Anchoring Innovation: A Technical Analysis of “Facilities in This State” under the Kentucky Qualified Research Facility Tax Credit (KRS 141.395)

The Kentucky Qualified Research Facility Tax Credit provides a 5% nonrefundable credit for investments in permanent research infrastructure physically located within the Commonwealth. These facilities must be constructed, remodeled, expanded, or equipped using tangible, depreciable property dedicated to qualified research activities.1

This state tax incentive, codified under Kentucky Revised Statutes (KRS) 141.395, is a distinct mechanism designed to encourage capital investment in research infrastructure rather than funding operating expenditures. The policy focuses exclusively on the construction, expansion, remodeling, or equipping of facilities used for research activities that align with the federal definition of qualified research under Internal Revenue Code (IRC) $\S 41$.3 By isolating facility costs, Kentucky establishes a clear economic development policy aimed at securing permanent physical assets and sophisticated laboratory equipment within the state, offering a nonrefundable credit against applicable state taxes.1

II. Legislative and Statutory Foundation (KRS 141.395)

A. Historical Context and Legislative Intent

The Qualified Research Facility Tax Credit was created by the Kentucky legislature in 2002 and was generally made effective for taxable years beginning on or after January 1, 2007.3 The primary policy objective behind this legislation is to provide a compelling financial incentive for businesses to commit to permanent research infrastructure within the Commonwealth.1 This approach ensures that the state benefits from long-term economic stability and enhanced technological capacity, as the credit is tied directly to the value of stationary, high-value assets that establish a lasting corporate footprint.1

B. Core Mechanics and Utilization Rules

Credit Rate and Calculation

The credit is calculated at a fixed rate of five percent (5%) of the qualified costs of construction of research facilities.1 A notable feature of the Kentucky credit, differentiating it from the federal R&D credit, is the absence of a base amount requirement or reliance on prior-year averages.1 The 5% rate is applied directly to all eligible current-year costs, simplifying the calculation and maximizing the incentive for large capital outlays.

Applicable Taxes and Ordering

The credit is nonrefundable, meaning it can only offset existing tax liability and cannot generate a cash refund.1 It is permitted against the tax assessed under KRS 141.020 (Individual Income Tax), KRS 141.040 (Corporation Income Tax), and KRS 141.0401 (Limited Liability Entity Tax, or LLET).2

The application of this credit, alongside other available business incentive credits, must adhere to the specific credit ordering requirements outlined in KRS 141.0205.7 Furthermore, when applied against the LLET, the credit cannot reduce the LLET liability below the statutory minimum tax threshold of $175.1

Carryforward Provision

To ensure that businesses with large initial capital expenditures but modest initial tax liabilities can fully realize the benefit, the statute allows for any unused portion of the nonrefundable credit to be carried forward for ten (10) consecutive years.1

Stacking the Benefits

Kentucky taxpayers are permitted to claim both the state-level Qualified Research Facility Tax Credit and the federal R&D tax credit (IRC $\S 41$). This capacity to layer benefits is a crucial element of state tax strategy. Since the Kentucky credit focuses exclusively on capital expenditures related to the infrastructure (the place of research) 1, and the federal credit primarily focuses on operational Qualified Research Expenses (QREs) like wages, supplies, and contract research (the process of research) 8, the two programs complement each other. This creates a powerful incentive structure where the same R&D project generates a federal benefit for the manpower and materials involved (which typically ranges from 10% to 20% of incremental QREs) and a state benefit for the physical facility itself (5% of qualified facility costs).1 Strategic tax planning is thus optimized by ensuring the accurate segregation of capital costs for the state claim and operational costs for the federal claim.

III. Defining “Facilities in This State”: A Nuanced Interpretation of KRS 141.395

The eligibility for the credit hinges entirely on a precise interpretation of “Construction of research facilities” and the nature of the property located “in this state.”

