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Real Estate Development-When to Expense vs Capitalize Costs

PostPosted: 30-Sep-2019 8:22am
by haydengulf
Happy Monday to all!

Have a real estate developers LLC
The entity obtains a loan; buys land, & constructs
residential homes.
After the homes sell;the loans are paid off at closing.

The entity is under the $25 million gross receipts threshold.
I have in the past capitalized direct costs (WIP) until sales
& expensed interest, real estate taxes & insurance since
their receipts are under the threshold.

The Client wants to take the expenses each year as he incurs
them?? Is this method an option???

Obviously it will not be pretty when He actually sells property with
only currents costs in COGS. (he has another 2018 entity
with a large net income & is wanting to offset )

He isn't happy & I am not comfortable with this option..
Am I mistaken??

Thank you!

Re: Real Estate Development-When to Expense vs Capitalize Co

PostPosted: 30-Sep-2019 11:21am
by JAD
Interesting. TCJA did not change 263. But if developer does enough of these transactions, are the houses inventory, qualifying him to elect out of 471 requirements?

The $25M test is not just at the entity level - you also have to take a look at his other businesses. https://www.aicpa.org/interestareas/tax ... rules.html

Re: Real Estate Development-When to Expense vs Capitalize Co

PostPosted: 30-Sep-2019 11:45am
by Terry Oraha
The dmsh does not apply where inventory is concerned. In other words it’s not an option.

Re: Real Estate Development-When to Expense vs Capitalize Co

PostPosted: 30-Sep-2019 11:50am
by Nilodop
... are the houses inventory, qualifying him to elect out of 471 requirements? . I think they are
... property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business
. Else we would not need that phrase in section 1221(a)(1), after the word "or".

Re: Real Estate Development-When to Expense vs Capitalize Co

PostPosted: 30-Sep-2019 12:09pm
by Coddington
Terry Oraha wrote:The dmsh does not apply where inventory is concerned. In other words it’s not an option.


That's not what the JCT Blue Book said.

Re: Real Estate Development-When to Expense vs Capitalize Co

PostPosted: 30-Sep-2019 12:19pm
by Terry Oraha
Coddington wrote:
Terry Oraha wrote:The dmsh does not apply where inventory is concerned. In other words it’s not an option.


That's not what the JCT Blue Book said.



Are you saying that if the inventory is treated as materials and supplies then the DMSH could apply?

Re: Real Estate Development-When to Expense vs Capitalize Co

PostPosted: 30-Sep-2019 12:21pm
by haydengulf
DMSH ? ?

Re: Real Estate Development-When to Expense vs Capitalize Co

PostPosted: 30-Sep-2019 12:22pm
by Terry Oraha
De Minimis Safe Harbor.

Re: Real Estate Development-When to Expense vs Capitalize Co

PostPosted: 30-Sep-2019 12:36pm
by haydengulf
ok

Re: Real Estate Development-When to Expense vs Capitalize Co

PostPosted: 30-Sep-2019 12:50pm
by Coddington
Terry Oraha wrote:
Coddington wrote:
Terry Oraha wrote:The dmsh does not apply where inventory is concerned. In other words it’s not an option.


That's not what the JCT Blue Book said.



Are you saying that if the inventory is treated as materials and supplies then the DMSH could apply?


Yes.

Re: Real Estate Development-When to Expense vs Capitalize Co

PostPosted: 30-Sep-2019 1:00pm
by haydengulf
Doubtful that the taxpayers aggregrate gross receipts will go over the $25million threshold..
On the balance sheet is approximately $4million land/inventory acquired in 2018..
Can't imagine expensing this additional amount on 2018 tax return when there already is a significant
loss of approx. $195K..
thoughts appreciated

Re: Real Estate Development-When to Expense vs Capitalize Co

PostPosted: 30-Sep-2019 1:19pm
by Terry Oraha
Well apparently your asnwers are a combination of the suggestions by JAD and Brian. You change their method of accounting to treat inventory as materials and supplies (DCN 235) then apply the DMSH. To the extent DMSH applies you could arguably take an immediate deduction for some direcct costs.

