What is the R&D Tax Credit?

The Research & Development (R&D) Tax Credit is a federal tax incentive that lets businesses lower their tax bills dollar-for-dollar for specific qualified research expenses.

To put it simply, if your company is putting money into developing or improving products or processes, the R&D credit can help reduce the taxes you owe, rather than just decreasing your taxable income.

Eligible expenses usually cover the design, development, or improvement of products, processes, techniques, formulas, or software. For instance, costs associated with creating a prototype for a new building material or refining a more efficient construction method could qualify. This credit is available for research activities conducted in the U.S. under Internal Revenue Code §41, and it has been a permanent fixture in the tax code since the PATH Act of 2015, aimed at fostering continuous innovation.

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What costs can the R&D credit cover? 

The R&D tax credit is all about what we call Qualified Research Expenses (QREs). These expenses include the wages of employees who are hands-on in R&D, as well as those who oversee or support their efforts. It also covers the costs of supplies used during R&D and certain expenses tied to contract research, like bringing in third-party engineers or designers to help with your research.

Recently, the IRS has even updated its rules to let you count cloud computing costs related to R&D as supply expenses in specific cases.

In a nutshell, if you’re spending money on experimentation and innovation, that cost could help you qualify for the R&D tax credit. The great news is that both large and small companies can take advantage of this, it's not just for tech or biotech industries. Real estate developers, construction firms, architectural and engineering companies, and even investors backing innovative projects might qualify, as long as their work aligns with IRS guidelines.

For eligible small businesses and startups, this credit can also be used to offset up to $250,000 a year in payroll taxes if the company hasn’t started paying income tax yet (more details on that below). This means that a new development firm or a tech startup with minimal taxable income can still benefit from the credit, turning it into real cash savings by lowering their payroll tax bills.

Who Qualifies for the Research & Development Tax Credit?

Any company that takes part in qualified research activities could be eligible for the R&D tax credit, no matter its size or industry. Thanks to the PATH Act of 2015, this eligibility has been broadened to better support small and mid-sized businesses. This means that even real estate and construction companies can qualify, just like manufacturing or software firms, as long as they’re focused on innovation. The important factor here is the type of activities you’re engaged in, rather than just the industry you belong to. If your business is working on developing new or improved methods, designs, materials, or systems, it’s worth checking if those projects align with the IRS’s definition of “qualified research.”

To figure out if a specific activity or project qualifies, the IRS has a four-part test.

Qualified R&D activity needs to tick all 4 boxes:

✅ Permitted Purpose

It should aim to create something new or enhance an existing product, process, or business component (think techniques, formulas, inventions, or software) that boosts function, performance, reliability, or quality. For instance, if you're developing a building design that greatly enhances energy efficiency or structural integrity, that would definitely qualify as improving performance or quality.

✅ Technological in Nature

The work has to be grounded in the hard sciences (like engineering, physics, chemistry, biology, or computer science) rather than the arts or social sciences. In the context of construction, this could mean using engineering analysis, materials science, or architectural science to tackle technical challenges.

✅ Elimination of Uncertainty

The project needs to deal with technical uncertainty right from the start. This means it wasn't clear how to achieve the desired outcome, and the company didn't already have the solution figured out. For example, a developer might be unsure about how to design a foundation for a new type of structure on tricky terrain, requiring research to find the right approach.

✅ Process of Experimentation

The team has to engage in a process of experimentation to tackle these uncertainties. This often involves looking at various design options, building and testing prototypes, or going through trial-and-error to overcome technical hurdles. In real-world terms, this could be an architect or engineer trying out different structural systems or materials (using modeling, simulations, or physical mock-ups) to achieve a new building performance goal.

If a project ticks all the boxes of the IRS four-part test for R&D, then the activities are usually seen as qualified research eligible for the credit. However, there are a few exceptions to keep in mind: research that focuses solely on aesthetics, like style or cosmetic changes, routine data collection, or simply tweaking existing products without any real innovation typically doesn’t qualify. Additionally, the research has to take place in the United States to be eligible for the federal credit. If a client or a third party is funding the research and holds onto the rights to the results, the company doing the work usually can’t claim the credit. Essentially, the economic risk has to fall on the taxpayer who is claiming it.

