Research and Development (R&D) In the Construction Industry
The Research and Development (R&D) tax credit is an incentive that rewards companies that continue to innovate and pursue new challenges. In the construction industry, R&D encompasses the pursuit of knowledge, innovation and technological advancements to enhance building processes, materials and structural designs. R&D can take place in all areas of construction including commercial, residential, retrofitting and new builds. Contractors, subcontractors, engineering and construction firms involved in the design, development and construction of innovative buildings and infrastructures have the potential to qualify for this valuable tax incentive.
To be eligible, a company must examine its activities on an individual project level and determine if a given project meets a “four-part test.” The test is a combination of four separate qualifiers that a project must fulfill:
- New or improved products, processes, or software
- Elimination of uncertainty
- Technological in nature
- Process of experimentation
Within the construction industry, there are several possible activities that can be considered, including:
- Developing prototypes and modeling;
- Development of new, improved or more reliable products, processes or techniques;
- Development of environmentally friendly/green methods and processes, or sustainable technology;
- Development of unique assembly or construction methods and processes;
- Experimentation with new building materials;
- Identification of technological improvements in construction processes or to the products and software used;
- Development or adaptation of tools, equipment and/or materials to improve efficiency, or the adaptation of construction techniques to consider environmental or land conditions;
- Adapting equipment or processes to meet new regulatory requirements, which includes innovative scaffolding, safe working processes and automation, fire, health and safety, sound and thermal;
- Design and development of new mechanical and electrical systems into buildings, considering Moder Methods of Construction (MMC) and Building Information Modelling (BIM); and
- Any project that requires an extra level of testing or certification upon completion.
The R&D credit is calculated annually based on the amount of qualified research expenditures (QREs) paid or incurred by a company. QREs include expenses such as salaries for employees working on engineering, design and/or design/build projects, cost of raw materials and supplies used during prototype research, and payment made to third-party contractors for helping with the construction R&D (i.e. engineering contractors or research institutions). Generally, the amount of R&D credit generated represents between 7% and 10% of the QREs paid or incurred during the year.
As a result of the Tax Cuts and Jobs Act of 2017, significant changes were made to the reporting of QREs beginning January 1, 2022. Prior to this rule change, taxpayers were allowed to expense Section 174 costs in the year incurred, receiving an immediate tax deduction. For tax years starting after December 31, 2021, taxpayers are now required to capitalize and amortize Section 174 costs over five years. This change to the law sheds a negative light on those businesses incurring QREs as it created additional taxable income while taking away the immediate tax savings benefit of the R&D credit.
Hope may be on the horizon as the U.S. House of Representatives passed the Tax Relief for American Families and Workers Act of 2024 on January 31, 2024. If signed into law, this bill would reinstate immediate domestic research expensing under Section 174. In addition, the immediate expensing of QREs would be applied retroactively to the 2022 tax year, and it would remain in effect for tax years beginning before January 1, 2026.
If your company has not been claiming R&D credits, it’s time to revisit the potential benefits. Credits can be utilized to offset income tax or, if eligible, employer-paid payroll taxes. Additionally, any unused credit can be carried back one year or forward up to 20 years.
Contributing Author: Shawn T. Layo, CPA, is a tax partner at Dannible & McKee, LLP with over 22 years of experience in taxation and planning for individuals and closely-held companies. He is responsible for overseeing tax engagements for a variety of clientele with a focus on construction, architectural and engineering, multi-state corporations and high-net-worth individuals. For more information on this topic, you may contact Shawn at firstname.lastname@example.org or (315) 472-9127.