[Federal Register Volume 73, Number 150 (Monday, August 4, 2008)]
[Proposed Rules]
[Pages 45180-45184]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E8-17830]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG-120844-07]
RIN 1545-BG70
Rules for Home Construction Contracts
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking and Notice of Public Hearing.
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SUMMARY: This document contains proposed regulations amending the
regulations under Sec. 1.460 to provide guidance to taxpayers in the
home construction industry regarding accounting for certain long-term
construction contracts that qualify as home construction contracts
under section 460(e)(6) of the Internal Revenue Code (Code) and to
provide guidance to taxpayers with long-term contracts under section
460(f) regarding certain changes in method of accounting for long-term
contracts. This document also provides a notice of a public hearing on
these proposed regulations.
DATES: Written comments must be received by November 3, 2008. Outlines
of topics to be discussed at the public hearing scheduled for December
5, 2008, at 10 a.m. must be received by November 13, 2008.
ADDRESSES: Send submissions to CC:PA:LPD:PR (REG-120844-07), room 5203,
Internal Revenue Service, POB 7604 Ben Franklin Station, Washington, DC
20224. Submissions may be hand delivered Monday through Friday between
the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-120844-07),
Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue,
NW., Washington, DC. Alternatively, taxpayers may submit comments
electronically via the Federal eRulemaking Portal at
www.regulations.gov (IRS REG-120844-07). The public hearing will be
held in the auditorium, Internal Revenue Service Building, 1111
Constitution Avenue, NW., Washington, DC.
FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations,
Brendan P. O'Hara, (202) 622-4920; concerning submission of comments,
the hearing, or to be placed on the building access list to attend the
hearing, Richard Hurst, (202) 622-7180 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Background and Explanation of Provisions
This document contains a proposed amendment to the Income Tax
Regulations, 26 CFR part 1, under section 460 and Sec. Sec. 1.460-3,
1.460-4, 1.460-5 and 1.460-6 of the Income Tax Regulations. In general,
section 460(a) requires taxpayers to use the percentage of completion
method (PCM) to account for taxable income from any long-term contract.
Section 460(e) exempts home construction contracts from the general
requirement to use the percentage of completion method of accounting.
Section 460(e)(6) defines a home construction contract to be any
construction contract if 80 percent or more of the total estimated
contract costs are reasonably expected to be attributable to the
construction of (i) dwelling units contained in buildings containing 4
or fewer dwelling units, and (ii) improvements to real property
directly related to such dwelling units and located on the site of such
dwelling units. Section 460(e)(4) defines a construction contract to be
any contract for the building, construction, reconstruction, or
rehabilitation of, or the installation of any integral component to, or
improvement of, real property.
These proposed regulations expand the types of contracts eligible
for the home construction contract exemption and amend the rules for
how taxpayer-initiated changes in methods of accounting to comply with
the regulations under section 460 may be implemented.
Definition of a Home Construction Contract
Improvements to Real Property
The definition of a construction contract under section 460(e)
includes many transactions involving land developers and construction
service providers in the home construction industry. For example, a
construction contract under section 460(e) includes a contract for the
provision of land by the taxpayer if the estimated total allocable
contract costs attributable to the taxpayer's construction activities
(not including the cost of the land provided to the customer) are 10
percent or more of the contract's total contract price.
As noted, section 460(a) requires that the income from any long-
term contract be recognized using the percentage of completion method.
However, taxpayers with contracts that meet the definition of a ``home
construction contract'' are not required to use the percentage of
completion method for those contracts and may use an exempt method.
Exempt methods commonly used to account for home construction contracts
include the completed contract method (CCM) and the accrual method.
Under section 460, a home construction contract includes any
construction contract if 80 percent of the total estimated contract
costs are reasonably expected to be attributable to the construction of
improvements to real property directly related to qualifying dwelling
units and located on the site of such dwelling units. Commentators have
suggested that many contracts entered into by land developers in the
home construction industry should fall within the definition of a home
construction contract.
The proposed regulations expand the scope of the home construction
contract exemption by providing that a contract for the construction of
common improvements is considered a contract for the construction of
improvements to real property directly related to the dwelling unit(s)
and located on the site of such dwelling unit(s), even if the contract
is not for the construction of any dwelling unit. Therefore, under the
proposed regulations, a land developer that is selling individual lots
(and its contractors and subcontractors) may have long-term
construction contracts that qualify for the home construction contract
exemption.
