Part I – Real Estate Incentives

The evergreen life sciences industry is eligible for a myriad of specialty tax incentives. We’ll discuss these incentives in a Two-Part Series, focusing on real estate-based incentives this month, and covering the R&D Tax Credit in a future blog.

These types of properties – labs, R&D spaces, etc. – require improvements that are extremely specialized, extremely expensive, and demand a great deal of real estate space.

The cost per square foot associated with equipping a life sciences property is higher than that associated with fitting out any other type of commercial real estate.

These incentives are an excellent way to offset the large capital expenditures involved in equipping and maintaining life science facilities.

Cost Segregation

Standard depreciation occurs over a lengthy 39-year period, but many assets within a structure – from plumbing and electrical fixtures to flooring – are not designed to last that long. A cost segregation study quantifies and allocates building assets into shorter-lived 5-,7-, or 15-year categories where appropriate, accelerating depreciation deductions. The specialized nature of life science facilities means that there are many accelerable assets in play, and taxpayers may see up to $200,000 in federal tax benefits for every $1 million invested into a life sciences property.

Specific improvements depend on the type of life sciences property, but often include:

• Process equipment
• Walk-in coolers and freezers
• Specialty hookups such as plumbing connections, electrical distribution and mechanical infrastructure
• Customized waste and drainage systems, often incorporating grease interceptors that separate biohazardous waste from routine drainage
• Other biohazard-related improvements including flush devices, hoods for process exhaust and specialty air filtering systems
• Enhanced HVAC to maintain strict climate control, including backup generators to ensure uninterrupted power supply
• Expanded access control and surveillance monitoring systems, to ensure product and process confidentiality

All of these assets can be accelerated into  5- or 7-year class life categories.

Additionally, life science firms are reliable, high-end tenants that landlords want to entice. Many facilities are open around the clock, so landlords strive to offer amenities that appeal to employees working long shifts:

• On-site fitness centers
• On-site cafes
• Outdoor landscaping and trails
• Picnic areas

The above amenities can be accelerated into shorter-lived classes as well.

Cost segregation Study can be performed on new construction, acquisition, and renovation projects. In a renovation scenario, many assets that are no longer needed will likely be retired during demolition. The remaining depreciable basis of retired assets may be written off in the year the assets were removed. This powerful tax strategy is called Partial Asset Disposition Election.  A cost segregation study is required to provide the data for creation of a Disposition Table that supports this write-off.  

Bonus Depreciation 

Bonus depreciation permits the immediate write-off of a portion of the purchase price of eligible assets on top of other depreciation. Bonus depreciation can significantly boost tax savings, and new and used assets with class lives of 20 years or less are eligible – this would include virtually all the specialty life science assets considered above. Cost segregation is the primary vehicle used to determine and document which assets are eligible for this powerful extra incentive.  

How much of the purchase price may be written off using bonus depreciation? It depends on the bonus rate in play in the year the asset was placed-in-service. The table lists the established bonus depreciation rates through 2026. Note that bonus depreciation rates are currently declining, but bonus still brings additional tax benefits at any rate.  

Consider an example of a newly constructed pharmaceutical facility:   

• Placed-in-service in January 2024 (60% bonus available)
• Building Area: 461,220SF
• Production, assembly, and packaging areas, employee break rooms, administrative space, sewage treatment plant
• Depreciable Basis: $101,419,810
• Specialty assets included:
  • Special purpose air and water lines for process equipment
  • Gas lines including nitrogen and vacuum piping
  • Rough plumbing for sinks
  • Floor drains and sinks to remove lab waste
  • Air filtration and dehumidification systems
  • Emergency eyewash fountains
  • Data room cooling units
• Engineers Moved:
  • 9% to 5-Year
  • 1% to 7-Year
  • 8% to 15-Year
• First Year Tax Savings: $9.5M
  

Again, the specialized nature of these facilities results in greater acceleration of assets than in a typical project, resulting in strong cost segregation benefit.   

Qualified Improvement Property (QIP)  

Many life science facilities may become eligible for additional bonus depreciation if internal improvements are made to the existing facility. If these improvements fall into a category known as Qualified Improvement Property (QIP), they will be assigned a 15-year class life and will be eligible for bonus at the current rate.  QIP improvements must be made to a building’s interior, be non-structural, and must not increase a building’s footprint.    

Let’s consider a renovation example featuring QIP:  

• Building purchased in 2021, underwent gut renovation and complete fit-out to create laboratory space and office areas 
• Renovations placed-in-service December 2023 (80% bonus available) 
• Depreciable Basis: $32,591,920 
• QIP-Eligible Improvements Included:
  • Framing and drywall 
  • Doors and hardware 
  • Interior glazing and painting 
  • Fire protection 
  • Light fixtures 
  • Plumbing and electrical 
• Engineers Moved:
  • 1% to 5-Year 
  • 7% to 15-Year 
  • 4% to 15-Year QIP 
• First Year Tax Savings: $5.1M

Clearly, cost segregation is useful in a renovation scenario as well.   

The Energy-Efficient 179D Deduction   

The 179D Tax Deduction is a real-estate-based incentive that rewards energy-efficient construction and design. This incentive is also available for newly constructed, renovated, or expanded properties, and the tax deduction is calculated per square foot. This means that properties with bigger footprints can achieve bigger benefits. Since life science facilities are often quite large by necessity, they can be excellent candidates for this deduction.   

The Inflation Reduction Act recently increased the potential maximum benefit to $5.00/SF (adjusted for inflation.)  The benefit earned will depend on the degree to which energy consumption is reduced and on the satisfaction of Prevailing Wage and Apprenticeship requirements.   

Let’s return to the first example discussed above, the newly constructed pharmaceutical company. This property was constructed with energy-efficiency in mind, and was eligible for the maximum benefit of $5.36/SF. With an acreage of 461,220 SF in play, $5.36/SF translates into a $2.4M deduction.   

When constructing a new facility or renovating a space for life sciences use, consider incorporating energy-efficient improvements in any or all of the following:  

• Lighting
• HVAC 
• Building envelope 

Sometimes the nature of a facility demands an energy-efficient choice. For example, lab spaces are mandated to have 100% outside air systems that must be conditioned. The special-purpose HVAC and controls required to meet this mandate affordably also have the benefit of reducing energy consumption.  

Takeaways 

• Life science facilities require tremendous expenditures up front, but investors can leverage multiple specialty incentives to offset a portion of that cost.  
• The specialization involved makes these properties excellent candidates for Cost Segregation. 
• The properties’ generous dimensions often translate to large 179D Deductions.  
• Virtually all life science facilities are also eligible for the R&D Tax Credit, which will be discussed further in a future blog.