R&D Tax Credits in the Construction Industry

For construction companies with design-build capabilities, the Section 41 R&D tax credit — also known as the Research and Experimentation (R&E) tax credit — is among the most underutilized incentives in the tax code. The R&D tax credit is available to any industry, but projects must meet a four-part test and include supporting documentation that establishes the nexus between the activities performed and the credit being claimed.

Under the four-part test, all four parts must be met for a project to qualify.

1. Permitted Purpose

To pass this test, a company must be developing either a new or improved business component, whether that be a product, process, technique, or computer software. For design-build projects, this could be the designs themselves or the corresponding processes for building the solution optimally.

2. Technological in Nature

For this test to pass, the research being conducted must rely upon principles of the hard sciences. In the construction industry, principles of engineering, physics, or materials science may be utilized to address structural or mechanical challenges.

3. Uncertainty

At the onset of the project, there must be information being sought to eliminate technical risks or challenges related to the capability, methodology, and/or appropriate design of the solution. For the construction industry, this may involve achieving structural tolerances, accommodating site constraints, or selecting the optimal solution based on the client’s technical requirements and specifications.

4. Process of Experimentation

Once technical challenges are identified, there must be an iterative process to eliminate the uncertainties and evaluate the most optimal solution, whether it be through modeling, engineering calculations, or systematic trial and error.

Once the project meets the four-part test, we can look into which activities qualify for the credit.

Why Construction Companies Potentially Qualify for R&D Tax Credits

When considering a design-build project, one must first examine the types of activities involved throughout the project. Even if a project passes the four-part test, it does not mean that every activity can be included and credited. To qualify, activities must be directly tied to the discovery of new information, whether that be the development of a new design solution or the improvement of an existing one. If a client has specific requirements or specifications that must be met but does not have a design or solution in place, this is where R&D can be involved.

Qualified Activities in the Construction Industry

Once a design-build project passes the four-part test, one must then evaluate whether the activities are qualified or non-qualified. Below are some examples of common activities seen in the design-build landscape.

Qualified:

• Conceptual Design (Preliminary System/Structural Modeling)
• Schematic Design (Structural/MEP Performance Testing)
• Design Development (Energy Performance, System/Structural Designs)
• Construction Documents (BIM Modeling, Design Iteration Evaluation)
• Prototyping (Mock-Ups, Performance/Structural Testing)
• Startup (Pre-Commercial Functional Testing)

Non-Qualified:

• Permitting & Zoning Studies
• Designs That Only Utilize/Comply with Codes & Standard Industry Solutions
• Adaptations or Duplications of Existing Design Solutions
• Procurement (Vendor Sourcing, Pricing, Contract Negotiation)
• Site Preparation
• Construction/Installation
• Commissioning
• Warranty/Maintenance Work

When determining whether an activity is qualified, one must look to the purpose. The activity will likely qualify if it is directly tied to the development of new or improved functionality, performance, reliability, or quality of the solution.

Eligible Expenses for the R&D Credit

Once the qualified activities are identified within a qualified project, we can then review the associated expenses. Three main categories of expenses are eligible for the credit:

1. Employee Wages

Employee wages are typically the biggest driver of the credit. An employee who is either directly, technically involved, supervising, or supporting qualified research can be included. This can include roles such as, but not limited to:

• CAD/BIM Designers
• Architects & Engineers
• Project Managers
• Estimators & Quoters

2. Supplies

Materials can also be included. But to qualify, these materials must be tangible, non-depreciable items utilized during the process of qualified research. Examples include:

• Prototypes and mockups
• Pilot models
• Material validation and testing

3. Contract Research

Third-party consultants and sub-contractors can also be included up to 65 percent of the total cost. However, you must retain economic risk as well as substantial rights to the research.

Claiming the R&D Tax Credit

McGuire Sponsel’s R&D tax credit team specializes in construction and design-build studies and works directly with CPA firms to identify, document, and defend qualifying expenses. To discuss whether your client may qualify, contact us today.

Frequently Asked Questions

1. Does a construction company need a dedicated R&D department to qualify?

No — Construction companies routinely qualify with design-build projects based on the creation of a new or improved design solution or corresponding process, even without a formal R&D function.

2. What types of projects usually get disqualified?

Not every construction project is eligible for the credit. There must be a discovery of new information, whether it be the design of a new solution or its improvement. Examples of non-qualified projects include:

• Maintenance and repair work
• Adaptation and duplication work
• Aesthetic and cosmetic changes
• Bid-Spec and Design-Bid-Build work

3. What supporting documentation is needed to substantiate the credit claims?

Supporting documentation is required to prove the nexus between the credit being claimed and the activities being performed. Examples of supporting documentation include:

• Time-tracking logs
• CAD/BIM drawings
• Project and meeting notes
• Testing results
• Contracts

4. What if we do not have time-tracking capabilities?
Even if no time-tracking systems are in place, reasonable estimates are allowable. However, there must be corroborating evidence to support these estimates.

5. Does the project need to be successful to be eligible for the R&D credit?

No — The R&D credit rewards based on the attempt, not the success, of the project. As long as the project passes the four-part test, then it is still eligible for the credit.

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