For renewable energy developers, the phrase “beginning of construction” has never meant simply placing a ceremonial shovel in the ground, taking a few photographs, and ordering lunch for the project team. It is a federal tax concept that can determine whether a wind or solar facility qualifies for valuable clean electricity tax credits.
IRS Notice 2025-42 substantially tightened that concept for most wind and utility-scale solar projects. The guidance generally removed the familiar 5% cost safe harbor and required affected projects to demonstrate that physical work of a significant nature had begun. That change turned construction sequencing, manufacturing records, contracts, invoices, and progress reports into potentially decisive tax documents.
Why “Beginning of Construction” Became So Important
Sections 45Y and 48E of the Internal Revenue Code provide technology-neutral incentives for qualifying zero-emission electricity facilities. Section 45Y is generally a production-based credit tied to electricity generated and sold, consumed, or stored under qualifying conditions. Section 48E is generally an investment-based credit calculated using a taxpayer’s qualified investment in eligible property.
Public Law 119-21, enacted on July 4, 2025, accelerated the termination schedule for these credits as applied to wind and solar. A qualifying wind or solar facility could avoid the new termination rule by beginning construction on or before July 4, 2026. Alternatively, a project could remain eligible if it was placed in service no later than December 31, 2027.
That created two very different races. A relatively advanced project might aim to achieve commercial operation by the end of 2027. A less mature project might instead try to establish a defensible construction-start date before July 5, 2026, buying more time to finish the facility.
Executive Order 14315 then instructed the Treasury Department to strictly enforce the termination provisions and restrict broad safe harbors that could be used without a substantial portion of a project being built. IRS Notice 2025-42 was issued in response.
How the Rules Worked Before Notice 2025-42
Before the Notice, developers generally had two established ways to show that construction had begun.
The Physical Work Test
A taxpayer could begin physical work of a significant nature on property integral to the facility. The test focused on the nature of the work, rather than its cost or quantity. Both on-site and qualifying off-site work could count.
The 5% Safe Harbor
A taxpayer could also pay or incur at least 5% of the facility’s total eligible cost. This route was often easier to plan and document because it translated a fuzzy construction concept into a numerical threshold. Five percent is not pocket change on a $400 million project, but it is at least a number everyone can place in a spreadsheet without debating the philosophical meaning of an anchor bolt.
Both approaches were subject to continuity requirements. A taxpayer could not perform a small amount of work, disappear for several years, and later announce that construction had been progressing spiritually. The project had to continue moving toward completion under the applicable rules. These two construction-start methods had been recognized and refined through IRS guidance beginning in 2013 and were later applied to Sections 45Y and 48E through Notice 2022-61.
What IRS Notice 2025-42 Changed
The headline change was simple, even if the consequences were not: for most affected wind and solar projects, the Physical Work Test became the sole method for satisfying the July 2026 construction-start deadline.
The Notice removed the 5% Safe Harbor for all applicable wind facilities and for solar facilities with more than 1.5 megawatts of maximum net output, measured in alternating current. The original guidance applied to affected projects that had not already begun construction under the prior rules before September 2, 2025.
The Exception for Low-Output Solar Facilities
A solar facility with maximum net output of no more than 1.5 MW AC could continue using either the Physical Work Test or principles similar to the 5% Safe Harbor. This exception was particularly relevant to smaller commercial, distributed-generation, and community solar projects.
The capacity rule could not necessarily be avoided by dividing one coordinated project into an impressive collection of smaller project companies. Facilities could be aggregated when they had integrated operations, including common or related ownership, placement in service during the same taxable year, and use of the same interconnection point or support for the same behind-the-meter customer.
Understanding the Physical Work Test
Notice 2025-42 retained an important principle: there was no fixed minimum percentage, dollar amount, or volume of labor required under the Physical Work Test. The analysis focused on whether the work itself was significant and related to property forming an integral part of the facility.
That sounds flexible, but flexibility is not the same thing as simplicity. A percentage test can be checked with arithmetic. A physical-work analysis requires facts, documents, legal judgment, and occasionally a conference call involving so many advisers that the attendee list begins to resemble a small census.
Examples of Qualifying On-Site Work
For wind facilities, qualifying work could include excavating turbine foundations, setting anchor bolts, or pouring concrete foundation pads. For solar facilities, the installation of racks or other structures used to attach photovoltaic panels, collectors, or solar cells could qualify.
Off-Site Manufacturing Could Also Count
Physical work did not have to occur at the final project site. Manufacturing project-specific mounting equipment, racks, rails, inverters, transformers, or other power-conditioning equipment could count when the work was performed under a qualifying binding written contract.
