Executive Summary
The enactment of the One Big Beautiful Bill Act (OBBBA) on July 4, 2025, has introduced stringent deadlines for qualifying for the Clean Electricity Investment Tax Credit (ITC) under Internal Revenue Code (IRC) Section 48E, particularly for solar energy projects. To secure the full 30% credit, project owners must ensure that construction begins by July 4, 2026, and that the facility is placed in service by December 31, 2027. In response to these changes, the Internal Revenue Service (IRS) issued Notice 2025-42 on August 20, 2025, which updates the beginning-of-construction (BOC) rules for clean energy tax credits under Sections 45Y and 48E. This notice eliminates the 5% Safe Harbor for most wind and solar facilities but preserves it for low-output solar projects with a maximum net output of 1.5 megawatts (MW) alternating current (AC) or less.
This white paper provides a comprehensive guide for solar project owners on how to utilize the retained 5% Safe Harbor for eligible small-scale projects. It explains both the cash and non-cash options in detail, highlighting how these methods allow owners to incur or pay at least 5% of the total depreciable project costs to establish BOC. Additionally, the paper discusses the Continuity Requirement, the impact of recent IRS guidance, and practical strategies to maximize credit eligibility. By following these approaches, clients can navigate the evolving regulatory landscape and secure valuable tax incentives for their solar investments.
Introduction
The Section 48E ITC represents a critical incentive for the development of clean electricity facilities, offering a base credit of 30% of qualified investment costs, with potential adders for domestic content, energy communities, or prevailing wage compliance. For solar photovoltaic (PV) projects, this credit applies to facilities placed in service after December 31, 2024, but OBBBA accelerates the phase-out for solar and wind technologies, effectively terminating eligibility for projects that fail to meet the specified BOC and placed-in-service deadlines.
Prior IRS guidance, including Notices 2013-29, 2016-31, 2018-59, 2021-41, and 2022-61, established two primary methods for determining BOC: the Physical Work Test and the 5% Safe Harbor. The Physical Work Test requires the start of significant physical work, either on-site or off-site, while the 5% Safe Harbor focuses on financial commitment through payments or incurred costs. Following an Executive Order issued on July 7, 2025, which directed revisions to prevent artificial acceleration of construction starts, Notice 2025-42 implements targeted changes. Specifically, it eliminates the 5% Safe Harbor for all wind facilities and solar projects exceeding 1.5 MW AC, leaving the Physical Work Test as the sole option for larger projects. However, for low-output solar facilities, the 5% Safe Harbor remains available, providing a flexible pathway for small-scale developers to qualify for credits.
This paper focuses on the preserved 5% Safe Harbor, detailing how owners of eligible solar projects can meet the threshold through cash and non-cash strategies. It also addresses the Continuity Requirement and offers actionable strategies to ensure compliance amid OBBBA’s deadlines.
Determining Eligibility: What Qualifies as a Low-Output Solar Facility?
To utilize the 5% Safe Harbor under Notice 2025-42, a solar project must qualify as a low-output facility, defined as one with a maximum net output of no greater than 1.5 MW AC. This measurement is based on the facility’s nameplate generating capacity under standard test conditions, typically the sum of inverter AC capacities or the lesser of DC panel capacities and inverter limits.
The IRS applies aggregation rules to prevent circumvention: If multiple facilities are owned by the same or related taxpayers, placed in service in the same calendar year, share a common point of interconnection, or serve the same end user (in off-grid scenarios), their outputs are combined for the threshold. For instance, two 1 MW AC rooftop systems on adjacent buildings owned by the same entity would be aggregated if they share an interconnection, exceeding the 1.5 MW limit and disqualifying them from the 5% Safe Harbor.
This eligibility criterion supports smaller installations, such as commercial rooftop solar or community solar arrays, allowing owners to rely on financial commitments rather than immediate physical work.
The 5% Safe Harbor: Overview and Application
The 5% Safe Harbor deems construction to have begun when the taxpayer pays (for cash-basis accounting) or incurs (for accrual-basis accounting) at least 5% of the total depreciable costs of the qualified solar facility in the year claimed. The total depreciable costs encompass all expenses included in the facility’s basis under IRC Section 168, such as solar panels, inverters, mounting structures, and wiring, but exclude non-depreciable items like land or standalone roof repairs.
Notice 2025-42 applies this harbor only to low-output solar facilities that have not begun construction before September 2, 2025, ensuring alignment with prior guidance while limiting its scope to prevent abuse. Owners can meet the threshold through a straightforward cash option or various non-cash options, each leveraging binding contracts to demonstrate commitment.
The Cash Option
The cash option involves making direct payments for qualifying project costs that are part of the facility’s depreciable basis. For cash-basis taxpayers, these payments must be made in the tax year claimed, while accrual-basis taxpayers can recognize them upon economic performance. Importantly, the purchased equipment does not need to be delivered to the project site; off-site storage, manufacturing, or allocation under a binding contract is sufficient, as long as the costs are tied to the specific project.
For example, consider a 1 MW AC rooftop solar project with an estimated total depreciable cost of $2 million. If the owner pays $100,000 (5%) for solar panels in 2025 under a non-refundable binding purchase agreement, this payment satisfies the 5% Safe Harbor, even if the panels are stored in a warehouse for later installation. This approach provides a simple way to establish BOC without initiating physical work, allowing owners to secure credit eligibility amid supply chain uncertainties.
