New guidance on "beginning of construction" eliminates 5% safe harbor for ITC and PTC
The IRS has made it harder for solar and wind projects to satisfy the beginning of construction rules for purposes of qualifying for federal tax credits.
Under current rules, solar and wind projects can meet the deadline for qualifying for the clean electricity production credit (PTC) or clean electricity investment credit (ITC) by either starting physical work of a significant nature (physical work test) or paying/incurring 5% or more of the total cost of a facility (5% safe harbor) before July 5, 2026. On Friday, the IRS issued Notice 2025-42, which eliminates the 5% safe harbor for solar and wind projects for purposes of meeting that deadline (with a limited exception for small solar projects). The Notice goes into effect on September 2. Solar and wind projects affected by the new rule therefore have two weeks left to take advantage of the 5% safe harbor.
Under the physical work test, projects are required to undertake physical work "of a significant nature." They may do so in one (or a combination) of two ways—by performing on-site work or by having off-site work performed by another person under a binding written contract entered into before the work is done. Significant on-site work includes the installation of racks or other structures to affix photovoltaic panels to the site of a solar facility, or the setting of anchor bolts or the pouring of concrete pads for the foundation of a wind facility. Significant off-site work includes the manufacturing of custom components, but not components normally held in inventory by a vendor. Preliminary activities, such as planning, designing, obtaining permits, and clearing a site do not qualify under the physical work test. The physical work test does not attach a dollar or percentage amount to the definition, creating some uncertainty for developers and lenders on whether, and when, a project begins construction for purposes of the July 5, 2026, deadline. However, developers and lenders have relied on compliance with the physical work test in the past.
The One Big Beautiful Bill Act (OBBBA), enacted on July 4, 2025, accelerates the phaseout of tax credits for new solar and wind projects. Under the new law, solar and wind projects beginning construction before July 5, 2026, will qualify for the ITC or PTC if continuous efforts are made to complete the project. Continuous efforts will be presumed to have been made if the project is placed in service within four years after the year in which construction begins. Solar and wind projects that begin construction after July 4, 2026, must be placed in service by December 31, 2027, to qualify for the ITC or PTC.
Under the Notice, the 5% safe harbor remains available to solar facilities with a maximum net output of 1.5 megawatts AC ("low output solar facilities"). The IRS will review the relevant facts and circumstances for purposes of determining whether a solar facility is a single project or is part of the integrated operations of multiple facilities that should be treated as a single project for purposes of the 1.5-megawatt limit. The Notice also contains rules for facility transfers and the relocation of equipment.
The Notice was issued in response to President Trump's July 7 Executive Order directing Treasury to "strictly enforce" the termination of production and investment tax credits for wind and solar facilities in the OBBBA, including by "restricting the use of broad safe harbors unless a substantial portion of a subject facility has been built." (emphasis added). The Notice does not cite a basis in the OBBBA for selectively eliminating use of the 5% safe harbor for solar and wind projects. Indeed, the OBBBA expressly adopts current IRS guidance on beginning of construction—including the 5% safe harbor—for determining when a project begins construction for purposes of applying new prohibitions on the use of equipment from China and other countries of concern that go into effect on January 1, 2026 (FEOC rules). (Elimination of the 5% safe harbor under the Notice expressly is not intended to apply for purposes of the FEOC rules.) Treasury's selective elimination of the 5% safe harbor for wind and solar projects also seems to conflict with the overall purpose of the clean electricity ITC and PTC, which is to apply the tax credits to projects on a technology-neutral basis, i.e., to treat all clean energy technologies with a zero or negative greenhouse gas emissions rate alike for purposes of qualifying for the credits.
The IRS and Treasury are currently drafting guidance on the FEOC rules.
