As ITC extension promises growth, storage developers look to define position under tax code

The IRS is currently weighing changes to the ITC that could open the door for more energy storage

What was looking like a strong year for energy storage got even stronger in December when Congress passed an extension of the investment tax credit (ITC).

The extension does not specifically mention storage – standards for storage to qualify for the ITC remain the same as they were before the extension – but it does extend the credit for solar power, and robust solar installations provide more opportunities for storage deployments.

“I believe we will continue to see momentum build for adding storage to proposed solar projects. The ITC extension will ensure this continues, as the capital savings are significant, particularly as prices for storage continue to fall quickly,” says Michael Kleinberg, senior consultant at DNV GL.

Prior to the extension, the ITC was set to step down at the end of 2016, resulting in a 10% tax credit for non-residential and third-party owned residential systems and 0% for customer-owned residential systems.

The extension keeps the solar ITC at 30% through 2019. It then steps down to 26% in 2020 and 22% in 2021. In 2022, the ITC steps down to the original levels proposed for 2017. A commence-construction clause is included as well, meaning that systems that are in the process of installation and interconnected by 2023 can still claim the larger tax credits.

The extension could result in 3,700 MW of new wind and solar capacity, a 56% boost to the industry over five years, according to Bloomberg New Energy Finance.

Energy storage paired with renewables also gets a boost. A new report from GTM Research estimates the extension will result in an additional 500 MW of renewable-paired storage between 2016 and 2020, a 33% increase compared with a scenario with no tax credit extension.

But an even bigger boost for energy storage could be in the works. In October, the Internal Revenue Service and the U.S. Treasury Department requested comments on what qualifies as an “energy property” under Section 48 of the tax code.

The comment period closed on Feb. 16.

Could storage qualify for the ITC?

The update was spurred by an uptick in demandside technologies and the absence of IRS guidance with respect to dual-use properties and energy storage used as demand response or as backup power for non-renewable energy.

Section 48 definitions consider storage devices, but the language and examples largely focus on thermal storage, which raises many unanswered questions when energy storage is paired with renewable resources such as wind and solar power, which is increasingly common.

In the absence of clear guidelines, energy storage developers have sought to qualify for the ITC on a case-by-case basis through the IRS’ private letter ruling process. But that process has not always added clarity to the definition of what kind of energy storage project qualifies for the ITC.

Application of the dual use property rules to energy storage has been particularly unclear over the last several years. In 2011, the IRS issued two private letters allowing the full 30% tax credit for storage devices paired with wind farms. Those projects both use the stored energy for grid services like frequency regulation, and get some of their energy input from the grid. Then in 2012, the IRS issued a private letter for a solar + storage project, but reduced the tax credit by the amount of grid energy that was used to recharge the batteries.

The solar + storage private letter established the concept of the “75% cliff,” which advises that if a storage device derives more than 25% of its energy from the grid, it is ineligible for the ITC.

If a solar-related storage device derives more than 25% of its energy input from non-solar power in its first year of service it is not eligible for the ITC. And, once above the 75% threshold, the amount of non-solar power used limits the tax credit. So, a device that uses 10% non-solar power is only eligible for 90% of the ITC.

The ITC vests over five years from the in service date of the eligible property at a rate of 20% per year. A disqualifying event in the first year, triggers a 100% recapture of the ITC. In the second year, recapture falls to 80%, 60% in the third year and so on to the fifth year.

For storage, there is an added complication. The first year’s solar input sets a benchmark for the subsequent four years. If there is a reduction in the percentage of solar energy inputs below the level of the first year – but still above the 75% threshold – there would be proportionate recapture.

For example, if a $100 solar + storage project qualifies for 100% of the ITC in its first year of service, but solar input drops to 75% in the second year, it would only be eligible for 25% of the 80% of the full amount, or $6.

It may seem like a fine needle to thread, but it is possible to provide controls to make sure a solar + storage system keeps within its optimal ITC-driven parameters. “We routinely model projects and perform analyses of the impact of the ITC on a project.” Davion Hill, North American energy storage leader at DNV GL, says.

Refining parameters around the ITC

The intent of the rules is to make sure the ITC is encouraging the development of renewable resources, as opposed to incentivizing storage for uses such as arbitraging peak and off-peak rates. The downside is that some benefits of running a system for optimal performance may be lost in order to maintain the ITC.

Some developers argue that stand-alone storage achieves that same result by making the grid cleaner and more efficient, and they would like to see more latitude given to storage. And it is not surprising that those developers welcome a wider treatment of storage by the IRS. “A new definition is long overdue,” says Ravi Manghani, senior energy storage analyst at GTM Research.

Among the outcomes he sees when the IRS finishes sorting through the comments it has received is that the agency would explicitly include energy storage as an eligible energy property under Section 48. He says the least likely outcome would be for the IRS to exclude storage. Overall, he says, “vendors are optimistic that storage will find a place.”

It would be good to have energy storage clearly defined in Section 48, says Seth Mullendore, project manager at the Clean Energy Group, but meanwhile, “the vendors we talk to say they can still get it make it within the current hazy scheme.”

Correction: An earlier version of this post stated that the ITC extension would result in 5 MW of additional storage deployments. That was incorrect. The GTM report forecasts an additional 500 MW of storage capacity as a result of the tax credit extension.