Building a New, Expanded, or Upgraded Factory? You May Also Have Built a Significant R&D Tax Credit.

Why Manufacturing Facility Expansions Are Among the Most Overlooked and Underappreciated Sources of Section 41 Credits — and How the Law Makes It Possible

When a chicken processing company came to us after 40 years in business, their first question was essentially an apology: they weren't sure they had anything worth claiming. They had built new production lines, upgraded equipment, and expanded their footprint by tens of millions of dollars. They had been told, informally, that the juice wasn't worth the squeeze.

They were happy to learn they were wrong. Their $40M facility expansion generated $5.71 million in R&D tax credits — $3.82 million federal, $1.89 million from the state.

That outcome is not unusual. What is surprising is how many manufacturers never learn about the full potential of R&D tax credits from a buildout.

The Misconception That Handcuffs Manufacturers

The first question we hear constantly: our building is depreciated, so how can the construction costs qualify for R&D credits?

It is understandable. Fortunately, it is also only partially correct — closer inspection of the code reveals that the depreciation limitation does not apply to all categories of R&D expenses.

Brother-Sister Code Sections

Section 41 of the Internal Revenue Code (the provision governing R&D tax credits) draws a clear line between three categories of qualified research expenses: in-house wages, in-house supplies, and contract research. These are brother-sister code sub-sections, each with its own rules. The depreciation limitation applies only to in-house supplies — the stock materials a company purchases directly. It does not apply to in-house labor or contract research. Those two categories carry no such restriction.

Factory builds are almost entirely contract-driven. Engineering firms, specialty construction companies, and custom automation vendors are hired to build to the taxpayer's performance specifications. When those parties design and construct systems that meet the qualifying research tests, their costs are contract research expenses — not supplies — and the depreciation prohibition does not reach them. The plain text of Section 41 allows in-house wages and contract research to be used in the calculation of qualified research expenses, irrespective of whether the underlying asset is depreciated.

What "Qualifying Research" Means in a Factory Context

The natural skepticism is this: how is building a factory eligible as R&D? We have been building factories for 200 years.

The answer lies in what a modern manufacturing facility actually is. No two are carbon copies. Each is engineered to the specific product, process, and production requirements of the company operating it. When a food processor builds a new line, they are not installing a commodity system off a shelf. They are specifying custom equipment, solving integration challenges across subsystems, and — critically — incorporating decades of operational knowledge into how the facility is designed and how it will function.

That process satisfies the four-part test for qualified research under Section 41: the work is undertaken to eliminate technological uncertainty as to the final design, it involves a process of experimentation, it is used to discover information that is technological in nature, and it results in a new or improved business component. The custom engineering is not incidental to the construction — it is the construction.

What qualifies specifically?

In a typical facility build, the following systems frequently meet the standard: custom-engineered production equipment, HVAC systems designed for the specific manufacturing environment, electrical systems, plumbing, lighting, water treatment and waste removal systems, and, in some cases, the building envelope itself when standard structural loads do not exist for the application. If a system had to be engineered specifically for this taxpayer's production requirements, it belongs in the analysis. It excludes things such as offices, parking lots, landscaping, etc.

The Recent Legal Shift That Strengthens Your Position

There is one additional development that any manufacturer's tax advisor should appreciate: Loper Bright Enterprises v. Raimondo, decided by the United States Supreme Court in 2024.

For decades, federal agencies — including the IRS and Treasury — operated under what was known as Chevron deference. When a taxpayer and an agency disagreed about the meaning of a statute, courts were required to defer to the agency's interpretation as long as it was reasonable, even when it was not the best reading of the law. Loper Bright eliminated that framework. Courts are now the arbiter of statutory meaning, as they are in all other proceedings, not the agencies. If a taxpayer's reading of the code is the most accurate one, the court is no longer required to defer to a contrary agency position.

For facility build R&D claims, this matters. The plain text of Section 41 limits the depreciation exclusion to in-house supplies. Treasury's regulatory history has sometimes been read to suggest a broader prohibition. After Loper Bright, the text controls — and the text supports the position that contract research and in-house labor in a facility build are eligible expenses, regardless of depreciation treatment.

A Tax Treatment Advantage Not Fully Appreciated

Here is something that is rarely raised when discussing facility builds: the qualified research expenses associated with a factory build are also Section 174 costs — and Section 174 offers a choice between expensing and amortization that creates real planning opportunities.

