the qualified property in 2010 but after September 8, 2010, the taxpayer would have been eligible for 100% Bonus Depreciation in 2010 in the amount of $1,000.

Although there is no explicit authority in Section 168(k) as to the application of depreciation conventions (e.g., half-year, mid-quarter), the examples in the legislative history  and the Regulations indicate that the depreciation conventions do not apply to Bonus Depreciation.  However, after computing the Bonus Depreciation, the remaining adjusted basis of the property is depreciated using the applicable depreciation provisions under the Code.[6]  Such applicable provisions include the applicable convention prescribed by Section 168(d).  Therefore, the half-year, mid-quarter and other depreciation conventions do apply to the other first-year depreciation deductions allowed for qualified property, as illustrated in the above Example.

The adjusted basis of qualified property acquired by a taxpayer in a “like kind” exchange or an involuntary conversion is eligible for Bonus Depreciation.[7] Thus, a taxpayer does not have to “purchase” property in order to claim Bonus Depreciation. 

Bonus Depreciation generally is not affected by a short taxable year.[8] Accordingly, a taxpayer is not required to prorate the Bonus Depreciation based on the length of the taxable year in which the qualified property is placed in service.[9] In addition, Bonus Depreciation is determined without regard to any alternative minimum tax adjustments.[10]

A taxpayer may elect not to claim Bonus Depreciation with respect to qualified property.”[11] The election will apply to all qualified property in the same “class of property” placed in service during the same taxable year.[12] The term “class of property” means (i) each class of property set forth in Section 168(e) (e.g., 3-year property, 5-year property), other than water utility property and qualified leasehold improvement property, (ii) water utility property, (iii) computer software amortized under Section 167(f)(1), or (iv) qualified leasehold improvement property as defined in Section 168(k)(3).[13]

II. Qualified Property

In general, “qualified     property” must satisfy four requirements relating to the characteristics of the property, and the timing of the acquisition, placement in service and original use of the property.  In addition, an “anti-churning” rule applies.  Each of these requirements is considered in turn below.

A. Property Characteristics

(1) MACRS Eligible

In order for property to constitute “qualified property” and qualify for Bonus Depreciation the property must be subject to the general rules of MACRS.  Property that is subject to the “alternative depreciation system” described in Section 168(g) (“ADS”) is not “qualified property.”  ADS applies to, among other things, tangible property used predominantly outside the United States and any tax-exempt use property.[14] Subject to certain exceptions for short-term leases, “tax-exempt use property” includes any tangible property leased to any entity that is exempt from Federal income tax (e.g., domestic municipalities and most foreign entities).[15]

It should be noted that, property leased to a tax-exempt entity for less than three years may be excluded from ADS and eligible for both MACRS and Bonus Depreciation.  See Section 168(h)(1)(C).

The determination of whether or not property is subject to ADS is made after application of Section 280F(b).[16] Section 280F(b) provides that if any “listed property” is not used predominantly in a qualified business use for any taxable year, allowable depreciation is determined under ADS, and, accordingly, the property is not eligible for Bonus Depreciation.[17] “Listed property” includes the following property categories, as more specifically defined in the Code:

• any passenger automobile,
• any other property used as a means of transportation (e.g., corporate aircraft),
• any property of a type generally used for purposes of entertainment, recreation or amusement,
• any computer or peripheral equipment (as defined in Section 168(i)(2)(B)),
• any cellular telephone (or other similar telecommunications equipment), and
• any other property of a type specified by the IRS in regulations.

Excluded from the definition of “listed property” is computer or peripheral equipment used exclusively at a regular business establishment and owned or leased by the person operating such establishment, certain passenger automobiles and any property substantially all of the use of which is in a trade or business of providing to unrelated persons services consisting of the transportation of persons or property for compensation or hire.[18] Thus, for example, commercial aircraft is not listed property, but corporate aircraft is listed property.

