Qualified Improvement Property (QIP) is now a 15-year, bonus depreciation eligible property, after the CARES Act provided a technical correction from Tax Reform in December 2017.
What is QIP?
QIP is a tax classification of assets generally including interior, non-structural improvements to nonresidential buildings placed in service after the buildings were initially put into use.
What is not included in QIP?
Enlargements of buildings (buildouts or add-ons)
Interior structural framework (lumber and framing, concrete flooring, etc.)
Are improvements made with tenant improvement allowances eligible for QIP?
If the taxpayer is the tenant improvement owner, then the assets are eligible to be classified as QIP.
What is considered an interior, non-structural improvement eligible for QIP?
Carpet, tile, flooring
Installation or replacement of drywall
Can you claim Section 179 on QIP?
Yes, but it may be more beneficial to claim bonus depreciation. Bonus depreciation is an expense deduction reducing income. It adds to losses that can be carried back, whereas Section 179 depreciation is limited by taxable income, and is carried forward to offset future income.
What is eligible for Section 179 in a building and not bonus depreciation?
There are four types of assets eligible for Section 179 (not bonus depreciation) and are classified as nonresidential real property with a 39-year depreciable life.
HVAC – rooftop; or in, on, or adjacent to the building
Fire protection & alarm systems
These assets are specifically eligible for Section 179 expense deduction, but are limited to the entity’s taxable income and the partners themselves at an individual level.
What are some possible tax savings eligible with the replacement of existing property?
Replacement of existing HVAC, roofs, etc. are eligible to be written off when replaced. This will enable a business to take write-offs instead of carrying the NBV of two assets simultaneously.
Some assets are also eligible for specific use assets related to the manufacturing component it relates to. This includes a concrete floor underneath the particular machine for heat or structural integrity, or electrical or plumbing specific to an asset. These components are eligible for the same depreciable life as the asset they are supporting (usually five or seven-year lives).
Questions about Qualified Improvement Property?
Please contact your Smith Schafer professional to help you consider if this change is beneficial for your business.
The Internal Revenue Code Section 199A Qualified Business Income (QBI) Deduction allows a deduction equal to 20% of business income for owners of pass-through entities. When the law was passed, there was confusion about whether owners of rental real estate businesses would be eligible for the deduction. When the regulations were finalized, the IRS released Revenue Procedure 2019-38, which was intended to help these rental real estate businesses assess whether they are eligible for the QBI Deduction. This helps to clarify confusion by allowing a “safe harbor” for rental businesses who do not necessarily qualify as a trade or business, to qualify for the deduction.
What types of entities qualify for the safe harbor?
The safe harbor rules define a rental real estate enterprise as
an interest in real property existing for generating rents. If the taxpayer
owns several different real estate enterprises, they have the choice to either
treat each one of the rental properties individually or as a group. Properties
would be divided into groups for residential real estate and commercial real
estate if a grouping election is made.
What are the requirements to qualify for the safe harbor?
The taxpayer, their employees, agents, or independent contractors must perform at least 250 hours of rental services annually with respect to the enterprise.
Items qualifying as rental services:
Advertising for the rental of the properties
Performing repairs and maintenance
Supervision of employees or contractors
Processing tenant applications
Negotiation or execution of leases
Items not qualifying as rental services:
Making investment or financing decisions
Managing long-term capital improvements of the property
Hours spent traveling to or from the rental properties
Separate books and records must be maintained to track the income and expenses of each rental real estate enterprise, either individually or by group if electing to form a multiple property enterprise.
The taxpayer must maintain records proving who performed the services, hours of all service performed, description of the services performed, and the dates on which the services were performed.
What could disqualify a taxpayer from the safe harbor?
A taxpayer cannot use the safe harbor if they use the real estate property as a residence at any point during the year.
Real estate property leased using a triple net lease would not qualify for the safe harbor.
The safe harbor rule is not the only way to qualify for the
Section 199A deduction. This deduction can be quite powerful so contact us today
to discuss how to qualify. It is important to review your tax strategies to
ensure you are in the best position possible.
Smith Schafer is a recognized leader in providing accounting, auditing, and consulting services to the construction and real estate industry. Our Construction Group, comprised of numerous professionals, is committed to serving over 800 Minnesota construction and real estate entities. Click below to schedule a free 30-minute consultation.