In a situation like this you might want to look at change in method of not applying 263A (DCN 234) and cash method of accounting options (DCN 233). I'd consider all then figure in the best changes for your client's circumstances.

Here are some good readings:

https://www.currentfederaltaxdevelopmen ... ng-methods
viewtopic.php?f=8&t=12901

Re: Real Estate Development-When to Expense vs Capitalize Co

PostPosted: 30-Sep-2019 1:57pm
by haydengulf
Thanks Terry Will read!

Just can't get my head around deducting $4 million in inventory in 2018 and then not
have any costs for 2019 when majority of houses sell in 2019...

Re: Real Estate Development-When to Expense vs Capitalize Co

PostPosted: 30-Sep-2019 2:09pm
by Wiles
How do you apply the DMSH election to developments costs, such as $6,000 of insurance?

Re: Real Estate Development-When to Expense vs Capitalize Co

PostPosted: 30-Sep-2019 2:59pm
by Coddington
I probably should have mentioned this before, but the TCJA changes, at most, take us back to pre-'86 law. Developers can't use section 471 for their "inventory", since it isn't merchandise. Since it isn't inventory under 471, they cannot elect NIMS treatment. Examples 17 and 18 of Rev Proc 2002-28 may be instructive in what is possible.

Re: Real Estate Development-When to Expense vs Capitalize Co

PostPosted: 30-Sep-2019 3:17pm
by haydengulf
Thanks Brian!
Have my homework assignment for this evening!

S

Re: Real Estate Development-When to Expense vs Capitalize Co

PostPosted: 30-Sep-2019 3:35pm
by Terry Oraha
Coddington wrote:I probably should have mentioned this before, but the TCJA changes, at most, take us back to pre-'86 law. Developers can't use section 471 for their "inventory", since it isn't merchandise. Since it isn't inventory under 471, they cannot elect NIMS treatment. Examples 17 and 18 of Rev Proc 2002-28 may be instructive in what is possible.


That thought did cross my mind. That means that you can tell you client he can’t do it Hayden.

Re: Real Estate Development-When to Expense vs Capitalize Co

PostPosted: 30-Sep-2019 3:45pm
by haydengulf
Thank you Terry!!!

Re: Real Estate Development-When to Expense vs Capitalize Co

PostPosted: 30-Sep-2019 4:00pm
by haydengulf
Terry & Bryan!
Back to my original post ;
the entity IS allowed to Expense Indirect
Costs because the gross receipts are under
$25million -correct?

Re: Real Estate Development-When to Expense vs Capitalize Co

PostPosted: 13-Oct-2019 6:19am
by Chay
Coddington wrote:Developers can't use section 471 for their "inventory", since it isn't merchandise. Since it isn't inventory under 471, they cannot elect NIMS treatment. Examples 17 and 18 of Rev Proc 2002-28 may be instructive in what is possible.

I'm confused by a couple of things here.

Example 17 of Rev Proc 2002-28 says "Because the house is real property held for sale by Taxpayer, the house and the material used to build the house are not inventoriable items under this revenue procedure. Thus, Taxpayer may not account for the items used to build the house as non-incidental materials and supplies under § 1.162-3." On the other hand, this article says "The most favorable impact will be to manufacturers that will now deduct the cost of purchased raw materials when the materials move out of storage into the work-in-process phase. Direct labor and direct overhead will be immediately deductible under this method. For resellers and distributors there is much less of an impact since it will be likely that their material purchases will be used or consumed when the product is sold to customers."

Is the article correct? If so, what distinguishes a real estate developer from a manufacturer? In both cases, material and labor are combined to create a finished product. Is there some rule that distinguishes real property from inventory?

If real property held for sale isn't inventory in the first place, then aren't we free to employ the DMSH just as we would with improvements made to any other type of real estate?

And finally, in the case of a house flipper or other dealer in real estate, whose product apparently isn't "inventory", how do we report the cost of the sale? Would Form 1125-A or Part III of Schedule C be used in the same way, with a beginning and ending "inventory"?