The Kentucky Qualified Research Facility Tax Credit: Deconstructing the Definition of Construction of Research Facilities (KRS 141.395)

I. Executive Summary: The Kentucky Infrastructure Investment Incentive

The Kentucky Qualified Research Facility Tax Credit provides a powerful incentive for businesses to invest in research and development infrastructure within the Commonwealth.

The statutory definition, codified in Kentucky Revised Statute (KRS) 141.395(1)(a), specifies that the “Construction of research facilities” means constructing, remodeling, and equipping facilities in the state or expanding existing facilities in the state for qualified research.1 This definition strictly includes only tangible, depreciable property and explicitly excludes any amounts paid or incurred for replacement property.1

A. Credit Overview and Value Proposition

The Kentucky Qualified Research Facility Tax Credit is a vital mechanism used by the state to incentivize businesses toward long-term capital commitment, supporting the creation of permanent research infrastructure.3 The credit is nonrefundable and is calculated as 5% of the qualified costs associated with the construction of these research facilities.2

This state incentive offers broad applicability against primary Kentucky tax liabilities. The credit can be utilized to offset the Kentucky Corporation Income Tax (KRS 141.040), the Individual Income Tax (KRS 141.020), and the Limited Liability Entity Tax (LLET) (KRS 141.0401).2 To ensure that significant initial capital investments can deliver tax savings over a prolonged timeline, a key feature is the generous carryforward provision: any unused credit may be carried forward for a substantial period of ten (10) years.1

B. Strategic Positioning of the Credit

Kentucky’s tax policy, articulated through KRS 141.395, targets fixed asset investment, deliberately differentiating the state credit from the federal Research and Development (R&D) tax credit. This design creates a targeted capital expenditure subsidy that complements, rather than duplicates, the federal incentive.

The federal R&D tax credit (Internal Revenue Code (IRC) § 41) generally excludes costs related to land, buildings, and depreciable property from Qualified Research Expenses (QREs).5 Conversely, the Kentucky credit focuses precisely on these excluded capital costs—facilities and specialized equipment. This focus allows companies to stack both state and federal benefits on the same overall R&D project: federal credits on operational QREs (wages, supplies) and the state credit on the infrastructure.5 By concentrating exclusively on long-lived infrastructure, the state incentivizes the creation of permanent economic footprints, which is a stronger indicator of enduring commitment than routine operational spending.

II. Deconstructing the Definition: Qualified Costs and Scope Limitations

The statutory definition of “Construction of research facilities” is highly precise, limiting eligibility to capital expenditures used for the creation or expansion of R&D assets located exclusively within Kentucky.2

A. Scope of Qualifying Activities in Kentucky

The statute specifies four core activities that constitute “Construction of research facilities,” all of which must be located physically within the Commonwealth 1:

1. Constructing Facilities: This encompasses all capitalized costs associated with the ground-up development of new laboratory, testing, or specialized research centers dedicated to qualified research activities.1
2. Remodeling Facilities: This addresses significant internal or structural renovations undertaken to adapt an existing property specifically for R&D purposes. Examples include the installation of specialized air handling systems, cleanrooms, or complex utility infrastructure necessary for advanced experimentation.3
3. Expanding Existing Facilities: This covers the capitalized costs of additions or major improvements that increase the physical size or operational research capacity of an existing site.2
4. Equipping Facilities: This includes the cost of acquiring and installing specialized machinery, instrumentation, and testing equipment required for conducting qualified research. These assets must qualify as depreciable property and be integral to the R&D function.3

B. The Mandate for Tangible, Depreciable Property

Cost eligibility is entirely dependent upon the property meeting the statutory requirement that it “includes only tangible, depreciable property”.1

• Tangible Property: The asset must be a physical asset, thereby excluding intangible assets such as patents, software development costs (unless they are capitalized equipment used for internal software R&D), or goodwill.
• Depreciable Property: The property must have a useful life greater than one year and must be subject to depreciation under federal tax law, underscoring the policy’s focus on long-term capital investment.1
• “Placed in Service” Rule: The tax credit is not available merely when construction payments are made. The credit is generated and can only be claimed once the tangible, depreciable property is officially placed in service, meaning it is ready and available for its intended qualified research function.7

C. The Critical Statutory Exclusion: Replacement Property

KRS 141.395(1)(a) explicitly excludes “any amounts paid or incurred for replacement property”.1 This restriction is essential for distinguishing credit-eligible expansion from routine maintenance.