A. Statutory Definition of “Construction of Research Facilities”

KRS 141.395(1)(a) provides a comprehensive definition of the eligible activities, specifying that “Construction of research facilities” means “constructing, remodeling, and equipping facilities in this state or expanding existing facilities in this state for qualified research”.3

This definition encompasses four distinct types of capital investment:

1. Constructing: The erection of new structures, buildings, or permanent additions specifically intended for qualified R&D activities.1
2. Remodeling: Substantial renovations or alterations that adapt existing non-research spaces or facilities for new or expanded qualified research uses.1
3. Expanding: The physical enlargement of an existing research facility, adding space, and increasing capacity dedicated to R&D.1
4. Equipping: The purchase and installation of necessary equipment, specialized machinery, laboratory apparatus, or testing gear that is depreciable and integral to the qualified research process.1

B. The Essential Tangible, Depreciable Property Standard

The most critical limitation in the Kentucky statute is that eligible costs must consist of “only tangible, depreciable property”.3

The use of the term “depreciable property” inherently ties the state credit eligibility back to federal tax accounting principles. Under federal law, assets must be capitalized (and thus subject to depreciation) if they have a useful life extending substantially beyond the current tax year. Consequently, eligible expenditures typically include building shell costs, integrated specialized internal systems (such as clean rooms or specialized HVAC units necessary for research integrity) 7, lab benches, and fixed or movable scientific equipment.

Conversely, the statute and DOR guidance explicitly exclude expenses that are not capital investments, such as wages (even construction labor) 1, raw materials and supplies consumed in the research process 8, contract research fees 1, and leased or rented equipment.8

The implication of strictly relying on the “depreciable property” standard is that the taxpayer’s internal capitalization policy and federal tax treatment of an expense are determinative for the state credit claim. If a cost is treated as a deductible repair or maintenance expense (expensed) on the federal return, it cannot simultaneously qualify as tangible, depreciable property for the Kentucky research facility credit. Therefore, accurate tax accounting treatment of the asset at the federal level is paramount to establishing state credit eligibility.

C. The Critical Exclusion of Replacement Property

KRS 141.395 explicitly mandates that “construction of research facilities… does not include any amounts paid or incurred for replacement property“.3

This exclusion is absolute and represents a significant area of potential audit scrutiny. While the statute permits “remodeling” and “equipping” 7, taxpayers must navigate the fine line between a qualified expansion or improvement and a non-qualified replacement.

For example, if a manufacturer purchases a new piece of lab machinery to replace an identical, worn-out unit that performed the exact same function, that cost would be classified as non-qualified replacement property. However, if the new machine represents a significant technological upgrade, offering enhanced performance, higher capacity, or new functionality that is required to conduct the qualified research (e.g., meeting a technological uncertainty requirement of IRC $\S 41$), the cost should qualify as “equipping” the facility for qualified research. The necessary documentation must therefore strongly emphasize the functional improvement or expanded capability achieved by the new asset, rather than simply focusing on the retirement of the old asset.

D. The Nexus to Qualified Research (IRC § 41)

The investment must be made for facilities designated for qualified research. The Commonwealth defers to the federal definition, stating that “Qualified research” means qualified research as defined in Section 41 of the Internal Revenue Code.3

This linkage requires the activities conducted within the constructed or equipped facility to satisfy the stringent federal four-part test 5:

1. Permitted Purpose: The activity must aim to improve the functionality, performance, reliability, or quality of a business component.
2. Technological in Nature: The research must rely on the principles of physical or biological science, engineering, or computer science.
3. Elimination of Uncertainty: The taxpayer must be seeking to discover information that resolves or reduces technological uncertainty regarding the development capability or appropriate design of the component.
4. Experimental in Nature: The research process must involve a systematic trial-and-error approach or experimentation.

If the facility, despite being new construction, is used for activities that do not satisfy the IRC $\S 41$ standard (e.g., routine quality control, market research, or non-technical process modifications), the related facility costs will be deemed non-qualified.

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

The administrative guidance provided by the Kentucky Department of Revenue (DOR) details the specific processes required to claim and maintain the credit, highlighting the long-term stewardship requirements imposed by the 10-year carryforward period.7

A. Claiming the Credit: Schedule QR

The official mechanism for claiming the credit is the Schedule QR, Qualified Research Facility Tax Credit.7

The credit is generated and becomes available for utilization in the tax year when the underlying tangible, depreciable property is officially placed in service.5 Taxpayers must file the Schedule QR with their income tax return (Corporate or Individual) in that initial year to determine the total credit generated against the income tax liability and the LLET liability.7

