R&D Tax Credits Can be a Boon to Real Estate Businesses by Karen A. Lake, CPA
Posted on February 21, 2023
Mentioning the federal research and development (R&D) tax credit often conjures up images of scientists in white coats conducting lab experiments. Truth be told, the credit, which can reduce taxpayers’ federal tax liabilities, applies to a wide variety of activities conducted by companies outside of labs in an even broader range of industries, including construction design and real estate development.
Congress introduced the R&D tax credit in 1981 to reward U.S. businesses for being innovative, taking on risks and keeping jobs within the country. It provides eligible taxpayers with a dollar-for-dollar federal tax credit that offsets income tax. The credits are available for qualified research expenditures (QREs) taxpayers incur in the development, design or improvement of new or existing products, processes, techniques, software or other technologies. Additional state-level income tax credits are also available to eligible taxpayers that conduct qualifying R&D activities in more than 35 jurisdictions, including Florida, Georgia, New Jersey, California and New York. If an activity qualifies for the R&D credit, the costs taxpayers may include in their credit calculation are employees’ wages, supplies used, and payments to third-party contractors.
Qualifying Activities Specific to Real Estate
The IRS defines qualifying R&D activities under a broad four-part test, none of which requires taxpayers to discover something new to the world or expand the field of knowledge in their industries. Instead, the IRS will look at such factors as whether a taxpayer’s activities meet the following criteria that define R&D for tax purposes:
- The activity must be technological in nature.
- The activity must have a qualified purpose (creating or improving upon a business component).
- The activity must rise to a level of “technical uncertainty.”
- The activity must undergo an evaluative process of experimentation.
Within the real estate industry, it is the role of engineers, architects and other technicians to develop solutions given the constraints and requirements of a specific project. These constraints often require extensive evaluation and may include a property’s location, intended use, environmental impact and the topography of the land and the overall project budget. Rarely will the design of a building, roadway, bridge or other structure be copied from a previous project and built to print. Uncertainty regarding the appropriate design is a qualifying factor of the R&D credit, and, if technical uncertainty to accomplish a goal exists, there are likely qualified costs. Evaluating different designs, technologies and materials is a good indicator of qualifying R&D activities. For example, taxpayers may employ professionals to explore the use of alternate materials that are eco-friendly and can withstand extreme weather conditions. Or they may look to design airflow/windows intended to improve a building’s power efficiency.
It is important to note that uncertainty or selection decisions deemed structural or technical may also qualify as R&D activities, whereas aesthetic decisions, such as paint color and roof tile, will not unless there is a technical challenge associated with those designs. For example, consider the construction of a floating staircase with hidden structural beams. Although the staircase would improve the building’s appearance, its design’s ability to preserve the structural integrity of the staircase and the building itself could rise to the level of a qualifying R&D activity.
With this in mind, taxpayers may find a treasure trove of qualifying R&D activities in the development of certain buildings and structures that serve specific functional purposes. This can include dams, bridges, tunnels and stadiums. It may also be applied to a desired outcome or environment within a building. For example, a breezeway designed to provide guests with constant airflow and cool temperatures regardless of outside weather conditions may include qualified R&D activities in the design and development of unique structural curvatures and roof angles to ensure the building achieves these goals. Similarly, R&D credits can be found in projects that balance local laws and ordinances that require a specific exterior design (i.e., historical buildings) but aim for a more modern or open interior.
Finally, real estate businesses may also find activities surrounding the development of proprietary or unique software will likely qualify for the R&D tax credit. As with all matters relating to R&D tax credits, the best way to maximize these opportunities is to work with accountants and advisors with deep experience in identifying and applying for these benefits.
About the Author: Karen A. Lake, CPA, is a state and local tax (SALT) specialist and a director of Tax Services with Berkowitz Pollack Brant Advisors + CPAs, where she helps individuals and businesses navigate complex federal, state and local tax laws, and credits and incentives. She can be reached at the firm’s Miami office at (305) 379-7000 or firstname.lastname@example.org.
9-7000 or email@example.com.