Obtaining homebuilder status has long been the goal of many construction contractors. A homebuilder’s home construction contracts are exempt from the long-term contract provisions of Sec. 460 and so are not subject to the percentage of completion method for regular tax or AMT purposes or to the lookback rules for either regular tax or AMT purposes. Further, a home construction contract is exempt from the cost allocation rules of Sec. 460, although Sec. 263A cost capitalization rules apply to large homebuilders. However, there are clear limitations on what a home construction contract is, and these exclude real estate developers and condominium builders from being considered homebuilders.
Under Sec. 460(e)(6)(A), a home construction contract is any construction contract where 80% or more of the estimated total contract costs are reasonably expected to be attributable to the building, construction, reconstruction, or rehabilitation of:
- Dwelling units in buildings containing four or fewer dwelling units, and
- Improvements to real property directly related to the dwelling units and located on the site of the dwelling units.
The Service has issued Prop. Regs. Sec. 1.460-3(b)(2)(ii), which greatly expands the definition of homebuilder and, when finalized, will provide relief to a number of taxpayers (REG-120844-07). The proposed regulations provide that long-term contracts for land improvements directly related to and located on the site of the dwelling units and common improvements at the site are treated as home construction contracts, even if there is no home construction involved. Thus, under the proposed regulations, a land developer that is selling individual lots (and its contractors and subcontractors) may have long-term construction contracts that qualify for the home construction contract exemption. An allocable share of the common improvements must be included in the cost of the dwelling or land.
For purposes of the proposed regulations, a common improvement is one that the taxpayer is contractually obligated, or required by law, to construct within the tract or tracts of land containing the dwelling units or the land on which dwelling units are to be constructed and that benefits the dwelling units or the land on which dwelling units are to be constructed. A common improvement generally does not solely benefit any particular dwelling unit or any particular lot; however, land clearing and grading are common improvements, even when performed on a particular lot.
Other examples of common improvements are sidewalks, sewers, roads, and clubhouses. Where a construction contract involves the construction of both commercial units and dwelling units, a taxpayer must allocate the costs between the two types of units based on some reasonable method or a combination of reasonable methods. Whether a method is reasonable will be determined based on the facts and circumstances. The proposed regulations provide that reasonable methods may include allocation by specific identification, square footage, or fair market value.
In addition, Prop. Regs. 1.460- 3(b)(2)(iii) further expands the definitions of a townhouse and a row house (for purposes of determining whether the four-orfewer- dwelling-unit test is met) to include individual condominium units. Accordingly, each individual condominium unit is treated as a separate building and is thus eligible for homebuilder treatment. In a single building with multiple condominium units, each condominium unit will qualify as a home construction contract.
In the preamble to the proposed regulations, Treasury also solicits comments on appropriate severance and facts-andcircumstances tests to apply in determining when a home construction contract is completed and accepted.
The proposed regulations mean that developers and
condominium builders may be able to take advantage of the
various homebuilder exceptions to the longterm contract
rules. They also provide more planning opportunities for
those taxpayers. In this case, Treasury and the IRS deserve
credit for trying to ease the compliance burden on
taxpayers.
From Kevin F. Reilly, J.D., CPA, PKF Witt
Mares, Fairfax, VA, and Heather Leggiero, J.D., CPA, The DR
Group, Albany, NY
EditorNotes
Kevin F. Reilly, J.D., CPA, is a member of PKF Witt Mares in Fairfax, VA.
Unless otherwise noted, contributors are members of or associated with PKF North American Network.
For additional information about these items, contact Mr. Reilly at (703) 385-8809 or kreilly@pkfwittmares.com.
Correction
In the September Tax Clinic, in the item
“Transactions Between Private Equity Fund–Owned Portfolio
Corporations: An Update” on p. 568, due to an editing error,
the phrase “five or fewer persons own more than 50%” in the
example should have read “no five or fewer persons own more
than 50%.”