The Research and Development (R&D) Tax Credit is one of the best opportunities for businesses to reduce their tax liabilities, improve cash flow, and increase earnings-per-share. This tax credit was initially enacted in 1981 to incentivize companies to increase their investment in developing new or improved products or processes.
What is the R&D tax credit?
It provides a dollar-for-dollar cash savings each year to companies that perform activities related to the development of new, improved, or innovative processes and products. There is no limitation on the amount of expenses and credit that can be claimed each year.
Several industries are eligible to receive R&D tax credits. This article will focus on the benefits for the following industries:
What are some qualifying R&D job titles?
Civil, Electrical, Mechanical, Structural, or Environmental Engineer
Designer or Drafter
Construction or Project Manager
What are the qualifying research expenses?
Wages paid to employees for qualified services.
Supplies used and consumed during the R&D process.
Research expenses paid to a third party.
Research payments to qualified education institutions and various scientific research organizations.
What are the qualifying research activities?
Companies responsible for design, engineering or new construction, often have qualifying activities. Examples include:
Creation of new or improved processes, methods, and techniques used in the construction process.
Design and development of new or innovative buildings and related components.
Development of new or innovative electrical, HVAC, or energy-efficient systems.
Design of temporary systems such as falsework, shoring, and dewatering systems.
Developing preliminary design and development plan.
Creating new software to use internally to interact with vendors or customers.
Formulation of schematic designs.
Construct preliminary CAD modeling and testing.
How much can a company save with the R&D tax credit?
Depending on company size and types of activities performed, our clients have saved anywhere from $10,000 to $1 million through R&D tax credits. The amount saved is based on the total expenses eligible for the credit. The revenue of the company is not relevant to the amount of credits available. The average percentage of credits available to a company is approximately 10 percent of the total eligible R&D costs.
Can I offset my alternative minimum tax (AMT) with the research credit?
For tax years beginning after December 31, 2015, eligible businesses may claim the R&D credit against their AMT tax liability if gross receipts are $50 million or less. If your business is a qualified start-up company with less than $5 million in gross receipts, you may also elect to use up to $250,000 of the R&D tax credit against payroll taxes.
Can I claim the R&D tax credit on amended returns?
R&D tax credits are available to be taken on amended tax returns going back three previous tax years.
How can I apply for the R&D tax credit?
Any size companies are eligible for the R&D tax credit, and many small-to-medium-sized businesses are missing out. The first step is to analyze the types of projects your company is working on to identify eligible activities. Smith Schafer works with R&D tax credit specialists that conduct a study to determine savings. While you may be tempted to try to calculate the credit on your own, there is expertise required to identify and collect the correct information. An expert will most likely be able to obtain a larger tax credit than if you would try to claim this on your own. Also, claiming it incorrectly may result in the loss of credit and possible penalties from the IRS.
Questions about R&D Tax Credits?
We are here to help. Smith Schafer can examine your company’s activities and determine which areas are eligible for the R&D tax credit. Send us a message to schedule a free consultation.
The COVID-19 pandemic has caused significant changes to the construction industry and has forced them to reevaluate many factors affecting their businesses. Making cash flow strategies a priority is something every construction or contractor company owner needs to keep in the forefront of their mind. With the potential loss of work, change in timing for contracts, and fewer bid opportunities available, many companies have begun to experience tighter cash flow. Below we discuss three strategies that will help prioritize and improve cash flow in your construction business.
Construction Industry Cash Flow Strategies
1. Renegotiate Terms
a. Banks We recommend renegotiating the terms of your line of credit agreements or other long-term debt agreements. Interest rates have dropped significantly in 2020. If you have a minimum interest rate on any variable debt agreements, it may be an excellent time to review and renew.
Helpful Tips: i. Go into the renegotiations with a plan. ii. Do not be afraid to ask for a fee reduction. iii. Make the banker aware that you are monitoring the fees and will continue to do so. iv. Consider extending the length of your renewals. Many bankers prefer to freeze pricing for 3-5 years as it is less likely for the client to switch banks.
b. Vendors Renegotiate terms with your vendors, but do not only focus on price. We recommend negotiating a discount related to early payments, requesting extended payment terms, or paying with a credit card. These may help improve cash flow while maintaining a positive relationship with key vendors.
