Similar to other industries in today’s economy, our contractor and developer clients deal in a highly competitive marketplace. As contractors and developers seek opportunities to expand business, they should consider some less orthodox (and less understood, but established) options.
Federal and state tax credits can help make a project financially feasible while providing financial benefit for both contractors and investors. When reviewing a project, contractors and developers should consider a number of federal and state tax credits that can push a project from the red to the black. Historic Rehabilitation Tax Credits, the New Markets Tax Credit Program, the Solar Investment Tax Credit, and the Research and Development Credit can alleviate tax burdens by providing dollar-for-dollar reductions in tax obligations, increase return on investment, and allow projects to move forward.
Historic Federal and State Rehabilitation Tax Credits
Construction companies and developers can take advantage of the Federal Preservation Tax Incentives program by participating in the ownership or tax credit equity-investing group of the entity that owns certain property.
A 20 percent federal income tax credit is available to individuals and entities for the rehabilitation of historic, income-producing structures that are “certified historic structures.” The amount of the federal credit is 10 percent with respect to a “qualified rehabilitated building,” which is generally considered to be a non-historic building built before 1936. The rehabilitation credit typically is claimed by a taxpayer in the year the building is placed into service in the taxpayer’s business.
Most states have historic preservation incentive programs that can be used in tandem with the federal program, including North Carolina, Pennsylvania, Virginia and West Virginia. Federal and state tax credits are based on a project’s qualified rehabilitation expenditures (“QREs”). QREs are amounts incurred such as construction costs, architect/engineering fees, and project management fees that become part of the depreciable basis of a building. Rehabilitation includes renovation, restoration, or reconstruction of a structure, but it does not include an enlargement (an increase in the total volume of the building) or new construction. Virginia, for example, has a 25 percent credit that can be combined with the federal credit. The result is 45 percent of a project’s QREs would be eligible for tax credits.
In addition to following a stringent structure certification process, contractors and developers also must be aware of the potential minefield of court decisions, IRS procedures and rulings, and investor requirements, all of which may affect how a deal is structured in order to maximize financial benefits for a project.
New Markets Tax Credit Program
The New Markets Tax Credit (“NMTC”) was designed to increase the flow of capital to businesses and low income communities by permitting individual and corporate investors to receive a tax credit against their federal income tax in exchange for making equity investments in specialized financial intermediaries called Community Development Entities
. The credit totals 39 percent of the original investment amount and is claimed over a period of seven years. This program can be used to finance new development projects or rehabilitation of historic structures, community facilities and operating businesses. Examples of NMTC projects, which are not limited to structures, include shopping centers, residential housing, schools, hospital and nursing home improvements, and acquisition of manufacturing equipment. The NMTC program expires on December 31, 2019 and is funded at a level of $3.5 billion in allocations annually.
Solar Investment Tax Credit
The Investment Tax Credit (“ITC”) is currently a 30 percent federal tax credit claimed against the tax liability of residential and commercial and utility investors in solar energy property. The ITC steps down to 26 percent in 2020 and 22 percent in 2021. After 2023, the residential credit will drop to zero while the commercial and utility credit will drop to a permanent 10 percent.
Research and Development Credit
While the research and development (“R&D”) tax credit has not been widely used by construction contractors, construction industry participants may be eligible to claim the credit in certain instances. The R&D program is a federal based credit, but many states (including North Carolina, Pennsylvania and Virginia) also have their own credit for state purposes. The R&D program was designed to stimulate research and development activity of U.S. companies of all sizes by reducing their after-tax cost.
It sounds as if only large companies with lab coat technicians need apply, but even construction contractors can perform R&D activities. Contractors and design professionals requiring engineering of electrical, mechanical, HVAC, environmental, roadway, subcontracted specialty work, and those exploring innovations such as LEED initiatives and designs, may qualify for these tax credits.
The credit was enacted in 1981 and was permanently extended by the Protecting Americans from Tax Hikes (“PATH”) Act of 2015. In order to be eligible for it, a four-part test is applied to a company’s activities and expenses that generally requires the R&D activity is intended to be useful in the development of a new or improved project, process, technique, formula, invention, or software that serves the general business purpose of the company.
The R&D credit calculation could include expenses such as wages, outside contractors and certain supplies. The standard credit is 20 percent of the current year qualified research expenses based on a four year gross receipt average. A simplified credit may be used that is generally 14 percent of the excess qualified expenditures over 50 percent of the average qualified expenditures for the previous three tax years. In general, any unused credits can be carried back one year and forwarded for up to 20 years.
Overall, these federal and state tax credit programs provide many opportunities for contractors, developers, design professionals, and real property owners to make projects financially feasible. These credit programs are not without risk and each has its own set of limitations due to technical issues and underlying tax and regulatory rules. Our attorneys have counseled clients and have handled many transactions involving these credit programs. Our familiarity with these credit programs equips us with the skills and expertise to provide timely and strategic advice with your projects.
*In the last months of 2017, the U.S. Congress is considering tax legislation that may limit or eliminate some of the tax credit programs discussed in this article. We continue to monitor the status of the legislation. Please check back for updates.