• Disallowed Costs: This exclusion dictates that the credit cannot be claimed for expenditures related to routine capital maintenance, repairs, or the simple replacement of components intended merely to restore functionality or replace worn assets.1
• Demonstrating Eligibility: To qualify, the expenditure must result in the creation of a new asset or a material expansion or adaptation of an existing facility that specifically enhances its qualified research capability, moving beyond the simple restoration of original functionality.

D. Apportionment for Mixed-Use Facilities

When a constructed or remodeled building is used partially for qualified research and partially for ineligible activities (e.g., administrative offices, commercial sales, or routine production), only the proportional costs related to the R&D function are eligible for the credit.

The statute requires that the facility must be built “for qualified research”.1 If only a fraction of the facility meets this purpose, then only that fraction of the capitalized cost qualifies for the 5% credit. Standard tax compliance practice, in the absence of explicit DOR administrative regulations on methodology, requires the taxpayer to implement a reasonable and auditable apportionment method. Common and defensible methods include allocation based on square footage dedicated to R&D, proportional utility consumption, or the allocation derived from R&D employee head count within the facility.

III. The Federal Nexus: “Qualified Research” Under IRC § 41

The applicability of the Kentucky facility credit is fundamentally tied to the definitions of qualified research established by federal law.

A. Mandatory Adoption of IRC Section 41

KRS 141.395 requires that “Qualified research” must be defined precisely as defined in Section 41 of the Internal Revenue Code (IRC).1 This establishes a strict technical standard for the activities conducted within the physical facility.

• Implication for Facility Use: The facility must support activities that meet the standards of IRC § 41, which typically involve developing or improving a business component, addressing technological uncertainty, and following a process of experimentation.8
• Exclusions: If a business invests capital into a facility used for non-R&D functions—such as routine quality control, general customer service, or management activities—those capital costs are ineligible for the Kentucky credit, as the underlying activity does not meet the “qualified research” test.1

B. The Dual-Benefit Opportunity for Capital Intensive Research

The federal R&D credit generally excludes expenditures for land, buildings, and depreciable property, making Kentucky’s credit a highly valuable mechanism to monetize the significant capital expenditure involved in creating research capacity.5

This structural difference allows for the beneficial stacking of incentives. The Kentucky credit effectively serves as a 5% discount on the capital basis of research infrastructure. This can be claimed in addition to the federal R&D tax credit generated from the associated operational QREs (e.g., wages and supplies).3 This stacking minimizes the total after-tax cost of establishing and expanding large-scale R&D operations in Kentucky.

C. Exclusion of Operational Expenses

The narrow statutory scope of “Construction of research facilities” means the credit is limited strictly to capital investments. Operational costs, such as those typically defined as QREs under federal law, are explicitly excluded 3:

• Wages paid to employees performing qualified research.
• Costs of supplies consumed in the R&D process.
• Contract research expenses.

The Kentucky credit focuses solely on tangible, depreciable facility investments.3

IV. Kentucky Department of Revenue (DOR) Guidance and Compliance Requirements

Effective utilization of the Qualified Research Facility Tax Credit necessitates strict adherence to the procedural and documentation requirements set forth by the Kentucky Department of Revenue (DOR).

A. Credit Mechanics and Carryforward Provisions

The credit is calculated simply as 5% of the total qualified costs.2 A significant administrative advantage is that Kentucky does not require a complex base calculation or prior-year averaging; all eligible current-year facility costs fully qualify for the 5% rate.3

The credit becomes available once the property is officially “placed in service”.7 Due to the potentially high value of the credit, the ten-year carryforward period is essential, allowing the tax benefit of large capital projects to be utilized against future income tax or LLET obligations over a prolonged period.1

B. Tax Liability Application and Ordering

As a nonrefundable credit, the facility credit can only offset existing tax liability.3 It can be applied against Individual Income Tax (KRS 141.020), Corporate Income Tax (KRS 141.040), and LLET (KRS 141.0401).2 The exact sequence in which this credit is applied relative to all other available state tax credits is dictated by the statutory ordering clause specified in KRS 141.0205.5

C. Critical Nuance: Separate Tracking for Income Tax and LLET

The DOR requires rigorous administrative separation regarding the utilization of the credit against the primary entity-level taxes.