Even if property is “listed property,” it is not subject to ADS (and hence is eligible for Bonus Depreciation) if the property is predominantly used in a “qualified business use” for the taxable year.  Property is treated as predominantly used in a qualified business use if more than 50% of the use of the property for the year is for a “qualified business use.”[19]  “Qualified business use” means any use in a trade or business of the taxpayer other than the (i) leasing of property to any 5-percent owner or related person, (ii) use of property provided as compensation for the performance of services by a 5-percent owner or related person, or (iii) use of property provided as compensation for the performance of services by any person that is not a 5-percent owner or related person, unless an amount is included in the person’s gross income with respect to such use. However, in the case of aircraft, the use of property will constitute “qualified business use” if at least 25% of the total use of the aircraft during the taxable year consists of qualified business use not described (i), (ii) and (iii).  Thus, an airplane will not fail the predominant use requirement solely because it is used by a 5-percent owner as compensation for services if such use does not exceed 75% of the aircraft’s total use and the remaining balance of the aircraft’s use is “qualified business use.”

(2) Property Type

“Qualified property” eligible for Bonus Depreciation must be either (i) property having a recovery period of 20 years or less, (ii) computer software (as defined in Section 167(f)(1)(B)) for which a deduction is allowable under Section 167(a), (iii) water utility property, or (iv) qualified leasehold improvement property.[20]

Property having a recovery period of 20 years or less includes most tangible personal property.

“Computer software” is any program designed to cause a computer to perform a desired function, except that such term does not include computer software acquired in a transaction (or series of related transactions) involving the acquisition of assets constituting a trade or business or substantial portion thereof.[21] Therefore, if computer software is not acquired in connection with the acquisition of a trade or business, it is both amortizable over 36 months under Section 167(f) and eligible for Bonus Depreciation.[22]

“Water utility property” means (i) property which is an integral part of the gathering, treatment, or commercial distribution of water and (ii) any municipal sewer.[23]

“Qualified leasehold improvement property” means any improvement to an interior portion of a building which is nonresidential real property and which meets the following requirements.[24] First, the improvements must be made under or pursuant to a lease between unrelated parties (as defined).  Second, the improvements must be made either by the lessee (or sublessee) or lessor of the relevant portion of the building.  For this purpose, a commitment to enter into a lease is treated as a lease, and the parties to such commitment are treated as lessor and lessee.[25]  As a result, improvements to property made by a person who commits to enter into a lease of such property and then assigns its rights to the property to the ultimate lessee will be treated as having been made by the “lessee” pursuant to a lease.  Finally, that portion of the building which is improved must be occupied exclusively by the lessee (or sublessee) and the improvement must be placed in service more than three years after the date the building was first placed in service.[26] “Qualified leasehold improvement property” does not include any improvement for which the expenditure is attributable to (1) the enlargement of the building, (2) any elevator or escalator, (3) any structural component benefiting a common area, and (4) the internal structural framework of the building.[27]

B. Acquisition Requirement

Property must satisfy an acquisition requirement in order to be considered “qualified property” eligible for Bonus Depreciation.  The property must meet one of two alternative acquisition requirements.  The property will be eligible for either 50% or 100% Bonus Depreciation depending on which requirement is met.

To qualify for 50% Bonus Depreciation, the property must be:

(i)         acquired by the taxpayer after December 31, 2007, and before January 1, 2013, but only if no written binding contract for the acquisition was in effect before January 1, 2008, or

(ii)        acquired by the taxpayer pursuant to a written binding contract which was entered into after December 31, 2007, and before January 1, 2013.[28]

To qualify for 100% Bonus Depreciation, the property must be:

(i)         acquired by the taxpayer after September 8, 2010, and before January 1, 2012, but only if no written binding contract for the acquisition was in effect before January 1, 2008, or

(ii)        acquired by the taxpayer pursuant to a written binding contract which was entered into after December 31, 2007, and before January 1, 2012.  (As discussed below, to qualify for 100% Bonus Depreciation, the property must also be placed in service after September 8, 2010.)

