By Mayer Brown partners David Burton and Jeff Davis and associate Binyomin Koff
With the price of storage declining substantially in recent years, some owners are considering adding storage to their existing solar projects. This is far more economically viable if the storage can qualify for the ITC. Here’s how and when storage can qualify under existing rules.
The ITC under Section 48 of the Internal Revenue Code allows project owners or investors to be eligible for Federal business energy investment tax credits for installing designated renewable energy generation equipment between 2006 through 2024. Such “energy property” includes equipment and materials (and parts related to the functioning of such equipment) that use solar energy directly to generate electricity, heat or cool a building or provide hot water.
Treasury Regulations (the Treasury Department’s official interpretations of the Internal Revenue Code) provide a list of qualifying equipment, which includes “storage tanks.” The Treasury Regulations further clarify that “solar energy property includes equipment that uses solar energy to generate electricity and includes storage devices, power conditioning equipment, transfer equipment and parts related to the functioning of those items.
Although the Treasury Regulations appear to focus on thermal storage devices, there is no indication that storage systems are limited to any specific type of storage system. Further, the legislative history of the ITC supports the inclusion of both thermal and electric storage systems as solar energy property:
Generally, a solar energy equipment system involves the transformation of sunlight into heat and electricity through the use of such devices as solar cells or other collectors, storage systems for electricity and for hot air or hot water (including rock beds), heat exchangers to utilize captured and stored energy, and related equipment, such as fans and thermostats. The credit for wind equipment similarly applies to the windmill or other devices to harness outdoor moving air to provide electricity and other forms of energy and includes storage and transfer systems to distribute this energy.
It appears the term storage system in the Treasury Regulations should be interpreted to include all storage systems, including electric systems such as batteries.
In recent years, the IRS has ruled privately on multiple occasions that storage devices including batteries are eligible for the ITC. In 2011, in a private letter ruling addressing lithium-ion batteries in a wind facility that was claiming the ITC in lieu of the production tax credit, the IRS determined that the batteries are storage devices, and thus, solar energy property. The IRS reasoned that the Treasury Regulations clearly provide that wind energy property includes a storage device and that “[t]he storage of electricity for use at a later time is a classic use of a battery (and hence a storage device).”
Further, the IRS determined that the battery does not constitute transmission equipment and is therefore eligible for the ITC. A second private letter ruling in 2012 similarly ruled that a battery in a wind facility that appeared in the ruling to have claimed the ITC is eligible for the ITC.
In 2013, the IRS applied the same analysis to storage in solar systems. In a private letter ruling addressing batteries that were a part of rooftop solar systems, the IRS noted that the primary purpose of the battery was to allow the customer to store the solar energy during the day, when the system produces energy, for its later use at night when the sun has set.
The IRSconcluded that the batteries were eligible for the ITC. However, the IRS also ruled that the batteries were subject to the dual use rules. In 2014, the IRS similarly concluded in a fourth private letter ruling, that a battery’s main function is to store the energy for use at a later time and is therefore a storage device that is solar energy property eligible for the ITC. 
In the case of storage devices that use energy from both solar (or wind) and non-qualified energy (“dual use equipment”), the ITC is available only to the extent of the basis of the dual use equipment allocable to its use of solar energy in the annual measuring period.  The allocation of energy use may be made by comparing, on a Btu basis, the energy input from solar energy with the input of energy from other sources. 
The use of Btu in the regulations appears to reflect the fact that in the 1980s, when the regulations were promulgated, solar powered storage generally was in the context of hot water (i.e., storing energy in the form of heat). Three decades later solar power storage is being pursued by independent power producers and residential solar companies for storing electricity. Electricity is measured in Watts, while Btus are a measurement of “energy.” We understand that storage devices for electricity, generally, provide two units of measurement: Watts (which measure the rate at which the device can charge and discharge energy) and Watt-hours (which measure the amount of energy stored in the device). A Watt-hour is a measure of “energy” and accordingly can be converted to Btu. Multiplying Watt-hours by 3.41 results in Btus. 