The contract had to be entered into before manufacturing began, and the property generally could not be an item already held or ordinarily held in the manufacturer’s inventory. If one manufacturer was producing components for several projects, the taxpayer needed a reasonable method of associating particular components with the correct facility.
Activities That Did Not Establish Construction
One of the biggest traps was confusing serious project development with qualifying physical construction. A developer could spend millions of dollars and thousands of staff hours without satisfying the Physical Work Test.
The Notice identified preliminary activities that generally did not count, including:
- Planning and designing the facility;
- Securing financing;
- Conducting resource mapping or modeling;
- Obtaining permits and licenses;
- Completing environmental or engineering studies;
- Clearing the project site;
- Conducting soil-condition test drilling; and
- Excavating merely to change the contour of the land.
The distinction between site grading and foundation excavation could therefore become extremely important. Moving dirt was not enough merely because the dirt looked busy. The work had to be tied to construction of the qualifying facility.
Continuity Still Mattered
Beginning construction was only the first chapter. Taxpayers also had to maintain a continuous program of construction involving continued physical work of a significant nature.
The Notice preserved a four-calendar-year Continuity Safe Harbor. A project placed in service by the end of the fourth calendar year following the calendar year in which construction began was generally treated as satisfying the continuity requirement.
For example, a project that began construction during 2025 could satisfy the safe harbor by being placed in service no later than December 31, 2029. After that date, continuity would be evaluated under the project’s facts and circumstances.
The Notice also recognized excusable disruptions beyond the taxpayer’s control. Examples included severe weather, natural disasters, government permitting delays, interconnection delays, labor stoppages, shortages of specialized equipment, endangered-species issues, financing delays, and supply shortages.
Project Grouping and Integral Property
Multiple facilities could be treated as one project based on their facts and circumstances. Indicators included common ownership, contiguous land, a shared power purchase agreement, a common intertie or substation, common permits, one master construction contract, or financing under the same loan agreement.
This grouping analysis mattered because a developer could not assume that construction work performed for one small part automatically protected an entire portfolio. Teams needed to identify which facility owned the components, how equipment was allocated, and whether separate projects might be combined for tax purposes.
Work also had to relate to property integral to electricity production. Work on electrical transmission property generally did not count. This distinction required careful coordination among tax counsel, engineers, procurement teams, and interconnection specialists because the commercial project boundary and the federal tax facility boundary were not always identical.
Contracts, Transfers, and Retrofit Projects
Binding Written Contracts
A contract used to support off-site physical work had to be enforceable under local law. A damages limitation could create problems, although a provision limiting damages to at least 5% of the total contract price was not treated as an impermissible specified limitation under the Notice.
Transfers of Developed Facilities
A fully or partially developed project could generally be transferred without losing its established construction-start date. Sections 45Y and 48E did not require the eventual credit claimant to have owned the facility when construction began.
A narrower rule applied when only equipment or contractual rights were sold to an unrelated party. In that situation, physical work performed for the seller might not follow the equipment to the buyer’s different project. Buying a box of previously safe-harbored parts was not automatically the tax-credit equivalent of adopting their construction history.
The 80/20 Rule for Retrofitted Facilities
A retrofitted facility could be treated as newly placed in service when the fair market value of its used property was no more than 20% of the facility’s total value. For such projects, the beginning-of-construction analysis focused on work performed on the new components. Land costs, lease payments, and property outside the qualifying facility were excluded from the relevant calculation.
How Notice 2025-42 Affected Development Strategy
The original Notice pushed developers away from accounting-driven safe-harbor strategies and toward construction-driven execution. Procurement teams needed more than purchase orders and deposits. They needed evidence that project-specific manufacturing had actually begun.
Engineering teams had to identify work packages that were unquestionably integral to the facility. Legal teams reviewed contract enforceability, assignment provisions, damages clauses, related-party rules, and project ownership structures. Tax-equity investors and credit buyers demanded detailed documentation because an uncertain construction-start date could affect pricing, closing conditions, indemnities, and eligibility opinions.
The guidance also favored projects with mature designs, executed contracts, available manufacturing capacity, and realistic construction schedules. Early-stage projects with unresolved land, permitting, interconnection, or financing issues faced a more difficult path, even when sponsors were prepared to spend significant amounts. Industry and professional analyses consistently identified the elimination of the 5% Safe Harbor as the Notice’s most consequential feature.
Why a Federal Court Vacated the Notice
In Oregon Environmental Council v. Internal Revenue Service, the district court concluded that the Notice was arbitrary and capricious under the Administrative Procedure Act.