            If a taxpayer manufactures, constructs or produces property for its own use, the taxpayer must begin the manufacture, construction or production of the property after December 31, 2007 and before January 1, 2013.[29]  A binding contract entered into before January 1, 2008 to acquire one or more components of a larger self-constructed property will not preclude the larger self-constructed property from satisfying the acquisition requirements, but the portion of the basis attributable to the component is not eligible for Bonus Depreciation.[30] Property that is manufactured, constructed or produced for the taxpayer by another person under a written binding contract that is entered into prior to the manufacture, construction or production of the property is considered to be manufactured, constructed or produced by the taxpayer.[31] 

A contract is binding only if it is enforceable under State law against the taxpayer or a predecessor, and damages thereunder are not limited to a specified amount.[32] The fact that there may be little or no damages because the contract price does not significantly differ from the fair market value of the property will not be taken into account.[33] For example, if a taxpayer entered into an irrevocable written contract to purchase an asset for $100 and the contract contained no provision for liquidated damages, the contract would be considered binding notwithstanding that the asset had a fair market value of $99 and under local law the seller would only recover the difference between the contract price and the asset’s fair market value in the event the purchaser failed to perform.  If the contract provided for a full refund of the purchase price in lieu of any damages allowable by law in the event of breach or cancellation by the seller, the contract would not be considered binding.

A contract that is subject to a condition will be considered binding, as long as the condition is not within the control of either party or a predecessor.[34] A contract will be considered binding even if the parties to a contract make insubstantial changes to its terms and conditions or there remain insubstantial terms to be negotiated by the parties.[35]

C. Placed In Service Requirement

To be considered “qualified property” eligible for Bonus Depreciation, the property must be placed in service within a specified time period.  In general, to be eligible for 50% Bonus Depreciation, the property must be placed in service before January 1, 2013.[36]  To be eligible for 100% Bonus Depreciation, the property must be placed in service after September 8, 2010 and before January 1, 2012.[37]

The 2010 Tax Act provides for a one-year extension of the applicable placed-in-service deadline for certain property with long recovery periods, transportation property and certain aircraft.  Such property must be placed in service by the end of 2012 to qualify for 100% Bonus Depreciation and by the end of 2013 to qualify for 50% Bonus Depreciation.  The one-year extended in-service deadline applies to property (i) which otherwise qualifies for Bonus Depreciation, (ii) has a recovery period of at least 10 years or is “transportation property,” and (iii) either (A) has an estimated production period exceeding two years or (B) has an estimated production period exceeding one year and a cost exceeding $1 million.[38] “Transportation property” is tangible personal property used in the trade or business of transporting persons or property.[39] The one-year extended in-service deadline also applies to certain classes of aircraft having a production period exceeding four months.[40]

A special rule limits the amount of costs eligible for Bonus Depreciation for property qualifying for the extended in-service date.  Only the portion of the basis in the property that is properly attributable to the costs incurred before January 1, 2013 (“progress expenditures”) are eligible for 50% Bonus Depreciation.[41]  As a result, any additional amount invested after January 1, 2013 in property that is eligible for the extended in-service date will not qualify for 50% Bonus Depreciation.[42]

D. Original Use Requirement

Property must satisfy an “original use” requirement to be “qualified property” eligible for Bonus Depreciation.  The original use of the property must commence with the taxpayer on or after January 1, 2008.[43]

The term “original use” means the first use to which the property is put, whether or not such use corresponds to the use of the property by the taxpayer.[44]  Further guidance on the meaning of “original use” can be found in the definition of “new section 38 property” in the investment tax credit regulations.  See Treas. Reg. § 1.48-2.  Thus, the cost of acquiring reconditioned or rebuilt property would not satisfy the original use requirement,[45] but capital expenditures incurred to recondition or rebuild such property would satisfy the original use requirement.[46]

If, in the normal course of business, a taxpayer sells fractional interests in property to unrelated parties, the original use of such property begins with the first user of each fractional interest (i.e., each fractional interest owner is considered the original user of its proportionate share of the property).[47]

(1) Sale-Leasebacks and Syndications

For sale-leaseback transactions, there is an exception to the requirement that the original use of property commence with the taxpayer.  If property originally placed in service by a person after December 31, 2007 is sold and leased back by such person within three months after the date such property was originally placed in service, the property is treated as originally placed in service not earlier than the date the property is used under the leaseback.[48]  If the sale-leaseback exception applies, the original use of the leased property will be deemed to commence with the lessor under the leaseback on the first day of the lease, and not with the lessee upon its use of the property prior to the commencement of the lease.

