Inflation increased throughout 2023, and higher prices for construction inputs and labor seem to be here to stay.1 This article looks back on some of the tax and operational updates from 2023 as the industry heads into 2024.
Research & Development & IRC §174 Capitalization for Contractors
As part of the Tax Cuts and Jobs Act of 2017 (TCJA), many taxpayers have faced mandatory capitalization of specified research or experimental expenditures under IRC §174.
Effective for tax years beginning after December 31, 2021, this legislation requires taxpayers to capitalize and amortize research and development (R&D) expenses over a period of five years for U.S. R&D expenses and 15 years for non-U.S. R&D expenses. Prior to this change, taxpayers had the ability to deduct these same costs.2
This new requirement has significantly impacted many contractors, resulting in higher tax burdens. Although there is bipartisan support to repeal or defer this capitalization requirement, no legislation is currently expected to pass for 2023 income tax returns. Released on September 8, 2023, IRS Notice 2023-633 states that the IRS and the U.S. Department of the Treasury intend to release proposed regulations addressing the capitalization and amortization of certain specified research or experimental expenditures and implications to Section 460. While this Notice provides insight into the IRS’ current thoughts, the document also requests comments on various topics. These comments are due by November 24, 2023. The IRS anticipates the proposed regulations to be applicable to years ending after September 8, 2023.
Companies continue to explore potential positions to minimize the effects of §174 capitalization while retaining the benefit of the R&D tax credit.4
179D Deduction: Energy Efficient Commercial Buildings Deduction
Although the 179D deduction has been available since 2005 for designers of certain buildings, it received an overhaul in 2022 as a part of the Inflation Reduction Act of 2022 (IRA).
Previously, the 179D deduction allowed government-owned building owners to allocate special tax deductions to the architects, engineers, and contractors responsible for modifying and designing the building’s energy-efficient systems.5 Beginning in 2023, buildings owned by non-profits were also included in this program.6
The IRA has modified additional aspects of the 179D deduction, with the most noteworthy item being the significant increase in potential deduction from this program; however, this increase has come with new hurdles that must be met and proven, such as a prevailing wage test. On August 29, 2023, the Department of Treasury and the IRS published guidance on IRA prevailing wage and apprenticeship labor standards.7
Another aspect of the new IRA allows taxpayers to elect an alternative 179D deduction for retrofit projects that meet energy efficiency criteria.8 These criteria are measured by annualized energy use intensity and require a written retrofit plan by a qualified professional.
45L Tax Credits: New Energy Efficient Home Credit
The 45L New Energy Efficient Home Credit initially expired at the end of 2021, but, according to the IRA, the 45L Credit is now extended through 2032. The new credit amounts and other modifications will apply for dwelling units acquired from contractors after 2022.
Under the new law, a new category of dwelling units is eligible for a $5,000 credit, which is defined as a home that qualifies as a zero-energy, ready-made home under the U.S. Department of Energy guidelines. Most other single-family units that qualify will receive a $2,500 credit. Dwelling units that are part of a multi-family building are eligible for smaller credits unless certain employment and wage standards are met. Under the prior New Energy Efficient Home Credit, the maximum credit was $2,000.9
Bonus Depreciation
IRC §168(k) allows an additional first-year depreciation deduction equal to the applicable percentage of the adjusted basis of qualifying property placed in service during the tax year.
The TCJA made significant changes as to which properties qualify for bonus depreciation — along with the applicable percentage of deduction — and instituted a sunset of the 100% bonus depreciation ability for companies.
Beginning in 2023, the amount of bonus depreciation able to be taken on bonus-eligible acquisitions will reduce to 80%. This amount will continue to reduce by 20% per tax year, until 2027 when it reaches 0% (Exhibit 1).10
There are notions of extending this sunset to begin at a future date, but no tax legislation has been passed to modify the TCJA.
Pass-Through Entity Tax Elections
A major component of the TCJA is the $10,000 annual limit on state and local taxes included in an individual’s itemized deductions. As a workaround, many states have enacted elective pass-through entity-level taxes (PTETs) to allow individuals to obtain a benefit for the state taxes paid on their income.
These PTET elections allow states to impose income tax directly on the pass-through entities rather than on the individual owners. Allowing this deduction at the entity level, over the individual level, can result in significant, permanent tax savings.11 Exhibit 2 shows a list of states and a city with current PTET elections.