Townhouses, Rowhouses, and Condominiums
Under section 460, a home construction contract also includes any
construction contract if 80 percent of the total contract costs are
reasonably expected to be attributable to the construction of dwelling
units contained in buildings containing four or fewer dwelling units.
Section 460(e)(6) states that each townhouse or rowhouse shall be
treated as a separate building, regardless of the number of townhouses
or rowhouses physically attached to each other. In certain
circumstances, the terms condominium
[[Page 45181]]
and townhouse are used interchangeably to describe similar structures.
Individual condominium units possess many of the characteristics
generally associated with townhouses and rowhouses such as private
ownership, shared portions of their structures, residential housing,
and the economics of the underlying purchase transactions.
The proposed regulations expand what is considered a townhouse or
rowhouse, for purposes of the home construction contract exemption, to
include an individual condominium unit. This will have the effect of
allowing each condominium unit to be treated as a separate building for
purposes of determining whether the underlying contract qualifies as a
home construction contract.
Completed Contract Method
Under the current regulations under section 460, the appropriate
severing of a home construction contract requires a facts and
circumstances analysis based upon certain factors that are neither
specific nor always relevant to home construction contracts. Likewise,
the date a home construction contract is considered completed and
accepted is determined using a facts and circumstances analysis.
The IRS and Treasury Department are aware of controversies related
to the application of the existing facts and circumstances analyses for
determining the appropriate severance and final completion and
acceptance of home construction contracts accounted for using the
completed contract method. Expanding the definition of a home
construction contract as provided in these proposed regulations may
heighten the significance of these issues. As a result, the IRS and
Treasury Department expect to propose specific severing and completion
rules for home construction contracts accounted for using the completed
contract method. Taxpayers are encouraged to submit comments on the
types of severing and completion rules that would result in the clear
reflection of income for home construction contracts accounted for
using the completed contract method. Specifically, the IRS and the
Treasury Department request comments on the circumstances (if any) in
which it would not be appropriate to require severing and completion of
a home construction contract to be determined on a dwelling unit by
dwelling unit or lot by lot basis or, when a contract is not for the
sale of a dwelling unit or lot, on the basis of when the taxpayer
receives payment(s) under the contract.
Method of Accounting
Currently, the regulations under section 460 provide that a
taxpayer that uses the percentage-of-completion method (PCM), the
exempt-contract percentage-of-completion method (EPCM), or elects the
10-percent method or special alternative minimum taxable income (AMTI)
method, or that adopts or elects a cost allocation method of accounting
(or changes to another method of accounting with the Commissioner's
consent) must apply the method(s) consistently for all similarly
classified contracts until the taxpayer obtains the Commissioner's
consent under section 446 to change to another method of accounting.
The regulations further provide that a taxpayer-initiated change in
method of accounting will be permitted only on a cut-off basis (that
is, for contracts entered into on or after the year of change), and
thus, a section 481(a) adjustment will not be permitted nor required.
The proposed regulations continue this cut-off method of implementation
but only for taxpayer-initiated changes from a permissible PCM method
to another permissible PCM method for long-term contracts for which PCM
is required and for taxpayer-initiated changes from a cost allocation
method of accounting that complies with the cost allocation rules of
Sec. 1.460-5 to another cost allocation method of accounting that
complies with the cost allocation rules of Sec. 1.460-5. Under the
proposed regulations all other taxpayer-initiated changes in method of
accounting under section 460 will be made with a section 481(a)
adjustment.
The proposed regulations provide that in determining the
hypothetical underpayment or overpayment of tax for any year as part of
the look-back computation, amounts reported as section 481(a)
adjustments shall generally be taken into account in the tax year or
years they are reported. For purposes of determining whether there is a
hypothetical underpayment or overpayment of tax under the look-back
computation, a taxpayer would use amounts reported under its old method
for the years the old method was used and would use amounts reported
under its new method for the years the new method was used, netted
against the amount of any section 481(a) adjustments required to be
taken into account. Thus, a look-back computation would not be required
upon contract completion simply because the taxpayer has changed its
method of accounting. However, a look-back computation would be
required upon contract completion if actual costs or the contract price
differ from the estimated amounts notwithstanding the fact a change in
method of accounting occurred. For example, if a taxpayer using PCM
changed its method of accounting for construction costs incurred in a
contract reported under PCM, the section 460 look-back would be
computed using the costs recognized prior to the year of change
(reported under the taxpayer's old method of accounting) and the costs
recognized in subsequent years using the new method of accounting,
netted against any applicable section 481(a) adjustment. Similarly, for
changes in methods of accounting where no costs were recognized under
the old method of accounting (for example, a change in method of
accounting from CCM to PCM), look-back would effectively only apply to
years in which the taxpayer's new method of accounting was used to the
extent that no costs were recognized prior to the year of change under
the old method of accounting. This approach to the look-back
computation is consistent with the underlying purpose of look-back as
well as the general accounting method change procedures. Comments are
specifically requested with respect to issues that taxpayers may
foresee with respect to the rules provided in these proposed
regulations for taking into account section 481(a) adjustments in the
year reported for purposes of the look-back computation.