Crucially, the Schedule QR acts as a perpetual ledger. A copy of the form must be attached to the tax return each year the credit is claimed to record the amount utilized and to track the remaining balance until the full credit is exhausted or the 10-year carryforward period expires.7 Furthermore, a separate Schedule QR is required to be filed for each distinct research facility construction or expansion project that qualifies.7

B. The Essential Supporting Schedule (Audit Defense)

The Kentucky DOR compliance requirements extend beyond the Schedule QR form itself. To substantiate the claimed credit amount, the DOR explicitly mandates that a comprehensive supporting schedule must be included with the return.6

This supporting schedule provides the necessary granular detail for every asset comprising the qualified facility costs. The required data points are 6:

• The date purchased.
• The date placed in service.
• A detailed description of the property.
• The cost of the property.

The requirement for this itemized documentation creates a robust audit trail. By demanding the purchase date, placed-in-service date, cost, and description, the DOR can verify the depreciable nature of the asset and its precise timing of credit generation. This supporting schedule is the foundation of audit defense, linking the company’s detailed capital expenditure records (e.g., invoices, fixed asset ledgers) directly to the tax claim, and allowing auditors to easily cross-reference the claimed costs against the statutory requirements for tangible, depreciable property that is not replacement property.

C. Pass-Through Entity and Individual Claiming Procedures

When the qualified facility is constructed by a pass-through entity (such as a partnership or S-corporation), the credit is allocated to the owners based on their proportional ownership via a Kentucky Schedule K-1.7

The owners—whether corporate or individual—must then file the appropriate secondary schedule to claim their share of the credit 7:

• Schedule TCS: Used by corporations and other pass-through entities claiming a share of the credit.
• Schedule ITC: Used by individual taxpayers claiming a share of the credit.

In both instances, the claimant is required to attach a copy of the originating Schedule QR, filed by the pass-through entity, along with their Schedule TCS or ITC, to their own tax return.7

For individual taxpayers who directly constructed a qualified research facility, specific documentation is required, particularly when filing jointly or separately. If a taxpayer and spouse contributed to the cost and both names are listed on the application, the credit may be claimed wholly on a joint return but must be split if they file separately. If the application only lists one spouse, that spouse is entitled to claim the full credit.7

Table 3 summarizes the primary DOR compliance requirements.

Table 3: Kentucky Department of Revenue (DOR) Compliance Checklist for Schedule QR

V. Practical Application and Financial Analysis

A. Cost Allocation in Shared-Use Environments

A common complexity arising in large-scale facility construction is the need to allocate costs when a building is not entirely dedicated to qualified research. Most modern corporate campuses are mixed-use, incorporating administrative offices, manufacturing assembly lines, or general warehousing alongside specialized research laboratories.

The statute specifies that the facility must be constructed or equipped for qualified research.3 Therefore, costs related to areas of the facility that do not directly support IRC $\S 41$ activities—such as general administrative offices, cafeterias, or non-technical training rooms—are not qualified for the credit. Taxpayers must establish a defensible, logical, and consistent allocation method (e.g., based on the relative square footage dedicated to research activities versus non-research activities) to determine the eligible portion of the overall construction or remodeling cost. Rigorous documentation is required to clearly define the functional purpose and physical boundaries of the qualified portion of the facility (e.g., dedicated labs, specialized server capacity, and research-specific ventilation systems) to support the claimed allocation percentage.

B. Case Study Example: Calculating and Utilizing the Credit

To illustrate the financial impact and mechanics of the credit, consider a pharmaceutical company undertaking a significant R&D capital project in Kentucky.

Scenario Details

A specialized pharmaceutical manufacturer completes the construction of a new drug testing and development lab in Louisville, Kentucky. The project is placed in service in the current tax year, 2024.

Credit Calculation

The first step is identifying the Qualified Facility Costs (QFCs), which strictly adhere to the tangible, depreciable property standard and exclude replacement property and operational costs.1

$$QFC = \$4,000,000 + \$1,500,000 + \$200,000 = \$5,700,000$$

The total credit generated is calculated by applying the 5% rate to the QFC:

$$\text{Credit Generated} = QFC \times 5\% = \$5,700,000 \times 0.05 = \$285,000$$

Utilization and Carryforward

In the 2024 tax year, the company files Schedule QR, claiming the $285,000 credit. Assume the company’s combined Corporation Income Tax and LLET liability for 2024 is $100,000.

