Editor: Susan M. Grais, CPA, J.D., LL.M.
In a critical update from the IRS on August 15, 2025, a significant change was announced concerning tax credits for wind and solar facilities. According to Notice 2025–42, the previous “5% safe-harbor” test was removed, leaving the “physical work” test as the sole method to determine the commencement of construction for tax credit eligibility under Sections 45Y and 48E.
This revision impacts projects that had not started construction before September 2, 2025.
Background
The One Big Beautiful Bill Act (OBBBA), identified as H.R. 1, P.L. 119–21, set forth changes to the wind and solar tax credits, terminating them for facilities operational after December 31, 2027, except for those that commence construction within a year of the act’s enactment on July 4, 2025.
Following this legislation, President Donald Trump issued an executive order on July 7, 2025, aimed at curbing subsidies for foreign-controlled energy sources. This order tasked the Treasury with issuing guidance to ensure strict adherence to the “beginning of construction” policies and limit broad safe harbors, only allowing them when a substantial portion of a facility has already been built.
Prior to Notice 2025–42, taxpayers could use either the “physical work of a significant nature” approach or the 5% expenditure method to establish the start of construction. The new notice eliminates the latter option for most projects.
Physical-work test
The IRS now mandates the use of the physical-work test, which assesses whether significant physical work has commenced and requires a continuous construction program. This test evaluates the type of work done rather than its cost, considering both off-site and on-site activities performed under a binding contract.
Off-site work: This includes manufacturing components like racks, rails, and transformers.
On-site work: For wind projects, this involves foundational work such as excavation and concrete pouring. If components are manufactured off-site under contract and not part of inventory, construction begins when manufacturing starts.
Preliminary activities: Preliminary actions, despite being part of the facility’s depreciable basis, do not count as significant work. These include planning, financing, and permitting efforts.
Continuity requirement
Section 4 of Notice 2025–42 outlines that a continuous construction program is essential, allowing for specific excusable disruptions such as severe weather or supply shortages. The continuity safe harbor remains, allowing projects to be completed within four years of starting construction, without applying excusable disruption rules to this safe harbor.
Low-output solar facility
The 5% safe harbor remains applicable solely for low-output solar facilities, defined as those with a maximum net output of 1.5 megawatts (MW) or less. This is determined by the nameplate capacity and applies to integrated facilities in aggregate.
Other factors
The notice provides criteria for determining the beginning of construction, including:
- Work performed under a contract;
- Qualification under Sec. 45Y or 48E;
- Property integral to the facility;
- Application of the 80/20 rule for retrofitted facilities;
- Transfer of the facility post-construction commencement.
Implications
Projects that previously met the 5% safe harbor before September 2, 2025, retain their tax benefits, while those using the physical-work method will adhere to unchanged rules. The extended continuity safe harbor is anticipated to be beneficial for developers.
Key timelines remain: projects starting before September 2, 2025, with the 5% safe harbor have until December 31, 2029, to be operational. Projects starting before July 5, 2026, using the physical-work method, must be operational by December 31, 2030. Projects beginning after July 4, 2026, must be operational by December 31, 2027.
Editor
Susan M. Grais, CPA, J.D., LL.M., is a managing director (retired) at Ernst & Young LLP in Washington, D.C.
For additional information about these items, contact thetaxadviser@aicpa.org.
Contributors are members of or associated with Ernst & Young LLP.
Original Story at www.thetaxadviser.com