This Tax Tip Spotify Podcast and/or WordPress Blog Post is in response to questions on how revenue will be recognized in a Home Construction Business.
Because favorable rules apply to home construction contracts and certain other contracts, it is important to determine if your contracts qualify for these more advantageous rules.
Any contract that meets the IRS definition of a “home construction contract,” is exempt from the following:
(1) the requirement to use Percentage of Completion Method;
(2) the application of the look-back provisions; and
(3) the requirement to use percentage of completion method for Alternative Minimum Tax purposes.
Note, however, that even though exempt from the above requirements, construction period interest must be capitalized. Thus, it is not currently deductible. Construction period interest is interest paid or accrued on debt incurred or continued to acquire, construct, or carry real property.
Having your contracts excluded from the percentage of completion method means you can use the completed contract method. This is generally preferable because, under the completed contract method, no profit is recognized until the construction contract is complete. On the other hand, the percentage of completion method recognizes profit on a piecemeal basis.
Construction Contract
A home construction contract is any contract where 80% or more of the estimated total contract costs (including the cost of land, materials, and services), as of the close of the tax year that the contract was entered into, are reasonably expected to be attributable to:
- the building, construction, reconstruction, or rehabilitation of dwelling units contained in buildings containing four or fewer dwelling units, and
- improvements to real property that are directly related to, and located at the site of, such dwelling units.
In addition, the percentage of completion method does not apply to a construction contract in which you estimate (at the time such contract is entered into) that such contract will be completed within the two-year period beginning on the date the contract begins, and where your average annual gross receipts for the three tax years preceding the tax year in which the contract is entered into does not exceed $10 million.
Home construction contracts that do not meet the two-year or $10 million gross receipts test are subject to the uniform capitalization rules and, if your contracts fall into this category, you are considered a “large home builder” and different rules apply.
Contracts of a subcontractor working for a general contractor are included in the definition of home construction contracts if they otherwise qualify.
As you can see, there are many issues to consider in determining the proper reporting of income for tax purposes. Please call me at your earliest convenience so we can discuss your situation and resolve any issues prior to preparing your tax return.
Please contact the office of Don Fitch Accountancy at (760)567-3110 or Email Don.Fitch@CPA.com if you have any questions or would like additional information.
DON FITCH, CPA
74478 Highway 111 #3
Palm Desert, CA 92260
Toll Free: (877)CPA-Help or (877)272-4357
Cell: (760)567-3110
Fax: (760)836-0968
Email: DonFitchCPA@paylesstax.com
Website: https://www.paylesstax.com
P.S. My firm is based upon referrals. Please feel free to refer my firm to anyone you know that is looking for a new CPA and/or tax preparer. Thank you in advance.
(Updated 05012021-1 320-296)