Accordingly, the sale-leaseback exception qualifies a lessor for Bonus Depreciation provided the sale-leaseback transaction is completed within three months after the property is placed in service by the lessee.

Moreover, in certain situations, the original use of property subject to a lease will commence with a taxpayer who purchases its interest in the property from the lessor.  If property is originally placed in service by a lessor, including by operation of the sale-leaseback exception, after December 31, 2007, and is sold by the original lessor or any subsequent purchaser of the original lessor’s interest in the property within three months after the date the property was originally placed in service by the original lessor, and the user of the property does not change, the purchaser of the property in the last sale during the three-month period is considered the original user of the property.[49] Therefore, the original use of leased property will commence with the purchaser of a lessor’s interest in a lease transaction, provided the lessee remains the same and the sale occurs within three months of the time the property was originally placed in service by the original lessor.  The original use of property will commence with the purchaser even if the original use of the property was deemed to commence with the original lessor by operation of the sale-leaseback exception.  Accordingly, if the sale-leaseback exception is considered, a taxpayer can be deemed the original user of property that has been in use by a lessee for a period of up to six months.

Example.  X, a taxable entity, purchases railcars on June 2, 2011 from the manufacturer and begins to use the property in its business.  X enters into a sale and leaseback of the railcars on September 1, 2011 with a leasing company, Y.  Y sells some of the railcars (subject to the lease) to another lessor, Z, on December 1, 2011.  The railcars are qualified property and Y and Z are eligible to claim 100% Bonus Depreciation with respect to the railcars for the following reasons.  First, the railcars meet the “property type” requirement of Bonus Depreciation because they have a recovery period of 20 years or less and they are eligible for MACRS depreciation.  The railcars also meet the “acquisition” requirements because they were acquired by Y and Z after September 8, 2010 and before January 1, 2012. Last, the placement in service and original use requirements have been met.  The lessee, X, placed the railcars in service in its trade or business on June 2, 2011 (the “original in-service date”).  Since the sale-leaseback transaction occurred within three months of the original in-service date, the original use of the railcars retained by Y is deemed to commence with Y on September 1, 2011 (the date of the leaseback).  The original use of the railcars sold by Y to Z is deemed to commence with Z on December 1, 2011 (the date of the sale) because the original use of the railcars subject to the sale-leaseback is deemed to commence with Y, Y sold the railcars to Z within three months of the sale-leaseback transaction, and the user of the railcars (X) did not change.  Accordingly, each of Y and Z is entitled to claim 100% Bonus Depreciation with respect to their railcars for 2011.

E. Disqualified Transactions

Property does not qualify for Bonus Depreciation when the user of the property (or a related party) would not have been eligible for Bonus Depreciation if the user (or a related party) were treated as the owner.[50] For example, if in 2010 Company A sells to a related party property that was under construction by Company A prior to January 1, 2008 (and hence would not qualify for Bonus Depreciation in Company A’s hands), the fact that the transferee acquires the property after December 31, 2007 does not cure the taint of the earlier construction.  The transferee is not eligible for Bonus Depreciation.  Similarly, if in 2010 Company A sells to a related party property that was subject to a binding written contract prior to January 1, 2008 (and hence would not qualify for Bonus Depreciation in Company A’s hands), the fact the transferee itself was not a party to that written contract does not cure the taint.  The transferee is not eligible for Bonus Depreciation.  In addition, if a person sells property and leases it back in a sale-leaseback, and the property would not have qualified for Bonus Depreciation if no sale-leaseback had occurred (e.g., because the seller-lessee had acquired the property or began construction of the property before January 1, 2008), the lessor is not entitled to Bonus Depreciation.

