New Procedure Allows Real Estate Developers to Use Optional Safe Harbor Method

(Parker Tax Publishing February 2023)

The IRS issued a procedure which obsoletes Rev. Proc. 92-29 and provides new tax accounting rules which allow real estate developers to use an alternative cost method for reporting certain common improvement costs. Developers that want to use this alternative cost method generally will be required to apply the method to all qualifying projects in a trade or business instead of on a per-project basis as required under Rev. Proc. 92-29. Rev. Proc. 2023-9.

Background

Code Sec. 1011 provides, in part, that the adjusted basis for determining gain or loss from the sale or other disposition of property is the taxpayer's basis in the property, determined under Code Sec. 1012, adjusted as provided in Code Sec. 1016. Code Sec. 1012 provides that the basis of property is the cost of such property. Reg. Sec. 1.1016-2(a) provides that the cost or other basis is adjusted for any expenditure properly chargeable to a capital account, including the cost of improvements and betterments made to the property. A developer may allocate the costs of certain common improvements to the bases of lots held for sale if an analysis of the common improvements indicates that (1) the basic purpose of the taxpayer in constructing the common improvement is to induce sales of the lots, and (2) the taxpayer does not retain too much ownership and control of the common improvements.

Under Code Sec. 461, developers cannot add common improvement costs to the basis of the benefitted units until such costs are incurred under Code Sec. 461(h). Code Sec. 461(h)(1) provides that, in determining whether an amount has been incurred with respect to any liability during any tax year, the all events test is not treated as met any earlier than when economic performance with respect to such liability occurs. The term "liability," as defined in Reg. Sec. 1.446-1(c)(1)(ii)(B), includes any item allowable as a deduction, cost, or expense for federal income tax purposes, as well as any amount otherwise allowable as a capitalized cost, as a cost taken into account in computing cost of goods sold, as a cost allocable to a long-term contract, or as any other cost or expense. Thus, any common improvement costs that have not been incurred under Code Sec. 461(h) when the benefitted units are sold cannot be included in the basis of the units in determining the gain or loss resulting from the sales.

In Rev. Proc. 92-29, the IRS issued procedures under which it would consent to developers including the estimated cost of common improvements in the basis of units in a project sold without meeting the economic performance requirements of Code Sec. 461(h) (i.e., the 92-29 alternative cost method). The use of the 92-29 alternative cost method was conditioned on the developer's agreement to extend the statutory period of limitation for assessing any tax deficiency arising from employing that method for each tax year in which the 92-29 alternative cost method was used. In addition, developers were required to file annual statements with the IRS District Director for each project for which the 92-29 alternative cost method was used. The annual statements required detailed information about the developer, the project, and updates to the common improvement cost calculations under the 92-29 alternative cost method.

The developer also had to attach a copy of the annual statement to the developer's timely filed original federal income tax return for the tax year. If the project could not be completed within the original estimated completion period, a developer was required to file a supplemental request for consent to extend the period to use the 92-29 alternative cost method and to agree to extend the statutory period of limitation to assess income tax for each additional tax year that the 92-29 alternative cost method was used.

Rev. Proc. 2023-9

The IRS recognized that aspects of Rev. Proc. 92-29 are outdated due to the subsequent enactment of several laws and that certain terms and conditions in Rev. Proc. 92-29 placed additional administrative burdens on developers and the IRS. The IRS also said that the application of the Rev. Proc. 92-29 alternative cost method to contracts accounted for under the special rules for long-term contracts under Code Sec. 460 may be unclear.

Accordingly, the IRS issued Rev. Proc. 2023-9 to provide updates to Rev. Proc. 92-29 to reflect current law; to reduce the administrative, recordkeeping, and compliance burdens associated with the use of the 92-29 alternative cost method; and to clarify its application to contracts accounted for under Code Sec. 460 and the regulations thereunder.

Rev. Proc. 2023-9 obsoletes Rev. Proc. 92-29 and provides new rules and conditions for implementing the optional safe harbor method of accounting for developers to determine when common improvement costs may be included in the basis of individual units of real property in a real property development project held for sale to determine the gain or loss from sales of those units (i.e., the Alternative Cost Method). Under Rev. Proc. 2023-9, the Alternative Cost Method is a method of accounting under Code Sec. 446 and Code Sec. 481 and is an alternative to the general requirements under Code Sec. 461(h). Under the Alternative Cost Method, a developer includes the share of the estimated cost of common improvements allocable to the units sold in the basis of such units regardless of whether the costs have been incurred under Code Sec. 461(h), subject to the alternative cost limitations set forth in Rev. Proc. 2023-9.

Rev. Proc. 2023-9 also provides guidance on the application of the Alternative Cost Method to contracts accounted for under the special rules for long-term contracts in Code Sec. 460 and the regulations thereunder.

For a discussion of the tax accounting rules for the acquisition of land and buildings, see Parker Tax ¶110,505.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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