IRS generally eliminates 5% safe harbor for determining beginning of construction for wind and solar projects

Editor: Susan M. Grais, CPA, J.D., LL.M.

In Notice 2025–42, released on Aug. 15, 2025, the IRS updated the rule for determining when construction has begun on wind and solar facilities for purposes of qualifying for tax credits under Secs. 45Y (clean energy production credit) and 48E (clean electricity investment credit). The “5% safe–harbor” test is generally eliminated, leaving the “physical work” test as the only way to establish that construction has begun on a facility.

The notice is effective for applicable wind and solar projects for which construction had not begun before Sept. 2, 2025.

Background

H.R. 1, P.L. 119–21, known as the One Big Beautiful Bill Act (OBBBA), eliminated the Sec. 45Y and 48E credits for wind and solar facilities placed in service after Dec. 31, 2027, except for facilities for which construction begins within 12 months of the act’s enactment on July 4, 2025.

Following the legislation’s enactment, on July 7, 2025, President Donald Trump issued an executive order, Ending Market Distorting Subsidies for Unreliable, Foreign Controlled Energy Sources, in which he directed Treasury, within 45 days of the OBBBA’s enactment, to issue guidance for applicable wind and solar facilities to assure that policies concerning the “beginning of construction” are not circumvented and to restrict the use of broad safe harbors “unless a substantial portion of a subject facility has been built.“ The order also directed Treasury to issue guidance implementing the OBBBA’s enhanced foreign–entity–of–concern restrictions, which Notice 2025–42 said would be issued separately.

Before the issuance of Notice 2025–42, to establish the beginning of construction of a solar or wind facility, taxpayers could demonstrate that construction had begun by either: (1) starting “physical work of a significant nature” and maintaining a continuous program of construction (the physical–work test) or (2) paying or incurring 5% or more of the total cost of the facility and thereafter making continuous efforts to advance toward completion of the facility (the 5% safe–harbor test).

Physical-work test

The notice generally eliminates the 5% safe–harbor test for making the beginning–of–construction determination for wind and solar facilities, except for certain low–output solar facilities (discussed below). Instead, the notice states that the sole method for determining the beginning of construction is the physical–work test, which requires the start of physical work of a significant nature and that the taxpayer maintain a continuous program of construction (the continuity requirement). Whether physical work of a significant nature has begun in the 12 months before July 5, 2026, will depend on the relevant facts and circumstances.

According to the notice, the physical–work test is evaluated by the nature of the work performed, not the amount or cost. Work that is performed off–site or on–site, either by the taxpayer or by another person under a binding written contract, may be taken into account in determining whether physical work of a significant nature has begun.

Off–site work: Off-site physical work of a significant nature may include “the manufacture of components, mounting equipment, support structures such as racks and rails, inverters, and transformers … and other power conditioning equipment.”

On–site work: The notice contains a nonexclusive list of examples of what constitutes on-site work for wind and solar facilities. For example, for a wind facility, on-site physical work of a significant nature “begins with the beginning of the excavation for the foundation, the setting of anchor bolts into the ground, or the pouring of the concrete pads of the foundation.” If components such as wind turbines and towers are manufactured off-site by a person other than the taxpayer and delivered to the site, physical work of a significant nature begins when the manufacture of the components begins at the off-site location, but only if the work is done under a written binding contract and the components are not in (or not normally held in) the manufacturer’s inventory.

Preliminary activities: The notice specifies that physical work of a significant nature does not include preliminary activities, even if their cost is included in the facility‘s depreciable basis. Preliminary activities include (but are not limited to) planning, securing financing, researching, and obtaining permits and licenses (Notice 2025-42, §3.04).

Continuity requirement

Notice 2025–42, Section 4, contains the continuity requirement, which will be satisfied only if the taxpayer maintains a continuous program of construction with respect to wind or solar facilities. This means continuing physical work of a significant nature, either under the continuity safe harbor (described below) or the relevant facts and circumstances.

The notice contains a nonexclusive list of “excusable” construction disruptions that would not result in a taxpayer’s failing to satisfy the continuity requirement, such as delays due to severe weather conditions, in obtaining permits or licenses, in the manufacture of custom components, in obtaining financing, and due to supply shortages. Whether an excusable disruption has occurred in a project involving one facility is determined in the calendar year during which the facility is placed in service. For a project composed of multiple facilities, an excusable disruption is determined in the calendar year during which the last of the facilities is placed in service.

The continuity safe harbor was effectively retained and applies if the facility is placed in service no more than four calendar years after the calendar year during which construction began. The excusable–construction–disruption rules do not apply for purposes of applying the safe harbor. The continuity requirement generally prevents the potential unintended acceleration of tax credit eligibility and helps ensure that each eligible project makes ongoing, continuous progress.

Low-output solar facility

The 5% safe harbor can only be used for low–output solar facilities that begin construction before July 5, 2026. The notice defines a low–output solar facility as having a maximum net output of not greater than 1.5 megawatt (MW) (as measured in alternating current). The notice details how to determine which property is included in a low–output solar facility and how to measure the facility’s output. The determination of whether a qualified facility has a maximum net output of not greater than 1.5 MW is based on the nameplate capacity. For purposes of the 1.5 MW maximum, the nameplate capacity of two or more applicable solar facilities having integrated operations is measured in the aggregate.

Other factors

The notice also details how to evaluate the various factors that are included in making beginning–of–construction determinations, including whether:

• The work is performed under contract;
• The facility is qualified under Sec. 45Y or 48E;
• The property is integral to the facility;
• The 80/20 rule for retrofitted facilities applies; and
• The facility was transferred after construction began.

Implications

Developers with solar and wind projects that had already met the 5% safe harbor and those that chose to accelerate spending to meet the standard before the notice was effective (Sept. 2, 2025) will still benefit. For projects intending to utilize the physical–work approach to meet the beginning–of–construction standard, the rules under this notice are substantially unchanged from the previous requirements. Although this notice retains a list of permissible delays similar to existing rules, the preservation of the four–year continuity safe harbor should be well received by developers.

To recap key dates, projects qualifying under the 5% safe harbor with a 2025 beginning–of–construction date preceding Sept. 2, 2025, will continue to have until Dec. 31, 2029, to be placed in service. Likewise, projects with a 2026 beginning–of–construction date occurring before July 5, 2026, (which will now be exclusively under the physical–work method) will have until Dec. 31, 2030, to be placed in service. Projects beginning construction after July 4, 2026, however, must be placed in service by Dec. 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.