Posted by William Mehi on 11.01.23

Evaluation of Qualifying R&D Tax Credit Activities in the Construction Industry

Contractors that provide design-build services, use new and innovative construction techniques, and enlist engineers and architects to provide construction services are most likely to qualify for Federal and state research and development credits.

Many activities required to design and construct a new building or expand/improve an existing structure may meet the R&D tax credit requirements, specifically those performed by the project architect, engineers, and other design services consultants (including electrical contractors doing design work, HVAC fabricators, mechanical design, etc.). Since a taxpayer that is building a new facility for its own use will typically engage third-party consultants to perform these services, the taxpayer must also be at risk with respect to the research performed on its behalf.

In order to identify potentially qualifying activities in connection with the construction of a building, it's necessary to understand the design and engineering processes. The delivery of architectural, engineering, and certain design consulting services generally follows a standardized process that involves six phases. While the architect and engineers typically engage in some activities to resolve design uncertainties that might qualify as research and experimentation in each of these phases, the extent of qualifying services rendered varies.

Research Tax Credits Within the Construction Industry

Most qualifying research activities, however, are performed in the first three phases of the architectural/engineering process. The phase and the extent to which qualifying and non-qualifying research activities may (or may not) be performed in each generally include:

Phase I - Programming (or Conceptual Design)

This first phase of the architectural/engineering design process typically involves allocation of space (stacking and blocking), space planning, and assessment of available and required square footage. There is significant uncertainty at this stage, as the architect/engineer is asked to determine whether and how the proposed site may accommodate the overall functional and nonfunctional elements required by the client (for example, placement of personnel and equipment).

Phase II - Schematic Design

This next phase typically involves exploring the general concept of the building. Several schemes will be designed, and the building owner will select one. There is significant uncertainty at this stage, as the architect/engineer is asked to:

• Consider several alternatives for development of the selected space, and
• Determine (on an overall basis) whether and how each alternative may be constructed, given architectural and related principles.

Phase III - Design Development

This portion of the architectural/engineering process typically involves expanding the selected design, including assessment of alternative materials and the cost of various options. Significant uncertainty also exists at this stage, as the architect is called upon to resolve major design issues related to fitting the selected architectural scheme into a workable overall plan.

Phase IV - Construction Documents

This phase typically involves reducing the design concepts to precise drawings, which will be complete enough to allow permitting and final cost estimates. Since this stage represents indirect construction labor, uncertainty typically exists only to the extent that the drawing process reveals the need to reassess the design determined in Phase III.

Phase V - Construction

Assistance with the actual construction process takes place during this phase, which represents direct and indirect construction labor. So, uncertainty at this stage exists only to the extent that rework or change orders require that the design development stage be reassessed.

Phase VI - Commissioning/Testing

This final phase of the architectural/engineering process typically involves certification that the structure has been assembled successfully. This phase largely represents quality control, and uncertainty exists only to the extent that the testing identifies necessary rework, which in turn leads to reassessment of the design determined during the design development stage. Examples of Qualifying Activities Some examples of qualifying activities that may be performed during these phases include:

• Experimentation with new material combinations and evaluation of their performance properties;
• Development of innovative assembly or construction methods that accelerate or improve the construction process associated with large infrastructure assets;
• Unique bridge or roadway designs;
• Unique construction or innovation techniques in untested environments;
• Building designs to support unique structures; or
• Design and development of unique energy-efficient buildings and/or features.

Examples of Non-qualifying Activities

While there is typically significant uncertainty in the first three phases of the architectural/engineering process, not all of the activities in these phases qualify as research and experimentation.

Examples of typical non-qualifying activities that may be performed during these phases include:

• Participating in meetings with the city or county to obtain zoning review of plans;
• Producing drawings or promotional materials;
• Participating in marketing efforts;
• Assisting in the review or development of bid packages related to building or component construction; or Participating in building construction scheduling or construction oversight services to verify that the building and its components are constructed according to the design specifications.

As you can see, each construction project must be evaluated individually through each design phase to determine if the activities meet the definition of research and experimentation. Given the current IRS examination landscape of the R&E Credit, a detailed analysis should be done to properly mitigate risk upon examination. For more information, contact Tax Point Advisors, Inc., www.taxpointadvisors,com, (800) 260-4138, info@taxpointadvisors.com