DOR guidance mandates that the credit claimed and the resulting balance available “must be calculated separately for income tax and the LLET”.9 The credit is non-transferable between the two tax types; if the balance available for the income tax reaches zero, that balance cannot be used as a credit against the LLET liability, and vice versa.9 This procedural mandate requires meticulous annual tracking over the ten-year carryforward period to ensure the correct remaining balance is applied to each respective tax liability.

D. Mandatory Forms and Documentation

Compliance requires specific forms and detailed supporting evidence to be filed with the taxpayer’s annual return 2:

1. Schedule QR (Qualified Research Facility Tax Credit): This form (e.g., Form 41A720QR) is used to determine the credit, claim the annual offset, and track the carryforward balance for each project.2 A separate Schedule QR must be filed for each qualifying project.2
2. Supporting Schedule of Assets: Taxpayers are explicitly required to attach a detailed schedule listing the tangible, depreciable property that generated the credit. This schedule must list the date purchased, the date placed in service, a description of the asset, and the cost.2
3. Utilization Schedules (ITC/TCS): Taxpayers claiming the credit must attach either Schedule TCS (Corporate & Pass-Through Filers) or Schedule ITC (Individual Filers) to reflect the utilized amount on their final tax return.2
4. Pass-Through Entities: The credit generated by S Corporations, Partnerships, or LLCs flows through to the owners via Kentucky Schedule K-1 for use against their respective tax liabilities.2

E. Rigor in Asset Data as Audit Defense

The requirement for granular, asset-level data, especially the “date placed in service,” is the DOR’s primary mechanism for ensuring eligibility and preventing the claim of ineligible costs, particularly those related to replacement property.

Because the statute is highly specific regarding the exclusion of replacement property 1, the DOR uses the required asset schedules to verify the capital nature and placement date of the assets.2 The documentation must unequivocally demonstrate that the expenditure created a new, depreciable asset specifically for qualified research, rather than merely restoring or replacing a worn component. The quality of this supporting documentation is the critical factor in successfully defending the credit upon audit.

V. Illustrative Case Study: Credit Generation and Utilization

This example demonstrates the calculation and utilization process for a business investing in Kentucky R&D infrastructure.

A. Scenario Setup: Advanced Manufacturing R&D Expansion

A technology firm, Bluegrass Innovations, completes a new R&D facility project in 2024. The total project costs $\$4,350,000$. After careful cost segregation, the costs break down as follows:

The total Qualified Facility Costs (QFC) eligible for the credit are: $\$3,500,000$ (Construction) + $\$750,000$ (Equipment) = $\$4,250,000$.

B. Calculation of Total Credit Generated

The credit is a simple application of the statutory 5% rate to the total QFC.

Calculation of Credit Generated (2024)

C. Utilization and Carryforward Application (Year 1)

If Bluegrass Innovations has a 2024 Corporate Income Tax (CIT) liability of $\$150,000$ and a Limited Liability Entity Tax (LLET) liability of $\$40,000$.

The company utilizes $\$190,000$ of the credit in Year 1. The remaining balance of $\$22,500$ must be carried forward for up to 10 years and tracked separately against future Income Tax and LLET liabilities.3

D. Strategic Benefit: Maximizing LLET Offset

The capability of the credit to offset LLET is a significant strategic benefit. Since LLET is often a minimum tax that corporations and limited liability entities must pay regardless of profitability, the facility credit provides an avenue for guaranteed tax reduction, even when the entity has zero or negative net taxable income (due to Net Operating Losses).2 This feature ensures reliable cash flow savings from the capital investment, confirming that the credit is not merely contingent upon high profitability.

VI. Conclusion: Strategic Capital Planning in Kentucky

The Kentucky Qualified Research Facility Tax Credit is a highly strategic tax policy designed to attract significant, permanent capital investment in research and development infrastructure. For corporations undertaking major construction or equipment acquisitions in the Commonwealth, this credit provides a guaranteed 5% capital discount.

The credit’s value proposition is robust due to its non-incremental calculation (5% of total QFC), its ability to offset LLET—providing high utilization certainty—and the sustained financial benefit delivered by the 10-year carryforward provision.3

Successful realization of this credit requires tax executives to integrate the statutory definition of “Construction of research facilities” directly into capital planning processes. This ensures the construction costs meet the technical eligibility standard (IRC § 41) and that meticulous cost segregation is performed to exclude all ineligible expenses, particularly replacement property. Finally, adherence to the DOR’s specific procedural filing requirements—including the annual filing of Schedule QR with detailed asset schedules—is mandatory for full compliance and maximization of the benefit over the full 10-year carryforward period.2

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