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New IRS Guidance on Carbon Capture Projects Answers Some Questions, Raises Others

IRS Releases Long-Awaited Carbon Capture Tax Credit Guidance Background Decorative Image

The IRS published Revenue Ruling 2021-13 on July 1, 2021, addressing a series of issues on the Section 45Q tax credit for carbon capture projects. Specifically, the Revenue Ruling focuses on a methanol plant and tackles questions relating to:

  • The scope of the definition of carbon capture equipment;
  • Requirements when components of carbon capture equipment are owned by multiple parties;
  • Construing the overall placed-in-service date for Section 45Q purposes when different components of carbon capture equipment began operating at different times; and
  • Reconciling placed-in-service dates for Section 45Q versus depreciation purposes.

Although the conclusions in Revenue Ruling 2021-13 are generally favorable to taxpayers, they are not universally helpful. Specifically, the Revenue Ruling broadly applies the functional-based definition of carbon capture equipment set forth in the final Section 45Q Treasury Regulations. At first blush, this broad application would appear to cause problems with many potential carbon capture projects not being able to qualify under the new, more favorable Section 45Q regime. However, the Revenue Ruling mitigates this concern by further providing that a single installation of carbon capture equipment will have one placed-in-service date determined when the overall system is in the requisite state of readiness. Accordingly, equipment that is classified as carbon capture equipment but was operating before the enactment of the new Section 45Q regime will not disqualify the overall system from being subject to the new regime. The potential problems this position could have caused with depreciation deductions was reconciled in the Revenue Ruling by allowing equipment to have different placed-in-service dates for depreciation and Section 45Q purposes.

The problem with the broad approach to construing carbon capture equipment taken in Revenue Ruling 2021-13 is that it will result in more projects having multiple owners of carbon capture equipment and/or increasing the scope of equipment that must be acquired in a tax equity partnership — which, given the high cost of tax equity capital, will make those projects more expensive. The issue of having multiple owners of carbon capture equipment was one on which the final Section 45Q regulations largely punted, referencing only a multi-pronged standard that will often not resolve the question. The conclusions in Revenue Ruling 2021-13 put greater importance on that standard and, absent additional guidance or the issuance of Private Letter Rulings on the question (neither of which may be forthcoming), careful analysis and construction planning will be required to attain the requisite comfort.

Nevertheless, Revenue Ruling 2021-13 represents progress towards addressing a number of open questions surrounding carbon capture projects and evidences the IRS’s efforts to work with taxpayers to clarify complicated factual scenarios as the industry works to move these projects forward.

This information is provided by Vinson & Elkins LLP for educational and informational purposes only and is not intended, nor should it be construed, as legal advice.