Learn more about these commonly underutilized tax incentives… and maximize their impact.
Too often, tax and accounting remain the final items on a project’s to-do-list. They are either forgotten or handed off to the wrong person, where they become ignored or underutilized. These are some of the most commonly underutilized tax incentives for architects, contractors, engineers and developers.
For Architects, Engineers & Contractors
According to the Internal Revenue Service (IRS), the professions of architecture, engineering and construction (especially design-build contractors who do architecture and engineering in-house), perform research and development (R&D), which makes them eligible for the R&D tax credit.
The federal R&D tax credit follows a four-part test to determine eligibility, then analyzes the eligible “qualified research activity” costs and wage allocations to employees, supervisors and owners to determine the final net credit. This can be substantial and may reduce a business’ and/or business owner's tax liability down to $0—new for 2016. It can also be retroactively applied to any open tax years (up to three), and any unused credit can be carried forward 20 years. Also new for 2016, the credit was made permanent, it was downgraded for audit risk, and incentives for small businesses and startup companies were added.
In addition to the federal credit, most states offer their own R&D tax incentive. Illinois’ expired in 2016, however, with no indication that it will be renewed. With the federal credit now permanent and available to small businesses and startups, it should be utilized in tax-planning strategies to reduce tax liability—especially when combined with a state’s R&D credit.
Another underutilized incentive is the tax deduction available through allocation to the “designer” of newly installed, energy-efficient building property. The 179D Energy Policy Act allows non-taxpaying entities (schools, cities, governments, etc.) to allocate their eligible tax deduction of up to $1.80/square foot to the “designer/s” of their choice. This deduction is derived from energy modeling results for three building components—lighting, HVAC and building envelope—each worth up to $0.60/square foot for a maximum benefit of $1.80/square foot. Any unused deductions can be carried forward to future tax years.
It’s important to note that LEED, Green Globes and other building credentials only identify a building as a good candidate, but have no effect on energy modeling requirements to achieve the tax deduction. Eligible projects include new construction, renovations and retrofits to most any type of building owned by a non-taxpaying organization. Most new buildings built to current building codes will, at a minimum, partially qualify. To maximize the benefit, start this conversation in the design phase, and use it as a tool to help win the bid.
Please note that this deduction has expired and is currently only available for property placed in service between January 1, 2006 and December 31, 2016. There has been no indication from the current administration that it will be renewed.
For Developers & Property Owners
The same 179D tax deduction of up to $1.80/square foot, as described above, is available to developers and property owners of for-profit commercial properties, warehouses, parking garages, offices, healthcare facilities and apartments (four or more stories above grade) to use against their own tax liability (not transferable).
Another energy-efficient building tax incentive for developers and property owners is the 45L Energy Efficient Tax Credit for Residential Properties. This credit is $2,000 per dwelling unit (per address, i.e. 123 USA Street #1A) for properties three stories or less above grade. The builder or developer of the dwelling units (i.e. the “entity” that owns the structure when it was built and financed its construction) qualifies for this credit.
45L requires a certified Home Energy Rating System (HERS) rater to test and certify the property, which must be single-family or multi-family, three stories or less above grade, for sale or for lease/rent, and placed in service and sold or leased/rented between 2012 and 2016. This credit expired at the end of 2016; however, like the R&D credit, it can be claimed for 2016 and retroactively applied to all open years (usually up to three years back) and carried forward 20 years.
Lastly, accelerated depreciation, or cost segregation, is a fixed-asset tax deferral strategy based on the net present value of money (i.e., a dollar today is worth more than a dollar tomorrow). Since the 1980s, the IRS has stated that certain fixed assets—identified through an engineering-based cost segregation study—can be separated and depreciated more quickly than others. This increases your depreciation tax shield now, which results in increased cash flow for the early years of a development when it is needed most.
Identification and separation of assets from 39 years into five-, seven- and 15-year depreciable class lives not only accelerates depreciation, it also helps comply with the IRS’ new tangible property regulations (TPR). TPR requires improvements, repairs and maintenance to be examined and then categorized as either an expense or capitalized asset. The disposable nature of these shorter class life assets also makes fixed-asset full disposition and/or partial-asset disposition easier and more advantageous. Now, when you replace an item, you can easily and accurately dispose of the existing asset from your depreciation schedule and claim new accelerated depreciation on the newly installed asset.
If you haven’t been taking advantage of accelerated depreciation, no worries: the IRS allows for a change in accounting method for those who want to retroactively claim and catch up on their depreciation. Depending on the type of property and when it was placed in service, you may also be eligible for bonus depreciation (30%-100%), qualified restaurant property, qualified retail property, qualified leasehold improvement property and qualified improvement property incentives, all of which offer special accelerated depreciation. Accelerated depreciation can be applied to any new construction, renovations and/or purchases of fixed assets from the past or current year. Essentially, whenever a new asset is placed in service on depreciation/fixed-asset schedule, there is an opportunity to take advantage of accelerated depreciation.
Utilization & Implementation
Now that you know about these tax incentives, how do you use them? Utilization is key. They all have facts and circumstances that may affect your utilization, such as reduction in basis, AMT, 179 expense limit, entity flow-through, etc. Your CPA may or may not know about these incentives, but they are usually best qualified to advise on whether you can use them to offset past tax liability and/or mitigate potential tax liability in your specific situation. But just because a CPA can help identify utilization, that does not mean they are best qualified to perform the specialized studies and testing required to generate the maximum benefit with minimal risk.
Many small to middle-market CPAs won’t have this ability in-house, but they should be able to refer you to one of the many boutique tax incentive firms that will work with them to achieve this balance. Boutique firms can be a bit more expensive, but their expertise usually results in more benefits than costs. iBi
Aaron Roy Coffeen, MLA is a LEED Green Associate and Senior Consultant for Engineered Tax Services, a licensed engineering firm that specializes in these tax incentives. Contact him at [email protected], (309) 231-3812, or on LinkedIn or Twitter @HybridBusiness.