As a construction business owner, you understand that the landscape of your industry is constantly changing, and so is the tax environment that comes with it. With the 2017 Tax Cuts and Jobs Act (TCJA) provisions currently scheduled to expire in 2025, it’s essential to equip yourself with knowledge and develop strategies to navigate these changes effectively. Efforts are currently underway in both the House and Senate to advance a compromise budget resolution, with hopes of delivering the final package to President Donald Trump before Memorial Day. However, various factors could delay this process, increasing the urgency for construction business owners to stay proactive as the future of TCJA and the potential for extension hang in the balance.
As the expiration of certain tax benefits approaches and political dynamics shift, now is the time for construction business owners to take stock. Revisit tried-and-true tax strategies that have stood the test of time and are expected to remain in the tax code. By doing so, you can ensure your construction business remains on solid financial ground regardless of upcoming legislative changes.
Section 1031 Exchanges: A Path to Deferred Taxes
Section 1031 exchanges have long been a cornerstone for investors and developers, allowing for the deferral of taxes on real property sales. This strategy is equally beneficial for business owners who own their office buildings, warehouses, and other types of business or investment properties. Imagine you’re running a construction firm and need to upgrade your facilities. By reinvesting the proceeds from the sale of your location into a new property, you can defer taxes, keeping your cash flow intact.
To fully leverage Section 1031 exchanges, it’s important to understand the rules. You must reinvest all proceeds from the sale, including any debt proceeds, into the new property. Engaging a qualified intermediary to manage the transaction is required to ensure compliance with IRS regulations, and it streamlines the process. Remember, to meet IRS requirements, you must identify a suitable replacement property within 45 days of selling the original property and complete the exchange within 180 days.
Understanding the specifics of 1031 exchanges and state-level tax regulations is vital for navigating tax implications effectively. Some states may have “claw-back” provisions for 1031 tax benefits, which impact state tax liability. For example, my home state of Michigan does not have a “claw-back” provision, different from states like California, Oregon, Montana and Massachusetts, meaning it won’t attempt to collect state taxes on gains deferred through a 1031 exchange if the replacement property is sold in another state. Be sure to consult with a knowledgeable construction CPA to ensure compliance with all applicable state and local regulation compliance.
Section 1033 Exchanges: Deferring Gains From Involuntary Events
The construction industry is not immune to unforeseen events such as fires, thefts or condemnations. When such incidents occur, Section 1033 exchanges provide an opportunity to defer taxes which may have otherwise resulted from disposing of such property. For involuntarily converted business or investment real property to qualify for tax deferral, you must reinvest the proceeds from insurance claims or other compensatory amounts within a three-year period.
For instance, if a fire devastates your construction site and you receive insurance proceeds, you can use those funds to rebuild. The new property must serve a similar purpose, although it doesn’t have to be identical. This flexibility can be crucial during recovery, allowing you to focus on restoring your property without the immediate burden of tax liabilities.
Qualified Opportunity Funds: Reinvesting for Tax Benefits
These funds allow investors to defer capital gains taxes by investing in qualified opportunity zones and potentially exclude those gains permanently after a 10-year holding period. This program is designed to align tax deferral with community development goals. Most provisions of the Qualified Opportunity Funds (QOF) program are set to expire at the end of 2025 unless Congress acts; however, the ability to reinvest capital gain proceeds on a tax-deferred basis through the Opportunity Zone program will continue until the end of 2026.
For construction companies, QOFs present an excellent opportunity to expand into infrastructure or community development projects. For instance, a construction company could sell land at a capital gain and invest the proceeds into a QOF focused on affordable housing. With support from the second Trump administration and Congress, extending and improving the program could be on the horizon. It will be interesting to see how this is addressed in the forthcoming budget resolution.
Cost Segregation Studies: Accelerating Deductions
Cost segregation studies are a powerful strategy for construction companies looking to accelerate depreciation and improve cash flow. This approach is particularly relevant for companies that frequently acquire, develop or improve real estate. These studies identify and quantify property components, like HVAC systems, appliances or fixtures, that can be depreciated over shorter periods leading to significant tax savings. For example, if your company acquires a new building, a cost segregation study can help you identify components eligible for depreciation over five, seven or 15 years instead of the standard 27.5 or 39 years for residential and commercial properties, respectively. Additionally, Section 179 expensing or Section 168(k) bonus depreciation can offer more immediate tax deductions for many of the identified property components. This accelerated depreciation reduces your taxable income in the early years of ownership, freeing up cash flow for reinvestment in other projects or operations.
To fully benefit from this strategy, it is crucial to select a qualified professional to perform the study and ensure thorough documentation for compliance and financial advantages.
Strategic Tax Planning for Growth
As the construction industry evolves, so must your tax strategies. A comprehensive tax plan should address current challenges and anticipate future opportunities. By revisiting traditional tax strategies and embracing new opportunities, construction companies can navigate uncertainties and thrive in a changing environment. Whether deferring taxes through exchanges, reinvesting gains or optimizing deductions, these moves can significantly impact your financial health. Staying proactive, informed and strategic is key to ensuring long-term success. This allows you to focus on your core strength — building the future, one project at a time.