***

For further information, please contact:

Philip H. Spector
Troutman Sanders LLP
The Chrysler Building
405 Lexington Avenue
New York, NY  10174
(212) 704-6004
phil.spector@troutmansanders.com

[2]       The amendments to Section 168(k) made by recent legislation reflect the intention of Congress to provide for bonus depreciation rules that are substantially identical to the bonus depreciation rules enacted in 2002 and 2003 and embodied in Section 168(k) prior to amendment by the 2008 Act and later legislation. The amendments to Section 168(k) for the most part merely change the date references in Section 168(k) that applied to the former bonus depreciation rules. See Section 103(a) of the 2008 Act and Section 401 of the 2010 Tax Act. A comprehensive set of Treasury Regulations were promulgated under Section 168(k) in connection with the former rules.  See Treas. Reg. § 1.168(k)-0 et. seq. (the “Regulations”).   The IRS has issued a notice confirming that the existing regulations do apply.  See IRS News Release (IR-2008-58) (April 11, 2008).

[3]       Bonus Depreciation is allowed for both regular tax and alternative minimum tax purposes for the taxable year in which the qualified property is placed in service.  Section 168(k)(2)(G).

[4]       Treas. Reg. § 1.168(k)-1(d)(2).

[5]       Joint Committee on Taxation, “Technical Explanation of the Revenue Provisions of H.R. 5140, The Economic Stimulus Act of 2008,” JCX-16-08 (February 8, 2008) (hereafter, the “2008 Act Explanation”). See also “Joint Explanatory Statement of the Committee of Conference for The American Recovery and Reinvestment Act of 2009 – Division B” (February 13, 2009) (hereafter, the “2009 Act Explanation”) at 28; Joint Committee on Taxation, “Technical Explanation of the Tax Provisions In Senate Amendment 4594 to H.R. 5297, the Small Business Jobs Act of 2010,” JCX-47-10 (September 16, 2010) (hereafter, the “2010 Jobs Act Explanation”), at 9; and  Joint Committee on Taxation, “Technical Explanation of the Revenue Provisions Contained in the ‘Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010’ Scheduled for Consideration by the United States Senate,” JCX-55-10 (December 10, 2010) (hereafter, the “2010 Tax Act Explanation”), at 54.

[6]       See Treas. Reg. § 1.168(k)-1(d)(2).

[7]       Treas. Reg. § 1.168(k)-1(f)(5).

[8]       Treas. Reg. § 1.168(k)-1(d)(1)(i).

[9]       However, the depreciation deduction allowable for the remaining adjusted basis of qualified property is affected by a short taxable year. See Treas. Reg. § 1.168(k)-1(d)(2).

[10]     Section 168(k)(2)(G).

[11]     See Section 168(k)(2)(D)(iii); Treas. Reg. § 1.168(k)-1(e).

[12]     Id.

[13]     Treas. Reg. § 1.168(k)-1(e)(2).

[14]     Section 168(g)(1).

[15]     Section 168(k)(2)(D)(i)(I) provides a limited exception for property that is subject to ADS by virtue of an election to apply ADS to the property in lieu of the general rules of MACRS. For example, if a taxpayer elects to apply ADS to certain property, and the property was otherwise eligible for depreciation pursuant to the general rules of MACRS, the property will remain eligible for Bonus Depreciation. Congress did not intend to penalize taxpayers who choose to apply the slower ADS depreciation system rather than the more generous MACRS general depreciation system.

[16]     Section 168(k)(2)(D)(i)(II).

[17]     Section 168(k)(2)(C)(i)(II) provides that Section 280F(b) must be applied before determining whether property is eligible for Bonus Depreciation.  Although Section 280F(c) excludes from ADS treatment certain property leased or held for leasing by persons regularly engaged in the business of leasing such property, there is nothing in the legislation or the legislative history underlying the bonus depreciation rules that suggests that Section 280F(c) is relevant for purposes of Bonus Depreciation. Accordingly, absent guidance to the contrary, we believe the Bonus Depreciation provisions should be applied after the application of Section 280F(b), without regard to Section 280F(c).

