Real Estate Developers Face New Rules

The IRS has recently issued new guidelines and conditions for the real estate developer alternative cost method, which is an optional safe harbor method of accounting to determine common improvement costs that may be included in the basis of individual units of real property. These changes will help developers determine gain or loss from the sale of units that are part of a larger property.

Background

Under Code Sec. 461, developers cannot add common improvement costs to the basis of benefitted units until the costs are incurred under the Code Sec. 461(h) economic performance requirements. Thus, common improvement costs that have not been incurred under Code Sec. 461(h) when the units are sold cannot be included in the units’ basis to determine the gain or loss resulting from the sales. The earlier procedure, Rev. Proc. 92-29, allowed developers to include the estimated cost of common improvements in the basis of units sold without meeting the economic performance requirements of Code Sec. 461(h), but it also placed additional administrative burdens on developers and the IRS.

Rev. Proc. 2023-9 Alternative Cost Method

The alternative cost method must be applied to all projects in a trade or business that meet the definition of a qualifying project. However, the alternative cost limitation of this revenue procedure is calculated on a project-by-project basis. Thus, common improvement costs incurred for one qualifying project may not be included in the alternative cost method calculations of a separate qualifying project.

The revenue procedure provides definitions including definitions of “qualifying project,”“reasonable method,” and “CCM contract” (related to the completed contract method). Also included are rules alternative cost method application for developers using the accrual method of accounting and the completed contract method of accounting, rules for allocating estimated common improvement costs, and a method for determining the alternative costs limitation. The revenue procedure also provides examples of how its rules are applied.

Accounting Method Change Required

Under Rev. Proc. 2023-9, it is important to note that a change to this alternative cost method is a change in accounting method to which Code Secs. 446(e) and 481 apply. An eligible taxpayer that wants to change to the Rev. Proc. 2023-9 alternative cost method or that wants to change from the Rev. Proc. 92-29 alternative cost method, must use the automatic change procedures in Rev. Proc. 2015-13 or its successor. In certain cases, taxpayers may use short Form 3115 in lieu of the standard Form 3115 to make the change.

Effective Date

The new revenue procedure is effective for tax years beginning after December 31, 2022.

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