Proposed Effective/Applicability Date
These regulations are proposed to apply to taxable years beginning
on or after the date the final regulations are published in the Federal
Register. The final regulations will provide rules applicable to
taxpayers that seek to change a method of accounting to comply with the
rules contained in the final regulations. Taxpayers may not change or
otherwise use a method of accounting in reliance upon the rules
contained in these new proposed regulations until the rules are
published as final regulations in the Federal Register.
Special Analyses
It has been determined that this proposed regulation is not a
significant regulatory action as defined in Executive Order 12866.
Therefore, a regulatory assessment is not required. It has also been
determined that section 553(b) of the Administrative Procedure Act (5
U.S.C. chapter 5) does not apply, and because the regulations do not
impose a collection of information on small entities, the Regulatory
Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to
section 7805(f) of the Code,
[[Page 45182]]
this notice of proposed rulemaking will be submitted to the Chief
Counsel for Advocacy of the Small Business Administration for comment
on its impact on small businesses.
Comments and Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to any written comments (a signed original
with eight (8) copies) or electronic comments that are submitted timely
to the IRS. The IRS and Treasury Department request comments on the
clarity of the proposed regulations and how they may be made easier to
understand. All comments will be available for public inspection and
copying.
A public hearing has been scheduled for December 5, 2008, beginning
at 10 a.m., in the auditorium of the Internal Revenue Building, 1111
Constitution Avenue, NW., Washington, DC. Due to building security
procedures, visitors must enter at the Constitution Avenue entrance. In
addition, all visitors must present photo identification to enter the
building. Because of access restrictions, visitors will not be admitted
beyond the immediate entrance area more than 30 minutes before the
hearing starts. For information about having your name placed on the
building access list to attend the hearing, see the FOR FURTHER
INFORMATION CONTACT section of this preamble.
The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who
wish to present oral comments at the hearing must submit electronic or
written comments and an outline of the topics to be discussed and the
time to be devoted to each topic (signed original and eight (8) copies)
by November 13, 2008. A period of 10 minutes will be allotted to each
person for making comments. An agenda showing the scheduling of the
speakers will be prepared after the deadline for receiving outlines has
passed. Copies of the agenda will be available free of charge at the
hearing.
Drafting Information
The principal author of these regulations is Brendan P. O'Hara,
Office of Associate Chief Counsel (Income Tax and Accounting). However,
other personnel from the IRS and Treasury Department participated in
their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 1 is proposed to be amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.460-3 is amended by:
1. Revising paragraph (b)(1)(ii).
2. Redesignating paragraphs (b)(2)(ii), (b)(2)(iii) and (b)(2)(iv)
as paragraphs (b)(2)(iii), (b)(2)(iv) and (b)(2)(v), respectively, and
revising them.
3. Adding a new paragraph (b)(2)(ii).
The revisions and addition read as follows:
Sec. 1.460-3 Long-term construction contracts.
* * * * *
(b) * * *
(1) * * *
(ii) Construction contract, other than a home construction
contract, that a taxpayer estimates (when entering into the contract)
will be completed within 2 years of the contract commencement date,
provided the taxpayer satisfies the $10,000,000 gross receipts test
described in paragraph (b)(3) of this section.
(2) * * *
(ii) Land improvements. For purposes of paragraph (b)(2)(i)(B) of
this section, improvements to real property directly related to, and
located on the site of, the dwelling units consist of improvements to
land on which dwelling units (as described in paragraph (b)(2)(i)(A) of
this section) are constructed, and common improvements as defined in
paragraph (b)(2)(iv) of this section. A long-term construction contract
is a home construction contract if a taxpayer (including a
subcontractor working for a general contractor) meets the 80% test in
paragraph (b)(2)(i) of this section as applied to either paragraph
(b)(2)(i)(A) of this section or paragraph (b)(2)(i)(B) of this section,
or both paragraphs (b)(2)(i)(A) and (b)(2)(i)(B) of this section,
collectively.
