IRS Chief Counsel, in a Technical Advice Memorandum (TAM), has determined that long-term construction contracts requiring grading and soil compaction of the pad area necessary to construct home foundations qualified for the completed-contract method of accounting. As such, the taxpayer would only recognize any profit on the completion of the contract.

Take away. Generally, long-term contracts requires use of the percentage-of-completion method of accounting. However, home construction contracts are usually excepted from this general rule. To determine whether a contract is a home construction contract is a matter of whether it passes the so-called “80-percent test” of Code Sec. 460(e).

Background

The taxpayer was a corporation that actively participated in private subdivision housing projects. The contracts required that the taxpayer make construction improvements necessary for the development of a housing subdivision to include grading and compacting of soil for construction of homes. The taxpayer performed grading and soil compaction of the pad area for individual lots where the houses were to be constructed.

The IRS originally consented to the taxpayer’s use of the completed-contract method of accounting for its long-term contracts that qualified as home construction contracts within the meaning of Code Sec. 460(e)(6)(A). On audit, a revenue agent who examined the contracts claimed that they did not qualify as home construction contracts, and sought to revoke consent to the taxpayer’s use of the completed contract method.

Comment

Code Sec. 460(e)(6)(A) exempts home construction contracts from the percentage-of-completion method of accounting.

Comment

Under the completed-contract method of accounting, revenue and gross profit are recognized when the contract is completed, deferring revenue and gross profits to the date of completion. In contrast, the percentage-of-completion method requires that a taxpayer estimates the revenue and gross profit in each period based on the percentage of work completed.

If you have any questions regarding this or other tax concerns, please contact your BMSS professional at (205) 982-5500.

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