Real Estate Development-When to Expense vs Capitalize Costs

Technical topics regarding tax preparation.
#21
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My understanding is that the real property is still inventory, but not merchandise. A legal definitioon for merchandises is, generally, the term merchandise is used to denote a movable object involved in trade or traffic and that is passed from hand to hand by purchase and sale.That means it is not allowed various treatments that are common to inventory that is merchandisable. Example, it cannot be subject to a write off for obslescence, treated as materials and supplies (new to me), other possible exceptions could be out there that I'm not aware of.
 

#22
Chay  
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Since posting those questions, I've stumbled on the Construction Industry Audit Technique Guide, which states that "[t]he Internal Revenue Code defines inventory as tangible personal property" (on page 99). I'm not sure where that particular rule is found, but in any case the Guide has plenty of case law support for the position that real estate cannot be inventoried. So, Terry, I think your analysis is on point, except that real estate seems not to be considered inventory at all.

But then there are the other two questions I asked. The DMSH can't be applied to "property that is or is intended to be included in inventory property", and the cost of goods sold calculation makes explicit reference to "inventories". Are we to understand the term "inventory" identically both these instances and as it applies to real estate that can't be "inventoried"? I have a feeling the answer is complex and might involve something that Coddington would refer to as a "through the looking glass" moment.
 

#23
Coddington  
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We don’t know how the DMSH will work for real property development. I’d suggest making the DMSH election on the return, making sure book expensing is in place, but not tax conformity. Amend if they approve real estate expensing, otherwise the audit risk seems too big.
-Brian

Director of Tax Accounting Methods & Credits
SourceAdvisors.com

Opinions my own.
 

#24
Coddington  
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Just to follow up, under the DMSH, the section 263A coordination rule combined with the anti-abuse rule should work to eliminate the DMSH for many development activities. But what do we do when we have a developer that is no longer subject to 263A as a small taxpayer and whose invoices are already sufficiently componentized to fit under the DMSH? At that point, the DMSH result would need to be compared to completed contract and other small taxpayer construction methods. I don't think it would necessarily provide a better result.
-Brian

Director of Tax Accounting Methods & Credits
SourceAdvisors.com

Opinions my own.
 

#25
Chay  
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Coddington wrote:But what do we do when we have a developer that is no longer subject to 263A as a small taxpayer and whose invoices are already sufficiently componentized to fit under the DMSH?

As it happens I do have one such client. His DMSH development costs are $40k+ after filtering them through the anti-abuse rule. There's no revenue from this business for the year, but the return itself has over half a million in AGI. We had a chat about this and he says he's fine with the audit risk and doesn't mind if the IRS expresses a "difference of opinion" as to how much tax he owes. So, we're going through with it.

If we get any pushback from the IRS, I'll post again to this thread. If not, you can assume the position has gone unchallenged.

As always, thanks Brian for your valuable insight.
 

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