2. Accelerate Receipts & Defer Payments
a. Accelerate Receipts Bill early and often, as the contract terms allow. The sooner you can get invoices out, the sooner you are likely to receive payment. This includes timely billing and tracking retention. The collection of retention receivables is often not seen as a priority, as many take the “we will get paid when they get paid” approach. However, making retention a priority and taking the time to follow-up with outstanding balances can significantly improve cash flow.
Helpful Tips: i. Ask for payment when invoices become due. ii. Do not allow unpaid invoices to accumulate and grow old. iii. Consider adopting new policies and letting your clients know about it. iv. Examples:
All invoices are due on receipt or charge a penalty.
Interest for invoices that are unpaid within 30 days.
Discontinue work on a project if payment is not received within 60-90 days.
b. Defer Payments Consider asking vendors if they would allow your construction company to defer payments until a later date. Review your upcoming expenses and determine whether these items are required considering the current pandemic environment. Items such as capital expenditures could be delayed.
Review your insurance policies, phone plans, health care plans, and any other plans to try to find savings, especially if you have not done so recently.
3. Bring in New Money
a. Excess Inventory Improved inventory management is an easy way to increase cash flow. Liquidate excess or slow-moving inventory by finding a single large bulk purchaser or asking the distributor you originally purchased from to repurchase it all. Although you will likely be charged a fee to do so, this removes the inventory and can improve cash flow.
Construction industry companies should reevaluate how much inventory needs to be kept in stock. Reducing the overall value in inventory may result in a simple improvement in cash flow.
b. Sell Assets Review your listing of fixed assets to determine if any non-productive assets can be sold. These could be old items that have not been used for a while, or items no longer being used due to the pandemic’s reduced workload.
c. Investors Consider bringing in new investors to help with cash flow needs. Although bringing on new investors may take a lot of time and effort, it is a way to bring an influx of cash into the business. This may be an excellent time to consider succession planning for your construction company, and you may consider offering key employees the opportunity to purchase ownership.
Another way to bring in investment is through loans from the owners. This can be done through low interest and low-risk loans which can be paid back once business returns to normal. Loans from ownership may be required to be subordinated to any banks debt. However, this can be negotiated with your bank.
The construction industry should be reevaluating their cash flow and formulating a plan to get business back in operation. This process starts with a cash flow analysis. The above recommendations have only skimmed the surface of what construction companies can do to manage their cash flow.
Smith Schafer professionals can help. Our Construction & Real Estate Group, comprised of numerous professionals, is committed to serving over 800 Minnesota construction and real estate entities. From large construction companies to specialty contractors, we have the experience to bring you innovative solutions.
Planning throughout the year is essential to reduce the tax owed on your construction company’s 2020 return. In light of the ongoing impact from COVID-19 and recent legislation, taking a step back to plan is more important than ever since you could potentially identify new construction tax strategies that will save you money. This article will discuss nine strategies, credits, and deductions for construction company owners to potentially take advantage of in 2020.
Credits & Deductions
1. Qualified Business Income (QBI) Deduction
Introduced as part of the Tax Cuts and Jobs Act, Qualified Business Income from pass-through entities (sole proprietorships, partnership, or S-corporations) are generally eligible for a 20% deduction. The deduction is limited for specified services or trade business. These include any companies where the principal asset is the reputation or skill of its employees. Businesses involved in the construction industry should be able to utilize this deduction fully.
Tax Planning Tip: QBI is determined by many factors, including payroll levels. A company should determine if there are enough wages paid out, so the QBI deduction is maximized. Alternatively, determine if additional money should be invested in equipment or machinery.
Aggregation is determined on an individual level, so it is essential to discuss with your tax advisor as aggregation could be irrevocable.
2. Empowerment Zone Employment Credit
The Taxpayer Certainty and Disaster Tax Relief Act of 2019 renewed the Federal Empowerment Zones, which had previously expired at the end of 2017. The Empowerment Zone Employment Credit is retroactively extended for qualified zones wages paid or incurred in 2018, 2019, and 2020. This credit provides an incentive to hire individuals who live and work in a federally designated empowerment zone. This is a wage credit of up to $3,000 for each employee.