R&D Examples for Real Estate and Construction: 

When we think of “R&D,” we often picture labs filled with scientists, but the truth is, there’s a lot of research and development happening in real estate and construction too.

Take, for example, an architecture or engineering firm that might earn credits for coming up with cutting-edge structural designs or testing out new building materials that can handle seismic activity or strong winds. A construction contractor could also get in on the action by creating and trialing a new construction method that boosts efficiency or enhances safety on-site.

Real-life examples of qualifying activities in these industries include making buildings more resilient against earthquakes or severe weather, designing eco-friendly features like innovative HVAC systems or water-recycling setups, experimenting with energy-saving lighting and power solutions, utilizing advanced software like Building Information Modeling (BIM) to refine designs, or crafting unique structures such as modern stadiums or bridges using fresh engineering techniques.

All of these efforts involve technological advancements and problem-solving that go beyond the usual practices. Even the expenses for highly skilled architects and engineers who are engaged in this innovative work can be counted toward the credit.

That’s why real estate developers and their CPAs should definitely keep an eye on R&D credits, especially if they’re pushing the boundaries in building design or construction methods.

How to Claim the R&D Credit?

Claiming the Research and Development tax credit is really about identifying your eligible expenses, calculating the credit amount, and making sure you submit the correct forms to the IRS. Since this credit is part of the broader category of general business credits, you'll need to include it when you file your annual income tax return.

Here’s a quick rundown of how to go about claiming the R&D credit:

1. Identify and document qualified R&D activities and costs.

   
   

   To get started, you’ll want to identify which of your business projects and expenses qualify as R&D according to the IRS. This means taking a close look at your projects to see if they pass the four-part test we talked about earlier. You’ll also need to gather all related costs, including the wages of employees who worked on the project, the expenses for supplies and materials, and any payments made to outside contractors who helped with the research. Keeping thorough records is crucial; be sure to hold onto documentation like project descriptions, design sketches, test results, lab reports, payroll records, and invoices that explain the nature of the research. For example, if a development company was testing a new type of construction material, you’d want to keep track of the engineering test results and the costs tied to the prototypes. Having solid documentation will strengthen your credit claim in case the IRS has any questions or decides to conduct an audit.

   
   

2. Calculate the credit using the appropriate method.

   
   

   There are two main ways to figure out the R&D credit: the Regular Credit Method and the Alternative Simplified Credit (ASC). The regular method, often referred to as the traditional method, involves looking at your current year's research expenses and comparing them to a fixed base amount, this base is usually tied to historical R&D spending from the 1980s or a formula designed for startups. If you've ramped up your R&D spending significantly, this method can give you a credit of 20% on the increase over that base, but keep in mind it requires some detailed historical data.

   
   

   On the other hand, the ASC method has become more popular lately. It typically offers a credit of 14% on your current year Qualified Research Expenses (QREs) that exceed 50% of the average QREs from the past three years. If you don’t have any prior R&D history, it gives you 6% of your current-year QREs instead. Many companies prefer the ASC because it’s simpler and doesn’t require digging through old R&D records.

   
   

   A good tip is to calculate the credit using both methods if you can. The IRS even recommends this! Once you’ve decided which method works best for you, make sure to indicate your choice on the tax form. Just a heads up: if you go with the ASC, you need to elect it on a timely-filed return, as you generally can’t apply it retroactively on an amended return.

   
   

3. Complete IRS Form 6765.

   
   

   This is your ticket to claiming the R&D credit on your tax return, you'll need to provide a detailed account of your company's qualified research expenses and calculate the credit amount for the year. This form must be attached to your business's income tax return. The form is divided into several sections to address the various calculation methods and elections available. Make sure to fill out the sections of Form 6765 that correspond to the method you've chosen (either regular or ASC) and include all the necessary information, like total qualified research expenses (QREs) and base amounts.

   
   

4. File the form with your tax return and apply the credit.

   
   

   Once you’ve filled out Form 6765, attach it to your timely-filed tax return to take advantage of the credit. This R&D credit will directly lower your income tax liability for the year. If the amount of your credit exceeds what you owe in taxes (or if you’re operating at a loss), you can usually carry that unused credit forward to future years.