(iii) Townhouses and rowhouses. For purposes of determining whether
a long-term construction contract is a home construction contract under
paragraph (b)(2) of this section, each townhouse or rowhouse is a
separate building. For this purpose, the term townhouse and rowhouse
includes an individual condominium unit.
(iv) Common improvements--(A) In general. A taxpayer includes in
the cost of a dwelling unit or land its allocable share of the cost
that the taxpayer incurs for any common improvements that benefit the
dwelling unit or land.
(B) Definition. For purposes of this section, a common improvement
is an improvement that the taxpayer is contractually obligated, or
required by law, to construct within the tract or tracts of land
containing the dwelling units (or the land on which dwelling units are
to be constructed) and that benefits the dwelling units (or the land on
which dwelling units are to be constructed). In general, a common
improvement does not solely benefit any particular dwelling unit or any
particular lot on which a dwelling unit is constructed. However, land
clearing and grading are common improvements, even when performed on a
particular lot. Other examples of common improvements are sidewalks,
sewers, roads and clubhouses.
(v) Mixed use costs. If a contract involves the construction of
both commercial units and dwelling units, a taxpayer must allocate the
costs among the commercial units and dwelling units using a reasonable
method or combination of reasonable methods. In general, the
reasonableness of an allocation method will be based on facts and
circumstances. Examples of methods that may be reasonable are specific
identification, square footage, or fair market value.
* * * * *
Par. 3. Section 1.460-4 is amended by:
1. Revising the third sentence in paragraph (c)(1).
2. Redesignating paragraph (g) as paragraph (g)(1) and revising
newly redesignated paragraph (g)(1).
3. Adding a paragraph (g)(2).
4. Revising Example 5. of paragraph (h).
The revisions and additions read as follows:
Sec. 1.460-4 Methods of accounting for long-term contracts.
* * * * *
(c) * * *
(1) * * * Permissible exempt contract methods are the PCM, the EPCM
described in paragraph (c)(2) of this section, the CCM described in
paragraph (d) of this section, the accrual method, and any other
permissible method. * * *
* * * * *
(g) Method of accounting--(1) In general. A taxpayer must apply its
method(s) of accounting for long-term contracts consistently for all
similarly classified long-term contracts until the taxpayer obtains the
Commissioner's
[[Page 45183]]
consent under section 446(e) to change to another method of accounting.
(2) Taxpayer-initiated change in method of accounting--(i) Change
to PCM for long-term contracts for which PCM is required. A taxpayer-
initiated change in method of accounting for long-term contracts (or
portion thereof) for which income must be determined using the PCM
described in paragraph (b) of this section and the costs allocation
rules described in Sec. 1.460-5(b) or (c) (required PCM contracts)
from a method of accounting that does not comply with paragraph (b) of
this section and Sec. 1.460-5(b) or (c) to a method that complies with
paragraph (b) of this section and Sec. 1.460-5(b) or (c) must be
applied to all required PCM contracts entered into before the year of
change and not reported as completed as of the beginning of the year of
change. Accordingly, a section 481(a) adjustment will be required.
(ii) Change from a permissible PCM method to another permissible
PCM method for long-term contracts for which PCM is required. A
taxpayer initiated change in method of accounting for required PCM
contracts, as defined in paragraph (g)(2)(i) of this section (or a
portion thereof), from a method of accounting that complies with
paragraph (b) of this section and Sec. 1.460-5(b) or (c) to another
method of accounting that complies with paragraph (b) of this section
and Sec. 1.460-5(b) or (c) must be made on a cut-off basis and applied
only to contracts entered into during and after the year of change.
Accordingly, a section 481(a) adjustment will be neither permitted nor
required.
(iii) Change to an exempt contract method for home construction
contracts. A taxpayer-initiated change in method of accounting for home
construction contracts, as defined in Sec. 1.460-3(b)(2), to a
permissible exempt contract method, as described in paragraph (c)(1) of
this section, must be applied to all home construction contracts
entered into before the year of change and not reported as completed as
of the beginning of the year of change. Accordingly, a section 481(a)
adjustment will be required.
(iv) Change to an exempt contract method for exempt contracts other
than home construction contracts. A taxpayer-initiated change in method
of accounting for long-term contracts (or portion thereof) not
described in paragraphs (g)(2)(i), (ii) and (iii) of this section to a
permissible exempt contract method as described in paragraph (c)(1) of
this section must be applied to all contracts that are eligible to use
the exempt contract method entered into before the year of change and
not reported as completed as of the beginning of the year of change.