[18]     Section 280F(d)(4).  The term “related person” includes a number of different categories of persons such as member of a family, two corporations that are part of the same controlled group and an individuals and a corporation if the individual owns more than 50 percent in value of the corporation’s outstanding shares.

[19]     Section 280F(d)(6)

[20]    Section 168(k)(2).

[21]     Section 167(f)(1)(B) refers to the definition of “computer software” set forth in Section 197(e)(3)(B) with the caveat that such term does not include an “amortizable section 197 intangible.”  An “amortizable section 197 intangible” means any “section 197 intangible” which is held in connection with the conduct of a trade or business or an activity described in Section 212. A “section 197 intangible” includes only software that is acquired in a transaction (or series of related transactions) involving the acquisition of assets constituting a trade or business or substantial portion thereof. Therefore, computer software that is not acquired in connection with the conduct of a trade or business is not an “amortizable section 197 intangible” and is eligible for Bonus Depreciation.

[22]     Rev. Proc. 2002-33, § 2.03.

[23]     Section 168(e)(5).

[24]     Section 168(k)(3); Treas. Reg. § 1.168(k)-1(c)(1).

[25]     Section 168(k)(3)(C)(i); Treas. Reg. § 1.168(k)-1(c)(3)(vi).

[26]     Section 168(k)(3)(A); Treas. Reg. § 1.168(k)-1(c)(1)(iii).

[27]     Section 168(k)(3)(B); Treas. Reg. § 1.168(k)-1(c)(2).

[28]   Section 168(k)(2)(A)(iii). A binding contract entered into before January 1, 2008 to acquire one or more components of a larger property will not prevent the larger property from qualifying for Bonus Depreciation, but the portion of the basis attributable to the component is not eligible for Bonus Depreciation.  2008 Act Explanation at 19 (footnote 19); Treas. Reg. § 1.168(k)-1(b)(4)(ii)(E). 

[29]     Section 168(k)(2)(E)(i). For this purpose, construction is considered to begin when physical work of a significant nature begins. Physical work does not include preliminary activities such as planning, designing, securing financing, exploring or researching.  Under a safe harbor, physical work of a significant nature will not be considered to begin before the taxpayer incurs more than 10% of the total cost of the property (other than the cost of preliminary activities).  Treas. Reg. § 1.168(k)-1(b)(4)(iii)(B).

[30]    Treas. Reg. § 1.168(k)-1(b)(4)(iii)(C).

[31]     Treas. Reg. § 1.168(k)-1(b)(4)(iii).

[32]     However, a contractual provision that limits damages to an amount equal to at least 5 percent of the total contract price will not be treated as limiting damages to a specified amount. Treas. Reg. § 1.168(k)-1(b)(4)(ii)(B).

[33]     Id.

[34]     Treas. Reg. § 1.168(k)-1(b)(4)(ii)(B).

[35]     Id.

[36]     Section 168(k)(2)(A)(iv).

[37]   Section 168(k)(5) and 168(k)(2)(A)(iv).

[38]     Section 168(k)(2)(B).

[39]     Section 168(k)(2)(B)(iii).

[40]   Section 168(k)(2)(C).

[41]     Section 168(k)(2)(B)(ii); Treas. Reg. § 1.168(k)-1(d)(1)(ii). For purposes of determining the amount of eligible progress expenditures, rules similar to Section 46(d)(3) as in effect prior to the Tax Reform. Act of 1986 apply. See 2008 Act Explanation at 11 (footnote 20), 2009 Act Explanation at 29-30; 2010 Jobs Act Explanation at 8 (footnote 40); 2010 Tax Act Explanation at 55 (footnote 65).