   
   

   Special provision for startups: If you qualify as small business you can choose to apply the R&D credit against your payroll taxes (specifically, the employer’s share of Social Security tax) instead of your income tax. This is a huge advantage for pre-revenue or early-stage companies, like many real estate development startups or prop-tech firms, that aren’t paying income tax due to losses or minimal income. To take advantage of the credit on payroll taxes, you’ll need to make this election on Form 6765 (Section D) and then file IRS Form 8974 with your quarterly payroll tax returns. The law currently allows eligible startups to offset up to $250,000 of R&D credits per year against payroll tax for up to five years, which could mean a total benefit of $1.25 million over that period. Essentially, the IRS will apply your credit to reduce your required payroll tax deposits after you file your income tax return claiming the election.

   
   

5. Maintain support and seek out a professional.

   
   

   Once you've claimed the credit, make sure to keep all your supporting documents for several years, just in case the IRS has questions about your claim. The IRS has specific requirements for information disclosure (as of 2022, if you're claiming a refund for prior-year R&D credits, you'll need to provide detailed written explanations of your research activities for each business component). This really highlights the importance of thorough documentation and accurate reporting. Given how complex the qualifying criteria and calculations can be, many real estate developers and investors turn to CPAs or specialized tax advisors to help pinpoint qualifying R&D activities and ensure they claim the credit correctly. A knowledgeable CPA can help you maximize your credit while staying compliant with IRS rules, which is especially beneficial in industries like real estate where R&D credits often go underused. This credit can significantly lighten your tax load, so it's definitely worth getting expert advice to claim it the right way.

   
   

How Far Back Can You Claim R&D Tax Credits?

If you’ve missed out on claiming R&D tax credits in the past, don’t worry you can still go back and claim them! Businesses have the option to retroactively file amended tax returns for previous years, as long as the statute of limitations is still open.

Generally, the IRS allows you to amend returns for up to three years from the date you file (or two years from when you paid the tax, whichever is later) to snag a refund. So, let’s say you realize in 2025 that you were eligible for R&D credits in 2022, 2021, and 2020 but didn’t claim them. You can usually file amended returns for those years and get that credit retroactively. This could mean cash refunds or credits that offset your taxes, effectively putting some money back in your pocket for those past R&D efforts.

It’s a good idea to chat with a tax professional since there are special rules that might let you carry credits forward or back, especially in years when you had losses.

Unused R&D credits can be carried forward for up to 20 years to help reduce future tax liabilities. (Before the PATH Act made the credit permanent, you could also carry credits back one year, but nowadays, most businesses just carry them forward if they weren’t used in the current year.) This means that if you can’t fully utilize the credit in the year you earned it, it can still benefit you in future profitable years. After 20 years, any unused credit will expire, but in reality, most companies will have used it up by then if their income is on the rise. The R&D credit is now a permanent part of tax law, allowing companies to plan with more confidence.

Key takeaway: If you’ve missed out on claiming R&D credits, you can usually go back three years and amend your returns, which might result in some pretty significant refunds, especially if your real estate development or construction business has overlooked credits for past innovations. And don’t forget, any credits you earn moving forward can help lower your taxes this year or even in the next 20 years! This makes the R&D tax credit a fantastic tool for long-term tax planning. If you think you might have unclaimed credits from earlier projects, it’s definitely worth looking into!

In Conclusion: 

Research and development is an incredible opportunity that real estate investors, developers, and their accountants should definitely keep in mind. It’s designed to reward businesses that are willing to innovate, whether that means creating advanced construction methods, designing eco-friendly buildings, or any other tech breakthroughs in the real estate sector. By getting a grip on what this credit entails, who can take advantage of it, and how to claim it (even retroactively), you could find some serious tax savings.

Since the rules can be quite intricate, teaming up with savvy CPAs or tax advisors is usually the smartest way to make sure all qualifying activities are spotted and documented correctly. With some thoughtful planning and adherence to the guidelines, the R&D tax credit can give your bottom line a nice boost, encouraging even more innovation and growth in your projects. It’s like the government saying, “We’ll help cover the costs” of your company’s creative endeavors.

A true win-win for businesses pushing the envelope in the real estate and construction world.