Home builders and developers can potentially claim significant tax benefits for designing new and improved plans and construction processes, among other activities. Congress enacted the Research and Development Tax Credit (R&D Credit) in 1981, and originally it only applied to patentable inventions and similar state-of-the-art products. That changed in the early 2000s with an expansion of the R&D Credit to include development of new or improved products, processes, techniques, formulas, inventions, and software.
The change opened the door for more industries to begin claiming the R&D Credit. Volume builders employing architects, engineers, scientists, and software developers are obvious candidates to claim the R&D Credit. Semi-custom and custom lower-volume builders are also candidates, though the devil is in the details regarding whether they have sufficient activities and qualified expenses to make the benefit material enough to perform an R&D Study.
So, what qualifies for the R&D Credit? Sections 41 and 174 are the relevant Internal Revenue Code sections, and they say that a qualified activity occurs when a taxpayer develops something (usually a product, process, or formula) by eliminating an uncertainty through an alternatives evaluation process that is technological in nature. Yes, that’s a mouthful. And it’s a complicated analysis that requires diving into employees’ day to day activities to understand whether they meet the definitions. This is the heart of an R&D Credit Study, which we discuss later.
But, how does this apply to a builder? The credit is heavily focused on design of products and processes, and designing and building homes could include both. Think about the sheer number of constructability considerations. A house is a series of integrated components and systems that all affect each other, with the design of those systems often having a cascading effect on other systems and performance attributes. These design considerations are often technical in nature and require iteration to overcome the uncertainty, leading to qualifying activities. For example, window specifications and locations can impact lighting and air conditioning systems; and wall materials, layouts, and insulation affect mechanical runs and infiltration rates. Plus, builders must meet increasingly stringent energy code requirements which requires constant redesign and evaluation of the home’s energy efficiency. Simply put, houses are complex beasts that require significant planning, design, and precision to get right and those activities can lead to R&D Credits.
An R&D Study will identify qualified activities and expenses and tie in the supporting documentation, such as redlined drawings, BIM/CAD modeling, emails, and meeting notes capturing the technical considerations. In the event of an audit by the IRS or state, they will request the supporting details and will scrutinize the R&D Study if it lacks contemporaneous records. While it is possible to reconstruct narratives with interviews, the best evidence of qualified activities is documentation highlighting technical design considerations. The presence or lack of this documentation should be a major deciding factor on whether to pursue an R&D Credit Study.
Credits can vary greatly from builder to builder, so it makes sense to conduct a free assessment with a reputable tax consulting firm if you have preconstruction design activities that consume a material amount of employee, owner, and executive time. There are many companies out there that provide R&D Studies, so be careful to ask the right questions, such as:
- Do you support us in the event of an audit?
- Do you charge a contingent fee?
- How many builders do you work with?
Builders can and do qualify for R&D Credits every day, so check with your CPA and consider reaching out to a trusted provider to discuss your options.