3. Work Opportunity Tax Credit (WOTC)
The WOTC is a federal tax credit available to employers for hiring individuals receiving government assistance and reintroducing them into the workforce. The Protecting Americans from Tax Hikes Act of 2015 (the PATH Act) retroactively allows eligible employers to claim the WOTC for all targeted group employee categories that were in effect before the enactment of the PATH Act, if the individual began or begins work for the employer after December 31, 2014, and before January 1, 2021.
Depending on the target group an individual belongs to, the credit per new hire can range from $2,400 to $9,600. Target groups include: Qualified IV-A Recipient, Qualified Veteran, Ex-Felon, Summer Youth Employee, and many more.
The value of this tax credit is determined by the target group under which the employee qualifies, the number of hours worked, and the wages earned in the period of employment applicable to that target group.
This deduction allows construction company owners to claim an amount based on the square footage of a new building construction remodel. The incentive provides a $1.80 per square foot deduction of energy-efficient space. This deduction can be divided into three energy-efficient categories:
HVAC & Hot Water Systems
Each of these can obtain a $0.60 deduction. To qualify for this deduction, a building must be modeled by a qualified third-party individual (as defined by IRS Notice 2006-52) and compared against a reference building designed following ASHRAE Standard 90.1-2007 using IRS-approved software.
5. Energy-Efficient Homes Credit
The Energy-Efficient Homes Credit has been retroactively extended for 2018, 2019, and 2020. This credit is a tax incentive allowing builders to claim a credit of $2,000 per qualified dwelling unit. A qualified dwelling needs to be modeled by an independent individual and compared against a reference building designed to meet the International Energy Conservation Code of 2006. It can be a single-family home, a unit in an apartment complex, or a senior living community. Each separate rental unit may qualify for the $2,000 credit. However, each unit must be eligible on its own (i.e., an entire building cannot be certified with one model). This credit may be claimed on any open tax year.
6. Payroll Tax Credits & Deferral
The Coronavirus Aid, Relief, and Economic Security (CARES) Act provides a refundable payroll tax credit for 50% of wages paid to employees during the COVID-19 crisis. The credit applies to wages paid after March 12, 2020, and before January 1, 2021.
The maximum amount of wages eligible for the credit is $10,000, with the maximum credit for any employee equal to $5,000. If the business experienced a government order limiting commerce, travel, or group meetings, or there was more than a 50% drop in quarterly sales compared to the prior year, this credit can be claimed. When the business sales exceeded 80% of sales in the same quarter in 2019, it no longer qualifies for the credit at the end of that quarter.
The credit may be claimed immediately by reducing the amount of payroll taxes. The credit is applied against the employer portion of social security taxes.
Other Tax Planning Strategies to Consider
7. Succession Planning
The succession planning process is often overlooked until it is too late. Tax planning is an integral part of the succession planning process. It would be best if there is a plan for managing the tax liability generated by the influx of income upon a potential sale or other methods for the transfer of the business ownership. When negotiating the terms of a transaction, it is crucial to keep taxes in mind. The last thing you want is to give the government more taxes than is necessary due to poor tax planning.
8. Cost Segregation Study
The purpose of a cost segregation study is to identify assets and their costs related to a real estate purchase or reconstruction and classify those assets for federal tax purposes. When taxpayers purchase or construct a building, it is typically depreciated, often over 39 years. However, a cost segregation study identifies costs related to real property that can be reallocated to a shorter-life for depreciation. These studies are among the most valuable tax-saving strategies for commercial real estate owners, leaseholders, and others.
9. Revenue Recognition
The main goal of Accounting Standard Codification (ASC) 606 is to create a similar revenue recognition policy and calculation across all industries. The construction industry, which has historically had its own guidance and industry practices, is no exception. ASC 606 replaces virtually all accounting standards related to revenue recognition. It had been required for non-public entities to implement for years beginning after December 15, 2018, resulting in many already undergoing implementation, but this has been delayed because of the COVID-19 crisis. It is now required for years beginning after December 15, 2019.
Note: early implementation of ASC 606 is allowed.
How can we help?
With several credits extended to the end of 2020, the construction industry has the opportunity to take advantage of tax incentives and reduce their next tax bill. Contact us today to work with a qualified advisor to help you leverage opportunities and make the best decisions for your construction company. Our Minnesota Construction Accounting Experts, comprised of numerous professionals, is committed to serving over 800 Minnesota construction and real estate entities. Smith Schafer has the experience and understanding of the construction industry to make a lasting positive difference in your future success. Please send us a message today.