The tax laws offer the construction industry many tax deferrals, deductions and credits. The most commonly utilized is the federal Domestic Production Activity Deduction (“DPAD”). This is a 9% federal deduction that is calculated using readily available information related to gross receipts and costs of goods sold. It is a year-by-year deduction with no carryovers to future years and requires taxable income to be utilized. There are many ways to qualify for the DPAD deduction, but we are just going to focus on the construction-related industries.
To qualify, the business must be in active conduct of a construction, engineering or architectural trade or business performing work in the United States related to the construction of commercial property, residential property, bridges, roads and other real property. The qualifying work is only for new construction and substantial renovations to real property. The IRS defines “substantial renovation” in Reg 1.199-3 to mean the renovation of a major component or substantial structural part of real property that materially increases the value of the property, substantially prolongs the useful life of the property, or adapts the property to a new or different use. The IRS has added that the real property must be capitalized and not qualify for repairs and maintenance treatment under the final regulations under 1.263(a)-3.
All items related to the physical improvement of a qualifying unit of real property will qualify for DPAD. These activities even include the initial site work of demolition, grading, excavating and other land transformations included in the process of the construction of a qualifying real property. The act of painting real property or repaving a parking lot by itself would not qualify, but would qualify if associated with the construction of new property or substantial renovations.
In conclusion, be aware of the requirements for DPAD when entering into contracts and it is recommended by the IRS to track why individual jobs qualify for DPAD. You can track this directly on your job schedule or on a separate workpaper. We are available for more detailed conversations about DPAD and unique circumstances that may exist for your company.