Discussion:Building condos - land development costs

My question is how to treat the land and its development costs. A homeowner's association was formed which I believe will be used to own the property although the title has not transferred yet.

Question:

1) If the land cost $200K and the property development cost $500K, I assume those costs should be treated on the Schedule C as part of COGS and as ending inventory, correct?

2) What happens on Schedule C to the $700K of costs when the property gets transferred to the Homeowners Association?

3) Is it prudent to make the election to allocate costs based upon estimated costs?

4) What accounting method....accrual? (the average 3-yr receipts will not exceed $10 million)

Thanks for any thoughts about any or all of the above.

While I agree Rev Proc 92-029 can be applicable, I use 263A when it is more advantageous than 92-029. I also note that parts of 92-029 maybe in conflict with 263A.

If you say that condos are never treated as inventory then how would you report the costs to build the condos that accumulate over the years during construction?

Where on Schedule C would you report the costs?

Are you saying that if the contruction process occurred during years 1 and 2 and condos started to sell in year 3 there would be no Schedule C filed for years 1 and 2 reporting the accumulation of costs as inventory?

I may do that also, however, it is not correct as you well know.

Belle, various methods depending on the way the client accumulates the costs. Speard sheets of the totals accumulated by the client, or a bunch of general ledger accounts, including contra accounts for removing costs to the profit loss, is the most common methods. Some software have the ability to handle work-in-process account allocations.

Phasing of the costs, is the one of the methods, I use.

For example a condo project with only two buildings, consisting of two phases, building one and building two. Under 263A using the phase approach, I would allocate all of the costs, such as, entrance, fire protection, etc. that was required in order to build the first phase, to the units in building one. Naturally, when phase two is started I would allocate those costs incurred that relate to phase two. Because the cost of the entrance, fire protection, etc. was properly allocated in phase one, there would be no allocation of these items to phase two. Naturally, phases must exist for this to be a proper allocation, and construction should follow the phases.

Following up what others have said I can not fathom how the costs can not be reported on Schedule C as inventory as they are incurred. If I am wrong that's fine, I just would like to know why so.

JR1 - if I read your post correctly you don't file a Schedule C until the first year a condo/townhouse/house is sold. Why wouldn't you be filing a Schedule C and recording the costs that were incurred as inventory in the years before sales occur?

Quote

"HOMES BUILT FOR SPECULATION (NO CONTRACT)

  Homebuilders will purchase a number of lots from a developer of a subdivision to build houses. The homebuilder may build some of the homes as speculative (spec) homes. Speculative homes are not built under a contract. In the industry, homes built for speculation that are on hand at year end are referred to as inventory of unsold houses or work in process. These speculation houses do not meet the definition of inventory in the Code. The Internal Revenue Code defines inventory as tangible personal property. Speculation houses are capital assets as defined in IRC section 263. The builder owns the real property (land) and the house inherently attached to the land. Courts have consistently held that developed real property must be accounted for under a capitalization method. See W.C. & A.N. Miller Development Co. v. Commissioner, 81 T.C. 619 (1983); Homes by Ayres v. Commissioner, T.C. Memo. 1984-475, aff'd, 795 F.2d 832 (9th Cir. 1986). See also Rev. Rul. 86-149, 1986-2 C.B. 67; Rev. Rul. 66247, 1966-2 C.B. 198."

Read for yourself....

I am not saying you should not do what you are doing on Schedule C, and I acknowledge that is common practice. But calling a duck, a pig, and putting lipstick on it does not made it a pig. Calling houses inventory does not made them inventory for tax purposes. The only point is that inventory accounting methods can not be used for real estate.

Well, Taxalmancer with all your experience you have, you already know this stuff, and just are testing us.

BTW - peeps = People (for you unedumecated few)

Oh and BTW = By the Way

AND unedumecated = hill talk for a lack of education (my roots keep poking up, here!)

I'll take a look at citations. Thanks for those.

Inventory is defined for tax purposes as consisting of tangible personal property, and does not include real property, such as condos. You can not elect to write down condos to lower of cost or market as you can with an inventory method costing method, which as I recall is required by GAAP.

Quote

1.263A-2(b)(2)(i)(B) Non-inventory property held for sale. Non-inventory property held by a taxpayer primarily for sale to customers in the ordinary course of the taxpayer's trade or business.

End Quote

You will find condos covered by this Regulation as non-inventory property held...

As I have stated I agree that as a professional if you know what you are doing concerning the treatment of condos as inventory or not I don;t see any problem. I just don't want the inexperienced or non-professional to be misled.

I absolutely agree that one cannot write-down condos under an LCM method. I use the term "inventory" very loosely, meaning that it's some asset on one's Balance Sheet. When people talk about Section 263A they talk about having to "inventory" certain costs that must be thrown onto the Balance Sheet. Here, the word "inventory" isn't used mean anything other than this. It is simply a word commonly used by tax accountants to mean, for example, that if you are a real estate developer, you can't just expense out your development costs to the P&L as you incur them.

Also, if you look at the COGS section of an entity tax return, there are lines for "Beginning of Year Inventory," "End of Year Inventory," and in between these two lines there is a line for "Additional Section 263A Costs."