[42]   As drafted, the 2010 Tax Act does not impose a comparable progress expenditure rule for property eligible for 100% Bonus Depreciation. It is not clear whether Congress intended this result. However, absent a technical correction or other guidance, progress expenditures incurred before January 1, 2013 with respect to property eligible for the extended in-service deadline may be eligible for 100% Bonus Depreciation.

[43]     Section 168(k)(2)(A)(ii) and 168(k)(5).

[44]     Treas. Reg. § 1.168(k)-1(b)(3)(i);  2008 Act Explanation at 10; 2009 Act Explanation at 28-29, 2010 Jobs Act Explanation at 10; 2010 Tax Act Explanation at 55.

[45]     The question of whether property is reconditioned or rebuilt property is a question of fact. The Regulations state that property that contains used parts will not be treated as reconditioned or rebuilt if the cost of the used parts is not more than 20 percent of the total cost of the property. Treas. Reg. § 1.168(k)-1(b)(3)(i).

[46]     Id.

[47]     Treas. Reg. § 1.168(k)-1(b)(3)(iv).

[48]     Section 168(k)(2)(E)(ii); Section 168(k)(4)(C).

[49]     Section 168(k)(2)(E)(iii); Treas. Reg. § 1.168(k)-1(b)(3)(iii)(B).  2010 Tax Act Explanation at 55 (footnote 62).

[50]     Section 168(k)(E)(iv); 2008 Act Explanation at 12; 2009 Act Explanation at 30; 2010 Jobs Act Explanation at 11; 2010 Tax Act Explanation at 54-55.

Two major stimulus packages spawned by the financial crisis have reshaped the federal policy landscape for renewable power. Most notably, qualifying solar, wind and other renewable energy-generation projects can choose either a 30% investment tax credit or a 30% cash grant in lieu of the ITC (the Treasury Grant Program). Wind and other nonsolar projects formerly eligible only for the production tax credit can for a limited time elect any of the PTC, the ITC or the Treasury cash grant.

To date, $2.7 billion of program grants have funded hundreds of renewable energy projects. Estimated 2010 total cash grants could approach $3.5 billion. However, the program is scheduled to expire at the end of this year. To qualify for the cash grant, projects must either be  perational by the end of 2010 or else must “begin construction” by then and be operational by the end of 2012 for wind and by the end of 2016 for solar. This article focuses on meeting the year-end deadline.

The American Recovery and Reinvestment Act of 2009 created the Treasury Grant Program, which is designed to fund the cash benefit of a tax credit without regard to whether the taxpayer can actually claim the credits on its tax return. Applicants are eligible for the Treasury grant only if they commence construction on qualifying projects by Dec. 31, 2010, and complete construction by Dec. 31, 2012, for wind and by Dec. 31, 2016, for solar.

In July, the Treasury Department issued guidance as to when “construction begins” for renewable energy projects that may be eligible for a cash grant in lieu of an investment tax credit in the form of frequently asked questions. The guidance is important and timely because of the impending deadlines for the cash grant program. As the deadline nears, some project developers will attempt to “begin construction” this year of those projects that have a practical chance of crossing that threshold in 2010.

An applicant can demonstrate that construction has begun either by beginning physical work of a significant nature or by meeting a 5% safe harbor.

BEGINNING CONSTRUCTION

Beginning work of a significant nature means that physical work on the specified energy property has started. Physical work of a significant nature includes any physical work on the specified energy property at the site. The following do not qualify as “physical work of a significant nature”:

• Planning or designing, exploring, researching, clearing land, building fences, obtaining permits or securing financing.

• Preliminary work such as the cost associated with the removal of existing structures.

• Building roads for access to the site, or roads used solely for employee or visitor vehicles. However, roads that are integral to the qualified facility do constitute the beginning of construction.

• Test-drilling for a geothermal deposit.

• Construction of a building. However, the following structures are not treated as buildings for this purpose: a structure that is essentially an item of machinery or equipment, or a structure that houses property used as an integral part of a qualified activity if the use of the structure is so closely related to the use of the housed property that the structure clearly can be expected to be replaced when the property it initially houses is
replaced.

