Section 48D Deadline Is Near: When Construction Begins And Contiguous Property Qualifies

Highlights

• The CHIPS and Science Act of 2022 added Section 48D to the Internal Revenue Code to incentivize the manufacture of semiconductors and semiconductor manufacturing equipment.
• Unless the U.S. Congress takes action to extend the credit, construction must begin by the end of 2026. Taxpayers that have not already begun construction should evaluate and execute a 2026 strategy now.
• Final Section 48D regulations allow taxpayers to establish the beginning of construction through either the Physical Work Test or the 5 Percent Safe Harbor.
• Qualified property on a separate parcel may be treated as part of an advanced manufacturing facility if the parcel is contiguous to the advanced manufacturing facility and the property is integral.

The window for new Section 48D projects is narrowing. Section 48D of the Internal Revenue Code provides an advanced manufacturing investment credit for qualified investment in facilities whose primary purpose is manufacturing semiconductors or semiconductor manufacturing equipment.

For qualified property placed in service after December 31, 2025, the credit rate is 35 percent. Under current law, the threshold issue for projects is timing: Construction must begin no later than December 31, 2026. 

This alert updates Holland & Knight's previous alert on the final Section 48D regulations and focuses on two planning questions that are increasingly urgent: 1) what a taxpayer must do to establish that construction began by the 2026 deadline, and 2) when property on adjacent or otherwise contiguous land may be treated as part of an advanced manufacturing facility.

The 2026 Deadline Is a Beginning-of-Construction Deadline

Section 48D does not require a project to be completed or placed in service by December 31, 2026. Instead, the statute and final regulations deny the credit for property whose construction begins after that date. A taxpayer may establish beginning of construction under one of two alternative methods: the Physical Work Test or the 5 Percent Safe Harbor. If both tests are satisfied, the beginning-of-construction date is generally the date the taxpayer first satisfies either test.

Option 1: Physical Work of a Significant Nature

The Physical Work Test focuses on the nature of the work rather than its cost or the percentage of the project completed. Although there is no fixed minimum expenditure or percentage threshold, the work must constitute physical work of a significant nature on the relevant item of property. On-site work may include a foundation and pouring concrete pads. Off-site work may count when performed under a binding written contract entered into before manufacture, construction or production begins, provided the work relates to property for the taxpayer and is not merely work on existing inventory or property normally held in inventory by the vendor.

Preliminary activities are not enough. Planning, design, financing, research, permitting, surveys, environmental, or engineering studies and site clearing do not constitute physical work of a significant nature, even if those costs are capitalized. Merely signing a contract also is insufficient; actual qualifying physical work must begin.

Option 2: The 5 Percent Safe Harbor

A taxpayer also may establish beginning of construction by paying or incurring at least 5 percent of the total cost of the relevant property. Cash-method taxpayers look to amounts paid, while accrual-method taxpayers look to amounts incurred under federal income tax principles. Because the test is measured against final project cost, later cost increases could create risk if the amount paid or incurred in 2026 ultimately falls below the required threshold. Taxpayers using this route should model project scope conservatively and maintain detailed cost support.

Beginning Construction Is Only the First Step: Continuity Matters

Both routes require the taxpayer to maintain continuity through continuous construction or continuous efforts. Under Section 48D, a 10-calendar-year continuity safe harbor is available. Property that begins construction in 2026 and is placed in service by December 31, 2036, is deemed to satisfy continuity. Missing that safe harbor does not automatically disqualify the project, but continuity then depends on all relevant facts and circumstances, subject to rules for specified excusable disruptions.

Property on Contiguous Land Can Be Part of the Advanced Manufacturing Facility

Section 48D is not limited to property within the walls, or even on the same tax parcel, as the advanced manufacturing facility that manufactures the semiconductors or semiconductor manufacturing equipment. The final regulations provide that property may be part of an advanced manufacturing facility if it is physically located or co-located at the facility or on a contiguous piece of land to the facility. Parcels or tracts are contiguous if they share a common boundary. They also are treated as contiguous if they would share a common boundary but for a road, street, railroad, public utility, stream or similar property.

Contiguity alone is not sufficient. The property also must be qualified property and integral to the operation of semiconductor or semiconductor manufacturing equipment production. In general, property is integral when it is used directly in the manufacturing operation, is essential to the completeness of that operation and is not materially transformed by the manufacturing operation. The examples in the regulations include an air separation unit that provides on-demand nitrogen to an advanced manufacturing facility.

Final Regulations Confirm That Split Ownership Can Work

The taxpayer claiming the credit does not have to own the entire advanced manufacturing facility. The preamble and regulatory examples recognize that one taxpayer may own qualifying property that serves another taxpayer's advanced manufacturing facility. For example, the air separation unit located on contiguous land supplying on-demand nitrogen to semiconductor manufacturing may be part of, and integral to, the advanced manufacturing facility.