Documentation is the backbone of tax credit transferability

As tax credit transactions under the Inflation Reduction Act (IRA) gain momentum, documentation has become a defining issue for both buyers and sellers. For tax credit sellers and organizations electing direct pay, the key to lowering risk lies in maintaining thorough, IRS-ready records. Credit buyers often require higher hurdles, which in practice means the selling entity must provide sufficient documentation to prove the credit is valid and transferable.

A new layer of complexity comes from the Foreign Entity of Concern (FEOC) restrictions, which trigger starting Jan. 1, 2026. These rules, especially the material assistance cost ratio calculations, require projects to carefully examine their supply chains to avoid disqualification. The good news is that taxpayers who establish beginning of construction (BoC) before 2026 may remain eligible under the current regime.

Two safe harbors are available:

• Physical work of a significant nature
• The 5% safe harbor test

The IRS reinforced this framework in Notice 2025-42, released on Aug. 15, 2025, which clarifies new rules and documentation expectations tied to BoC. With year-end deadlines approaching, the message is clear: investors and municipalities alike must move quickly and document thoroughly to lock in today’s more favorable rules. For practical guidance on physical work and the 5% safe harbor, explore our latest BoC analysis.

Key takeaways

• Time is running out: Projects must meet the physical work or 5% safe harbor tests by year-end 2025 to avoid stricter FEOC rules.
• FEOC kicks in: Starting 2026, the material assistance cost ratio test will apply, forcing projects to certify their supply chains.
• IRS steps up oversight: Notice 2025-42 (Aug. 15, 2025) raised the bar for BoC documentation.
• For those electing direct pay, listen up: Municipalities and other organizations electing direct pay are especially exposed if they can’t deliver safe-harbor-level reporting. These organizations may not be as sophisticated as large corporations when it comes to supply chain reporting, and they could miss out on significant credit benefits if they don’t comply with these new rules.

Get started today

Tax credit transferability is now a multi-billion-dollar market, but every transaction hinges on confidence. Without proper documentation, sellers risk indemnity claims, stalled closings or even IRS clawbacks. At the same time, FEOC restrictions beginning in 2026 and the new rules in Notice 2025-42 raise the bar on what “good documentation” looks like. Projects that can demonstrate timely BoC under the physical work or 5% safe harbor tests will avoid the heightened supply-chain restrictions, but only if their files are airtight.

Organizations can be proactive by:

1. Assessing project timelines: Determine if your project can qualify for the physical work or 5% safe harbor before Dec. 31, 2025.
2. Mapping your supply chain: Document sources of key materials to prepare for FEOC material assistance cost ratio testing if your project begins construction after this year.
3. Strengthening documentation: Build files now that meet IRS expectation under Notice 2025-42 and prior guidance.
4. Engage advisors early: Work with our experienced tax specialists to create BoC safe harbor documentation now to reduce your risk.

To navigate these complexities and prepare your projects for success, reach out to Baker Tilly’s team of specialists to learn more.

The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.