Accordingly, a section 481(a) adjustment will be required.
(h) * * *
* * * * *
Example 5. PCM--contract terminated. C, whose taxable year ends
December 31, determines the income from long-term contracts using
the PCM. During 2001, C buys land and begins constructing a building
that will contain 50 apartment units on that land. C enters into a
contract to sell the building to B for $2,400,000. B gives C a
$50,000 deposit toward the purchase price. By the end of 2001, C has
incurred $500,000 of allocable contract costs on the building and
estimates that the total allocable contract costs on the building
will be $1,500,000. Thus, for 2001, C reports gross receipts of
$800,000 ($500,000/$1,500,000 x $2,400,000), current-year costs of
$500,000, and gross income of $300,000 ($800,000-$500,000). In 2002,
after C has incurred an additional $250,000 of allocable contract
costs on the building, B files for bankruptcy protection and
defaults on the contract with C, who is permitted to keep B's
$50,000 deposit as liquidated damages. In 2002, C reverses the
transaction with B under paragraph (b)(7) of this section and
reports a loss of $300,000 ($500,000-$800,000). In addition, C
obtains an adjusted basis in the building sold to B of $700,000
($500,000 (current-year costs deducted in 2001)-$50,000 (B's
forfeited deposit) + $250,000 (current-year costs incurred in 2002).
C may not apply the look-back method to this contract in 2002.
* * * * *
Par. 4. Section 1.460-5 is amended by:
1. Adding a new sentence to the end of paragraph (c)(2).
2. Revising paragraph (g).
The revision and addition read as follows:
Sec. 1.460-5 Cost allocation rules.
* * * * *
(c) * * *
(2) * * * Further, this election is not available if a taxpayer is
changing from a cost allocation method other than as prescribed in
paragraph (b) of this section, in which case the taxpayer must follow
the procedures under Sec. 1.446-1(e) for obtaining the Commissioner's
consent for the change in method of accounting.
* * * * *
(g) Method of accounting. A taxpayer that adopts, elects, or
otherwise changes to a cost allocation method of accounting (or changes
to another cost allocation method of accounting with the Commissioner's
consent) must apply that method consistently for all similarly
classified contracts, until the taxpayer obtains the Commissioner's
consent under section 446 to change to another cost allocation method.
A taxpayer-initiated change in cost allocation method from a method
that does not comply with the cost allocation rules of this section to
a method that complies with the cost allocation rules of this section
must be applied to all long-term contracts to which the rules of this
section apply, including contracts entered into before the year of
change and not reported as completed as of the beginning of the year of
change. Accordingly, a section 481(a) adjustment is required. Any other
taxpayer-initiated change in cost allocation method to a method
permitted under the rules of this section must be made on a cut-off
basis and applied only to contracts entered into during and after the
year of change, in which case a section 481(a) adjustment will be
neither permitted nor required.
Par. 5. Section 1.460-6 is amended by:
1. Adding paragraph (c)(3)(vii).
2. Redesignating paragraph (d)(2)(iv) as paragraph (d)(2)(v).
3. Adding a new paragraph (d)(2)(iv).
The additions and revision read as follows:
Sec. 1.460-6 Look-back method.
* * * * *
(c) * * *
(3) * * *
(vii) Section 481(a) adjustments. For purposes of determining the
hypothetical underpayment or overpayment of tax for any year, amounts
reported as section 481(a) adjustments shall be taken into account in
the tax year or years they are reported. However, any portion of a
section 481(a) adjustment not yet reported as of the tax year in which
the contract is completed shall be taken into account in the tax year
the contract is completed for purposes of determining the hypothetical
underpayment or overpayment of tax.
* * * * *
(d) * * *
(2) * * *
(iv) Section 481(a) adjustments. For purposes of determining the
hypothetical underpayment or overpayment of tax for any year under the
simplified marginal impact method, amounts reported as section 481(a)
adjustments shall be taken into account in the tax year or years they
are reported. However, any portion of a section 481(a) adjustment not
yet reported as of the tax year in which the contract is completed
shall be taken into account in the tax year the contract is completed
for purposes of determining
[[Page 45184]]
the hypothetical underpayment or overpayment of tax.
* * * * *
Linda E. Stiff,
Deputy Commissioner for Services and Enforcement.
[FR Doc. E8-17830 Filed 8-1-08; 8:45 am]
BILLING CODE 4830-01-P