From green building initiatives to creating designs that improve cost efficiency, architects and engineers routinely develop solutions that can enhance quality of life for both their clients and society as a whole. But as they pursue these groundbreaking activities, many architecture and engineering firms overlook the powerful opportunities for tax savings available to them. Specifically, businesses in these industries may benefit from the §179D deduction (which is now a permanent part of the tax code), the Research and Development (R&D) Tax Credit, and for those that own their buildings, a tax deferral strategy called Cost Segregation.
The §179D Deduction for Architects and Engineers
Created under the Energy Policy Act (EPAct) of 2005 with the goal of incentivizing energy efficiency measures in commercial and public buildings, §179D of the federal tax code provides a deduction of up to $1.80 per square foot (indexed for inflation) for the installation of qualifying measures. Specifically, the deduction is worth up to $0.60 per square foot each for improvements to a building’s interior lighting systems, HVAC and hot water systems, and the building envelope.
The §179D deduction is most commonly claimed by the owners of commercial buildings in which qualifying energy efficiency measures are installed. However, in the case of public buildings, the owners are local, state, or federal government entities that do not pay taxes and therefore would not benefit from the deduction. Instead, these government entities may allocate their deductions to the primary designers—including architects and engineers—of qualifying measures.
Depending on the scope of the project, the §179D deduction may yield substantial tax savings for primary designers. For example, CRG worked with a large architecture firm that had served as the designer for the building construction and/or energy retrofit on several government contracts (primarily school buildings). Based on qualifying energy efficiency measures installed, the firm was ultimately entitled to deductions of almost $7,000,000 over a 5-year span.
While the §179D deduction was permanently added to the tax code—finally ending several years of uncertainty due to its former status as a tax extender—as part of a COVID-relief package enacted in late 2020, the new law also heightened the requirements with which projects must comply in order to qualify for the deduction. Measures installed must reduce energy and power costs by 50% or more compared to a building that meets the minimum requirements set by the applicable ASHRAE Standard. Prior to the 2020 law, the applicable standard was ASHRAE 90.1-2007. Now, however, projects must comply with the most recent 90.1 Standard that was in effect as of two years before construction began. For new projects beginning in 2021, this is ASHRAE 90.1-2019—which has significantly more stringent requirements for energy efficiency than 90.1-2007. Primary designers and building owners seeking to claim the §179D deduction should consult experienced tax professionals, such as the team at CRG, to ensure that their current and proposed projects will qualify.
The R&D Tax Credit
Created in 1981 to spur innovation and technological advancement in the U.S., the Research and Development (R&D) Tax Credit is one of the most lucrative incentives in the tax code—yet businesses in many industries, including architecture and engineering, erroneously assume that they are not eligible. In reality, the R&D Credit rewards a broad range of activities related to the development of new or improved products, processes, or software. For architecture and engineering firms, a few examples of activities that may be considered qualified research include:
- Identifying issues related to functionality, reliability, quality, and performance
- Creating designs that accommodate specific client requirements, municipal codes, and site or climate conditions
- Incorporating new design or construction techniques, including those that include green building features
- Performing engineering calculations
- Evaluating and testing designs via modeling, computational analysis or other means
- Performing construction planning
Since 2015, the R&D Credit has been a permanent part of the tax code and has been more available to smaller and mid-sized businesses than it was in years past. Specifically, businesses with an average of $50 million or less in gross receipts over the past three years may now use the Credit to offset their alternative minimum tax (AMT) liabilities. Additionally, businesses that have been in operation for less than six years, had no gross receipts for the five preceding tax years, and have gross receipts of $5 million or less in the current year may now apply the R&D Credit to their FICA payroll tax liabilities. Previously, the Credit could only be used against income tax, which reduced its utility for some businesses that did not have significant income.
Many states offer their own R&D Credits, which may be even more lucrative than the federal version. For architecture and engineering firms whose projects have sought to create new or improve the existing functionality of a product, process, or software, the financial rewards for pursuing state and federal R&D Credits can be significant. For example, one CRG client was a mid-size engineering firm that had developed innovative solutions to promote sustainability and public safety across a variety of industries, including construction, energy, and aviation. After reviewing the firm’s project records, we determined that they qualified for both state and federal R&D Credits. Ultimately, the engineering firm was able to save an estimated $117,000-$152,000 per year at the federal level, and $180,000-$234,000 per year in Arizona over the course of a few years.
Cost Segregation for Building Owners
Another powerful tax-saving strategy available to many commercial building owners is Cost Segregation, which yields more substantial and immediate depreciation deductions by simply reclassifying certain assets within a building. Typically, real property is depreciated over a 39-year period, while tangible personal property is depreciated over 5, 7, or 15 years. Cost Segregation studies examine the assets within a building—such as carpeting, electrical wiring, plumbing fixtures, wall coverings, and more—and identify those that could be reclassified as personal property. As a result, the building owner can take advantage of the shorter depreciation lives and claim accelerated deductions, thereby minimizing taxation and boosting cash flow.
Any architecture and engineering firms that own commercial buildings that were placed into service after December 31, 1986 should consult a tax professional to determine if they qualify for a Cost Segregation study. However, the ideal time to perform a study is within the first year after the building has been purchased, built, or remodeled, in order to begin maximizing depreciation deductions as soon as possible.
At CRG, our team offers a unique combination of expertise in tax, engineering, and commercial real estate, making us well-equipped to help our clients—including architecture and engineering firms—maximize their tax savings through opportunities such as the §179D deduction, the R&D Credit, and Cost Segregation.
Looking for ways to boost your firm’s bottom line by reducing your tax burden? Contact us today to schedule a consultation!