1. Credit Claimed (2024): $100,000 (limited by tax liability)
2. Unused Credit Carried Forward: $\$285,000 – \$100,000 = **\$185,000**$

The unused balance of $185,000 may be carried forward and claimed against future tax liabilities for up to ten (10) years.1 The taxpayer must continue to file a copy of the Schedule QR annually to track this balance.7

C. Statistical Overview and Economic Impact

Analysis of state utilization data provides perspective on the scale and impact of the research facility credit. According to Kentucky Tax Expenditure Analysis reports for Fiscal Years 2024 and 2025, the estimated total utilization of the Qualified Research Facility Tax Credit across all tax types is limited, totaling approximately $1.1 million annually.10

This utilization is primarily distributed as follows 10:

• Offset against Corporate Income Tax: $0.7 million
• Offset against LLET: $0.4 million
• Offset against Individual Income Tax: Minimal

The low total utilization figure of $1.1 million indicates that the credit, while potentially lucrative for qualifying projects, is not broadly claimed across Kentucky’s business landscape. Mathematically, a $1.1 million credit utilization implies only about $22 million in statewide qualifying capital expenditures ($1.1M / 5%) are claimed annually. This suggests that the credit is highly concentrated among a few select companies undertaking massive capital projects, or that many smaller R&D-performing firms lack the substantial state tax liability necessary to benefit fully from a nonrefundable, facility-focused credit, leading to a liquidity constraint on its value realization.

VI. Conclusion and Strategic Compliance Considerations

The Kentucky Qualified Research Facility Tax Credit (KRS 141.395) represents a highly focused, specialized incentive designed to anchor permanent research and development capital assets within the state. Its structure—a direct 5% nonrefundable credit with a generous 10-year carryforward—makes it a significant strategic tool for corporations planning major facility construction or expansion in Kentucky.

To effectively claim and defend this credit, taxpayers must recognize its unique constraints and implement robust, long-term compliance strategies:

1. Mandatory Separation of Costs: Taxpayers must establish an audit-ready methodology that strictly separates facility-related capital costs (qualified for the Kentucky 5% credit) from operational research costs (such as wages and supplies, qualified for the Federal $\S 41$ credit).1 Misclassifying operating expenses as facility costs will result in disallowance.
2. Rigor in Defining Capital Assets: Eligibility hinges entirely on the investment being “tangible, depreciable property.” Taxpayers must ensure that facility expenditures are consistently capitalized and depreciated for federal purposes, thereby establishing their depreciable nature for state credit purposes.
3. Proof Against Replacement: The statutory exclusion of “replacement property” necessitates proactive documentation emphasizing the functional improvement, expansion, or technological upgrade achieved by the capital investment, rather than simply recording the cost of swapping out an old asset for a new one.3
4. Long-Term Administrative Stewardship: The requirement to file the Schedule QR and its detailed supporting schedule annually for up to 10 years transforms compliance into a multi-year administrative responsibility.7 Companies must ensure their fixed asset records maintain the high level of granularity demanded by the DOR (purchase date, placed-in-service date, cost) for the entire utilization period to ensure defensibility during any potential state audit.

R&D Tax Credit Preparation Services

Swanson Reed is one of the only companies in the United States to exclusively focus on R&D tax credit preparation. Swanson Reed provides state and federal R&D tax credit preparation and audit services to all 50 states.

If you have any questions or need further assistance, please call or email our CEO, Damian Smyth on (800) 986-4725.
Feel free to book a quick teleconference with one of our national R&D tax credit specialists at a time that is convenient for you.

R&D Tax Credit Audit Advisory Services

creditARMOR is a sophisticated R&D tax credit insurance and AI-driven risk management platform. It mitigates audit exposure by covering defense expenses, including CPA, tax attorney, and specialist consultant fees—delivering robust, compliant support for R&D credit claims. Click here for more information about R&D tax credit management and implementation.

Our Fees

Swanson Reed offers R&D tax credit preparation and audit services at our hourly rates of between $195 – $395 per hour. We are also able offer fixed fees and success fees in special circumstances. Learn more at https://www.swansonreed.com/about-us/research-tax-credit-consulting/our-fees/