The court found that the IRS had not adequately explained why use of the 5% Safe Harbor amounted to circumvention or artificial manipulation. It also questioned why wind and large-scale solar projects were treated differently from other technologies eligible for the technology-neutral Sections 45Y and 48E credits.
Another central issue was reliance. Developers, investors, manufacturers, utilities, and advisers had structured transactions around the 5% Safe Harbor for more than a decade. According to the court, the agency did not sufficiently consider those reliance interests or meaningful alternatives before eliminating the rule.
The court vacated the Notice nationwide and remanded the matter to the IRS. Consequently, the historical 5% Safe Harbor was technically restored for wind and large-scale solar projects, although the possibility of an appeal, a stay, or revised guidance created continued risk.
Practical Experience: What Project Teams Learned
The period surrounding IRS Notice 2025-42 offered a concentrated lesson in how tax policy affects real-world project development. The first experience repeated across the market was that a construction-start strategy cannot be owned by the tax department alone. Tax lawyers may interpret the standard, but engineers determine what is being built, procurement managers know what the manufacturer has started, and construction teams control the evidence created in the field.
Successful teams formed cross-functional working groups rather than passing a single checklist from department to department. They identified the exact facility, the relevant taxpayer, the qualifying property, the chosen construction-start method, and the continuity plan. This reduced the risk that a beautifully drafted tax memorandum would describe one project while the purchase order, engineering drawings, and contractor reports described another.
Another lesson involved manufacturer documentation. A signed contract and a large deposit did not necessarily prove that physical work had begun. Developers sought dated production reports, photographs, serial numbers, material-release forms, engineering drawings, labor records, quality-control reports, and written confirmation that the components were not ordinary inventory. The goal was to build a timeline that a reviewer could understand years later, after the project team had changed and everyone’s inbox had become a digital archaeological site.
Project teams also learned to avoid vague work descriptions. An invoice stating “equipment fabrication services” was less helpful than a record identifying the particular racks, inverter assemblies, transformer components, or mounting structures being manufactured for a named facility. Clear allocation became especially important when master contracts covered several projects or when components were later assigned to special-purpose entities.
On-site work created its own practical challenges. Developers needed records showing that excavation related to actual foundations rather than general grading. Daily construction logs, GPS-stamped photographs, survey records, concrete tickets, inspector reports, and contractor certifications helped connect visible activity to qualifying facility property. A dramatic photograph of heavy machinery was useful for the project newsletter, but tax diligence usually wanted dates, locations, specifications, and contractual context.
The continuity requirement encouraged teams to prepare long-term evidence plans. Construction schedules were preserved alongside explanations for weather interruptions, permitting delays, supply shortages, interconnection problems, labor disruptions, and financing setbacks. The best files did not merely show that work stopped; they explained why, documented that the disruption was outside the taxpayer’s control, and demonstrated how the project continued advancing when conditions allowed.
Transaction experience added another warning: construction-start status had to survive financing and ownership changes. Buyers and tax-credit investors reviewed whether the entire facility was transferred or only selected equipment, whether parties were related, whether contract rights were properly assigned, and whether the original work could be associated with the acquired project. A developer claiming that “the safe harbor comes with the transformer” could expect several follow-up questionsand possibly a very long diligence call.
The court’s 2026 vacatur delivered the final lesson: legal guidance can change after commercial decisions have already been made. Projects that accelerated physical work may have incurred extra costs. Projects that relied on the restored 5% Safe Harbor faced uncertainty about appeals or replacement guidance. The most durable strategy was therefore layered documentation. A project able to support both qualifying expenditures and significant physical work generally entered financing discussions with a stronger factual record than one relying on a single fragile theory.
Conclusion
IRS Notice 2025-42 represented a major, though ultimately contested, shift in the federal beginning-of-construction rules for wind and solar projects. It removed the 5% Safe Harbor for all wind facilities and most utility-scale solar facilities, elevated the Physical Work Test, and placed greater importance on project-specific manufacturing, binding contracts, integral property, and continuous construction.
The June 2026 court decision changed the legal landscape by vacating the Notice and restoring the historical safe harbor. Nevertheless, the original guidance remains important because it shaped project decisions, documentation practices, financing negotiations, and litigation surrounding the clean electricity credits.
For taxpayers, the practical takeaway is not to rely on slogans such as “we spent enough” or “work definitely started.” Eligibility depends on the statute, applicable IRS guidance, court rulings, project facts, accounting methods, contracts, and evidence. In renewable energy tax planning, paperwork may not generate electricity, but it can determine whether the project generates a tax credit.