Physical work of a significant nature includes physical work undertaken by third-party contractors under a binding written contract, which is enforceable under state law, for the manufacture, construction or production of specified energy property, provided the contract is entered into prior to the work taking place. Additionally, the contract terms cannot limit damages in the event of a breach to less than 5% of the total contract price.

Only the work that will become specified energy property for the applicant counts when work is performed by third-party contractors. Therefore, if a contractor is manufacturing solar panels specifically for the applicant under a binding written contract, any physical work on those panels is physical work of a significant nature on specified energy property of the applicant. If an applicant has a binding written contract with a contractor that is manufacturing solar panels for several different customers, physical work on the panels would be considered
work performed under the applicant’s binding written contract only if the contractor can reasonably demonstrate that physical work has started on panels that will become specified energy property of the applicant.

Purchasing components or other parts from the inventory of a vendor under a binding written contract does not count as work of a significant nature because these components are in existing inventory or are normally held by a manufacturer.

SAFE HARBOR

Applicants meet the 5% safe harbor only if they pay or incur 5% or more of the total cost of the specified energy property before the end of 2010.

“Paid or incurred” means costs are taken into account when cash-method taxpayers “pay” them and when accrual-method taxpayers “incur” them. The cost to acquire property is not generally “incurred” for tax purposes until the property is finally delivered or provided by the contractor to the purchaser. However, under an exception to that rule for purposes of the 5% safe harbor, for periods before the property is delivered to the purchaser, costs incurred by the contractor are treated as costs incurred by the purchaser when the costs are incurred by the contractor.

The Treasury grant applicant determines what costs have been incurred on its behalf by the contractor by relying on a written statement from the contractor as to the amount incurred by the contractor under the binding written contract. The contractor may use any reasonable, consistent method to allocate its costs among the units of property to be manufactured, constructed or produced by the contractor.

The exception that allows the applicant to take into account costs that are incurred by its contractor does not apply to costs incurred by a subcontractor. Thus, if components are manufactured for the contractor by a subcontractor, the cost of those components is incurred only when the components are provided to the contractor and not as the subcontractor pays or incurs the costs of manufacturing the components.

To satisfy the 5% safe harbor, applicants must demonstrate that costs paid or incurred before the end of 2010 are equal to or greater than 5% of the actual total costs of the specified energy property. If the applicant’s project includes multiple units of specified energy property, an applicant can apply for a grant based on some, but not all, units of property.

All applications for § 1603 grants must be submitted by the statutory deadline of Oct. 1, 2011. For property that has been or will be placed in service in 2009 or 2010, an application demonstrating that construction has begun is not required. For property that is placed in service after Dec. 31, 2010, but before Oct. 1, 2011, applicants need only submit a single application demonstrating both that construction began on the property in 2009 or 2010 and that the property has been placed in service. For property that is placed in service on or after Oct. 1, 2011, applicants must submit a preliminary application by Oct. 1, 2011, demonstrating that construction on the property began in 2009 or 2010. Such applications must then be supplemented at the time the property is placed in service.

For projects relying on “physical work of a significant nature,” applicants must document the physical work. Applicants should submit a written report from the project engineer or installer that describes the project’s eligibility and includes a detailed construction schedule, estimated budget for the project and a description of the work that has commenced. For projects with an anticipated cost basis of $1 million or more, the report must be from an independent engineer. When work is performed by contractors, the applicant must submit a copy of the binding written contract and a statement from the contractor describing the work that has commenced.

For projects relying on the 5% safe harbor, applicants must submit a statement from an authorized representative, or for projects with an estimated eligible cost basis of $1 million or more, from an independent accountant, that outlines the costs that have been paid or incurred before the end of 2010 including invoices and an estimate of the total cost of the specified energy property.

Philip Spector is a tax partner in the New York office of Atlanta-based Troutman Sanders. For the past 20 years, he has advised banks and other financiers, project developers, utilities and municipalities on the tax aspects of financing projects and equipment serving the power,  ransportation and manufacturing industries.