R&D Tax Credits and Real Estate Development

The research and development tax credit, established in 1981 and made permanent in 2015, provides a credit against federal income tax for companies engaged in qualified research activities. While often associated with technology and manufacturing, the credit applies broadly to any industry where companies work to overcome technical uncertainties through systematic research.

Real estate development and construction involve substantial engineering, design, and problem solving activities that can qualify for R&D credits. Custom structural systems, innovative construction methods, solutions to challenging site conditions, and integration of new technologies all create opportunities for rd credit developers to claim benefits.

The credit is particularly valuable because it provides immediate cash benefit based on current year research expenses, while cost segregation provides ongoing depreciation benefits on the completed property. Together these strategies reward both the innovation process and the resulting asset.

To qualify for the R&D tax credit, activities must meet a four part test established by statute and refined through regulations. All four elements must be satisfied for the research to qualify, though not every activity within a project needs to meet the test as long as qualifying activities can be identified and documented.

The four required elements

• Technological in nature: The research must rely on principles of physical or biological sciences, engineering, or computer science
• Elimination of uncertainty: The research must be intended to eliminate uncertainty about development or improvement of a product or process
• Process of experimentation: The research must involve systematic evaluation of alternatives to achieve the desired result
• Qualified purpose: The research must be for a new or improved function, performance, reliability, or quality

In real estate development, these elements are satisfied when developers engage engineers and architects to solve technical problems, design custom systems to meet project specific requirements, or develop innovative approaches to overcome site or structural challenges that cannot be addressed through routine application of existing knowledge.

Numerous activities common in real estate development can qualify for R&D credits when they involve overcoming technical uncertainty through engineering based problem solving. The key distinction is between routine construction following established methods versus innovative approaches to technical challenges.

Examples of rd tax credit building scenarios include mixed use developments requiring complex structural integration, projects on difficult sites requiring innovative foundation solutions, buildings incorporating experimental sustainable systems, renovations requiring custom engineering to preserve historic structures, and developments integrating new construction technologies.

The R&D tax credit is calculated based on qualified research expenses (QREs) which include wages for employees performing qualifying research, supplies used in research, contract research expenses, and in some cases computer rental costs. For real estate development, the primary expenses are typically engineering and design personnel wages and third party consultants engaged in qualifying activities.

The regular research credit equals 20% of QREs above a base amount calculated from prior year research spending. An alternative simplified credit calculation is available at 14% of QREs above 50% of the prior three year average. Most companies choose whichever method provides the larger credit.

State R&D credits provide additional benefit in many jurisdictions. Over 30 states offer their own R&D tax credits, often calculated as a percentage of the federal credit or based on similar QRE calculations. Combined federal and state credits can exceed 25% of qualifying research expenses in some cases.

Research development credit construction benefits operate independently from cost segregation, allowing both strategies to apply to the same development project without conflict. The R&D credit rewards qualifying research activities during the development process, while cost segregation accelerates depreciation on the completed property.

The typical coordination involves claiming R&D credits in the years when qualifying research expenses are incurred, which may span multiple years during development and construction. Cost segregation is then implemented when the property is placed in service to identify components eligible for accelerated depreciation.

For developers who capitalize development costs into building basis, the relationship between expensed research costs and capitalized costs should be evaluated. Generally, research expenses claimed for R&D credits are deducted currently rather than capitalized, while the resulting building cost that includes implementing the research results is capitalized and subject to cost segregation.

Comprehensive tax planning addresses both strategies as part of a complete approach. See Cost Segregation and Low-Income Housing Tax Credit for another example of coordinating cost segregation with major tax credit programs.

Architecture and engineering firms that provide design and development services to real estate projects often have substantial R&D credit opportunities. These professional service firms engage in qualified research when solving technical problems, designing custom systems, and developing innovative approaches to client requirements.

For design professionals, qualifying activities include structural engineering beyond standard applications, custom mechanical system design, innovative solutions to site constraints, integration of new building technologies, and development of novel construction approaches. Time spent on these activities by licensed professionals and supporting staff can generate meaningful credits.

Architecture and engineering firms do not typically perform cost segregation on their own operations because they provide services rather than owning income producing real property. However, these firms should evaluate R&D credits for their qualifying design activities while their developer clients pursue cost segregation on the resulting buildings.

Construction companies and general contractors can claim R&D credits for developing new construction methods, improving construction processes, and creating innovative solutions to building challenges. The construction r&d credit applies when contractors go beyond routine building to develop better ways of constructing projects.

Qualifying activities for contractors include developing prefabrication methods, creating innovative formwork or structural systems, testing new construction equipment or techniques, improving construction processes for efficiency or quality, and solving technical challenges on complex projects that require experimentation and testing.

Construction companies that retain properties they build can pursue both R&D credits for innovative construction methods and cost segregation on properties they hold for rental income. Build to rent developers and contractor developers are particularly well positioned to capture both benefits.

Claiming R&D tax credits requires documentation supporting the existence of qualifying research activities and the calculation of qualified research expenses. The documentation should be contemporaneous and sufficient to demonstrate compliance with the four part test and expense calculation rules.

Essential documentation elements

• Project records describing technical challenges and uncertainties
• Engineering reports and analyses documenting research process
• Design iterations and alternatives evaluated
• Time records showing personnel engaged in qualifying activities
• Expense records for wages, supplies, and contract research
• Technical documentation of solutions developed

Many development companies do not maintain R&D focused documentation during projects, but records created for normal business purposes often provide sufficient support. Engineering reports, design files, project meeting minutes, and change order documentation can all support R&D credit claims when they demonstrate the research process.

When coordinating with cost segregation, ensure documentation supports both analyses. Construction cost records should segregate components for cost segregation purposes while also identifying costs associated with qualifying research activities. Separate studies by qualified professionals address each incentive's requirements.

R&D tax credits can be coordinated with other real estate tax incentives to create comprehensive benefit structures. Development projects may qualify for R&D credits, energy incentives like Section 179D or 45L, location based credits, and cost segregation benefits simultaneously.

For projects incorporating innovative energy efficient systems, both R&D credits for developing the systems and energy credits for the efficiency achieved can apply. The development r&d credit rewards the innovation process while energy credits reward the energy performance achieved.

Affordable housing developers may combine R&D credits with the Low-Income Housing Tax Credit. Community development projects could qualify for both R&D credits and New Markets Tax Credits. Each program operates through different mechanisms and can be claimed independently when eligibility requirements are met.

For understanding comprehensive multi strategy approaches, review Cost Segregation and New Markets Tax Credit which addresses coordination in community development contexts.