Therefore, we understand that for solar powered storage systems to comply with the regulation that such systems must be able to track how many Watt-hours are supplied by solar versus how many Watt-hours were supplied by the grid (or any source of electricity that does not qualify for the ITC).
Dual use equipment is subject to two special rules. First, dual use equipment is treated as solar energy property only if its use of energy from sources other than solar energy does not exceed 25% of its total energy input in each year after it is placed in services.  As noted above, the ITC is only available for the portion that the dual use equipment is used for solar energy. Second, dual use equipment is subject to a special recapture rule. 
If in a subsequent year during the recapture period, the percentage of solar energy use drops below the percentage of solar energy used in the year the dual use equipment was placed in service, but remains above 75%, a proportional amount of the ITC is subject to recapture.  If the percentage of total energy used that is from solar energy falls below 75% in a subsequent year during the recapture period, the entire ITC is subject to recapture. 
The recapture period is the five year period beginning on the date the equipment is placed-in-service, with the amount of recapture decreasing by 20% each subsequent year (i.e., 80% recapture in year two, 60% recapture in year three, 40% recapture in year four and 20% recapture in year five). No additional credit is available if the percentage allocable to solar energy increases in a year subsequent to the recapture. 
The IRS also appears to have blessed adding storage to existing solar projects.
In the 2012 private letter ruling referred to above, the batteries were added to an existing project that had been already placed in service, and the IRS ruled, without addressing the placed-in-service issue, that the storage device qualified for the ITC.  The IRS apparently concluded that storage device was eligible for ITC, despite it having a different placed-in-service date than the ITC eligible power generating facility that charged it. 
In the 2012 private letter ruling referred to above, the batteries were added to an existing project that had been already placed in service, and the IRS ruled, without addressing the placed-in-service issue, that the storage device qualified for the ITC. The IRS apparently concluded that storage device was eligible for ITC, despite it having a different placed-in-service date than the ITC eligible power generating facility that charged it.
There are still many outstanding questions in this area that have not been addressed in the IRS rulings.  For example, none of the rulings addressed a situation where the storage device and the generation assets are owned by different taxpayers or where the storage is located in a different location than the generation assets.  These questions were addressed affirmatively in Treasury’s guidance related to the section 1603 program  but in a context unrelated to storage: conversion equipment for open-loop biomass and municipal waste power plants. Treasury determined that with respect to open-loop biomass and municipal waste projects that the equipment that converted the waste into a gas or liquid could be owned by a different party than the facility it served and could be at a separate site from the facility it served, so long as the conversion equipment was “integral” to the facility. 
The section 1603 program was intended to“mimic” the ITC;  therefore, it would appear that a storage device, if integral to the project it is charged by, could have different ownership than the project or be located at a different site.
Further, in a private letter ruling, the IRS allowed a taxpayer to claim the Section 25D residential credit for qualified solar electric property expenditures, where the taxpayer purchased solar panels and a part ownership interest in related equipment required to integrate the panels.  The IRS allowed the credit for the entire purchase price paid by the taxpayer for the solar panels and the interest in the related equipment, notwithstanding that interest in the related equipment was owned by other parties. Although these authorities suggest that separate ownership of the storage devices may not preclude availability of the ITC, the IRS will ultimately need to make a policy call on when to allow the ITC. Additional guidance from the IRS would be welcomed by the solar industry to provide clarification on the separate ownership issue.
The IRS has open regulation project that was announced in Notice 2015-70 to overhaul the investment tax credit rules generally. The solar industry would welcome updated rules for storage devices as part of that guidance. The IRS is continuing to work on those regulations, although it is unclear in the current political and regulatory environment when or if such guidance will be forthcoming.
A bipartisan bill introduced in 2016 by Senator Heinrich (D-NM) and Senator Heller (R-NV) would have provided the ITC for energy storage without regard to the charging source of the storage and the ITC for stand-alone storage would have been subject to the same phase-out currently in effect for the ITC for solar projects.  Unfortunately, the legislation failed to pass out of committee. Although the bill does have bipartisan support, it is unlikely to be considered as a separate tax bill going forward but could be included in a larger tax reform package.