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Don’t Overlook Opportunities to Benefit from Internal Revenue Code (IRC) Section 199 Deduction

A section of the IRS code may have renewed relevance to the construction and real estate sectors as commercial and residential development rebounds in the New York area.

Section 199 of the IRC, which is commonly known as the “manufacturer’s deduction,” allows for a 9 percent deduction to professionals who are in the construction business on a regular and ongoing basis for building services performed in the United States. To qualify, the work must result in a material increase in the value of the property, substantially extend the life of the property, or adapt the property for another use.

Therefore, lesser enhancements, such as patching a roof, are not eligible. But major renovations to a structure or its components – such as heating, air conditioning, electrical work, plumbing, façade or exterior improvements – do qualify.

Some types of businesses with eligible construction activities include home builders, residential remodelers; commercial and institutional building contractors; contractors specializing in foundations, structure, and building exteriors; structural steel and precast concrete contractors; and electrical, plumbing, heating and air-conditioning contractors.

The Section 199 deduction has been frequently overlooked – especially as real estate development and construction slowed down during the recession. But among CPAs who specialize in real estate and construction services, eligibility for Section 199 deductions is among the first items scrutinized to ensure that qualifying clients can capitalize on their eligibility for this significant deduction.

The deduction is limited to 50 percent of a taxpayer’s W-2 wages. In some cases, businesses may find an advantage to restructuring some operational organization in order to take advantage of this generous deduction. For example, a company with two partners who take distributions instead of wages may find tax benefits to reorganizing their compensation structure. A cost-benefit analysis can help these partners determine whether revising their compensation structure will allow them to take the deduction, and if so, whether such a revision would be worthwhile.

Another factor to consider is the use of subcontractors. For example, the electrical trade tends to have larger W-2 payrolls, while other construction-related specialties rely more heavily on subcontractors. If subcontractors are performing a considerable amount of the work, a company may not qualify for the Section 199 deduction. A cost-benefit analysis can help ascertain whether using employees instead of subcontractors for the work in order to qualify for the Section 199 deduction would merit a revised approach to the use of subcontractors.

This deduction favors employers who use employees and thus collect and withhold payroll taxes. It is designed to offer employers an incentive to position workers as employees rather than as subcontractors. The Section 199 deduction benefits contractors of all sizes as long as they have the payroll and other criteria to qualify for the deduction.

The real estate experts at Margolin, Winer & Evens can help businesses in the real estate and construction industries determine whether they are eligible for the Section 199 deduction and provide analyses to uncover ways to ensure they are.

For more information, please contact John Schmuck.

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