Bonus Depreciation vs. Section 174 Expensing

Most manufacturers who have completed a facility build are familiar with cost segregation — the engineering study that reclassifies portions of a building’s depreciable basis from 39-year property into 5-, 7-, or 15-year categories eligible for bonus depreciation. For a manufacturing facility, a well-executed cost segregation study typically identifies 25% to 35% of the project’s total cost as eligible for accelerated treatment. With bonus depreciation restored to 100% under the One Big Beautiful Bill Act, that reclassified portion is fully deductible in the year the property is placed in service. On a $40 million project, that is a first-year deduction of roughly $10 to $14 million.

Section 174 Treatment: Full Expensing

Section 174 full expensing operates on a larger base and with fewer constraints. Where cost segregation is limited to the structural and mechanical components that can be reclassified out of 39-year property, Section 174 reaches the contract research and in-house labor costs across all qualifying systems — typically 50% to 60% of a custom manufacturing build. On that same $40 million project, the Section 174 deduction pool can approach or exceed $20 million, a $6M to $10M increase over bonus depreciation alone. And further, while bonus depreciation is delayed until the project is placed in service, 174 treatment occurs in the year paid or incurred—which is sometimes 2-3 years before the in-service year. 

Section 174 Treatment: Amortization vs Expensing

Amortization is expressly provided under Section 174 for qualifying research costs. Under this election, the company can choose an amortization schedule of 60 months or 10 years. That flexibility enables strategic tax planning to match revenues and expenses.

Accelerated depreciation that generates losses cannot reduce taxable income below zero; it is capped at 80% of taxable income for purposes of applying net operating losses. Depreciation can reduce deductible business interest expense, because it lowers adjusted taxable income (ATI), which in turn lowers the 30% of ATI ceiling under Section 163(j). Amortization under Section 174 faces neither of those constraints. It allows a full 100% reduction of taxable income, and because it increases ATI, it actually increases the allowable interest expense deduction. For manufacturers with significant debt financing on their capital projects, that is a material difference.

The two strategies of cost segregation/bonus depreciation and 174 treatments are not mutually exclusive. But understanding how they compare is essential before deciding how to combine them for the best outcome.

The Documentation Challenge — and How to Solve It

The legal position is important to establish, but the heavier lift is the project documentation. A typical facility build generates draw reports and invoices — financial records that show what was spent, but not why, not what technical challenges arose, and not how they were resolved. The substantive R&D narrative lives with the general contractor and their subcontractors, not with the taxpayer.

This is solvable. The key is going to the source.

In the chicken processor example, the work began with the general contractor: draw reports, meeting minutes, issues logs, invoices, and a complete subcontractor list. From there, each subcontractor was contacted to gather insight into the technical challenges encountered during their scope of work and how those challenges were resolved. Documents collected include technical specifications, change orders, quotes, and, where available, technical drawings from each trade. From the client, the team gathered bid documents, technical specifications, and the updated standard operating procedures developed during and after the build. All key participants were interviewed and their time respected.

Those materials form the foundation for written subsystem-level reports that demonstrate, for each system, how the work involved a process of experimentation, was technological in nature, resolved genuine technological uncertainty, and resulted in a new or improved product or process. A well-prepared claim produces a digital audit library organized by subsystem and component — detailed write-ups documenting engineering decisions and custom specifications, project documents, a tax credit methodology report explaining how QREs were identified and calculated, accounting workbooks with qualified cost calculations, and a "Read Me First" orientation document designed to allow an IRS auditor to evaluate the claim efficiently and without ambiguity.

That last element deserves emphasis. The goal of documentation is not merely to support the credit — it is to make the auditor's job straightforward. A claim that is easy to examine is a claim that holds up. History consistently shows that when the documentation is complete before an audit is called, resolutions are quick and outcomes are positive.

What You Should Do Now

If you have completed a facility build in the last three years or have one underway, the statute of limitations on prior-year claims may still be open. Federal returns generally have a three-year window from the date of filing, and some states extend that window further.

The first step is a viability conversation — not a full study. A qualified firm should be able to assess within an hour or two whether a project has meaningful credit potential. If it does, the documentation work can begin. This can be valuable for companies, as favorable tax treatment can reduce the effective cost of a new facility and thereby increase ROI.

Author Information

Rick Kleban is the founder and president of Sycamore Growth Group. He also advocates at the federal and state levels to improve the credit to better incentivize innovation, which in turn, helps communities by growing the tax base.

Jenna Tugaoen is a tax attorney at Sycamore Growth Group, specializing in assisting businesses in obtaining and substantiating R&D tax credits and resolving tax controversies.

James Bean, CPA, is a senior researcher and R&D tax controversy specialist at Sycamore Growth Group.

Sycamore Growth Group is an Ohio-based firm specializing in federal and state research & development tax credits by providing elite written substantiation and legal analysis for credit claims.