Non-Cash Options
Non-cash options enable owners to incur costs without immediate full cash outlays, particularly beneficial for accrual-basis taxpayers who can recognize expenses based on economic performance under Treasury Regulation Section 1.461-1. These methods rely on binding, enforceable contracts with limited contingencies.
Prepaid Equipment Agreements with Solar Providers: These agreements involve advance commitments to purchase equipment, such as PV panels or inverters, where costs are incurred upon the provider’s economic performance, like beginning manufacturing or allocating inventory. The equipment does not need to be custom-designed; standard items qualify if allocated to the project via the contract. For instance, an owner of a 0.8 MW AC solar array might prepay 5% for modules in 2025, incurring the cost when the provider reserves the panels, even if delivery occurs later. This option is ideal for locking in prices amid tariffs or shortages.
Vendor Financing Agreements: Under these arrangements, the vendor finances equipment purchases with deferred payments, and costs are incurred upon delivery or performance. Delivery can be partial or off-site, and financing terms are flexible, typically ranging from 12 to 60 months if arm’s-length and commercially reasonable. For example, an owner financing inverters for a 1.2 MW AC project might incur 5% upon partial delivery to a warehouse in 2025, with repayments spread over 36 months. Owners should ensure the structure is not recharacterized as a pure loan to avoid disqualification.
Turnkey EPC Agreements (Engineering, Procurement, and Construction): These comprehensive contracts bundle design, sourcing, and building into a fixed-price arrangement, allowing costs to be incurred at milestones. Unlike standalone cash payments for preliminary activities, bundled engineering or permitting qualifies when capitalized in the depreciable basis. For a 1.4 MW AC ground-mount solar farm, an owner might incur 5% upon completion of initial engineering drawings in 2025, even if full payment is phased. This method integrates costs effectively for complex small projects.
Lease-to-Own or Conditional Sale: These structures begin as leases with an option or obligation to purchase, incurring costs as payments accrue or upon recharacterization as a sale. There are no strict time limits on lease terms, but they should align with the equipment’s useful life (e.g., 5–10 years). For a 0.5 MW AC rooftop system, an owner might lease racking with a buyout after five years, incurring 5% upon initial possession and use in 2025. This differs from vendor financing by delaying ownership risks to the lessor initially.
Assignment of Equipment In-Progress: This involves transferring rights to partially completed equipment, inheriting the assignor’s incurred costs. For example, an owner assigning a contract for in-progress solar modules might count 5% of fabrication costs toward the threshold in 2025, stepping into the original contract’s progress.
Use of Intercompany Agreements: These agreements between related entities allow cost incurrence upon performance, provided they are arm’s-length under IRC Section 482. An owner might have a parent company incur 5% for solar equipment allocated to a subsidiary’s 1 MW AC project in 2025, documenting transfer pricing to withstand scrutiny.
The Continuity Requirement
Once BOC is established, the IRS requires demonstration of continuous progress to prevent placeholder claims. Notice 2025-42 retains a four-year Continuity Safe Harbor, presuming continuity if the facility is placed in service by the end of the fourth calendar year after the start year (e.g., a 2025 start by December 31, 2029). If this deadline is missed, a facts-and-circumstances analysis applies, evaluating ongoing efforts like contracts, permits, or payments, and forgiving excusable delays such as utility interconnections, weather, or regulatory approvals, provided they are documented and reasonable. Under OBBBA, however, the overriding 2027 placed-in-service deadline must be met for credit eligibility.
Impact of Recent Guidance: Executive Order and Notice 2025-42
The July 7, 2025, Executive Order directed the IRS to revise BOC rules by August 18, 2025, codifying January 1, 2025, standards for Foreign Entities of Concern (FEOC) compliance while addressing manipulation concerns. Notice 2025-42 fulfills this by eliminating the 5% Safe Harbor for larger projects but preserving it for low-output solar to balance incentives with oversight. This codification ensures that pre-2026 starts under current rules are protected from FEOC restrictions, providing certainty for small projects.
Strategies for Clients: Maximizing the 5% Safe Harbor
Clients should first assess their project’s output to confirm eligibility under the 1.5 MW AC threshold, carefully applying aggregation rules to avoid unintended disqualification. For qualifying projects, we recommend documenting all transactions meticulously, including binding contracts, invoices, and progress reports, to substantiate incurrence and continuity in the event of an audit.
To optimize timing, owners are advised to act promptly in 2025, utilizing prepaid agreements or EPC contracts to incur costs early without physical disruption. A hybrid strategy can be effective: Begin with the 5% Safe Harbor for financial certainty and switch to the Physical Work Test if circumstances change, as the IRS allows flexibility. For roof-integrated solar, ensure that work focuses on solar-specific components, as standalone roof replacements do not qualify under the Physical Work Test.
Additionally, owners should over-incur slightly (e.g., 6–7%) to account for cost overruns and consider utility delays as excusable under the facts-and-circumstances test, provided diligence is shown. By partnering with tax advisors, clients can structure agreements to align with arm’s-length standards and maximize bonuses like domestic content.
Conclusion
For solar projects of 1.5 MW AC or less, the 5% Safe Harbor under Notice 2025-42 offers a vital mechanism to establish BOC and secure the Section 48E ITC amid OBBBA’s phase-out. Through cash payments or non-cash options like vendor financing and EPC agreements, owners can demonstrate commitment without immediate construction, provided they maintain continuity and comply with deadlines. As the regulatory environment evolves, proactive planning is essential—our firm stands ready to assist clients in navigating these opportunities to achieve sustainable energy goals.
