Future costs.

• Author: Ross, Jeffrey A.
• Position: Improvement inclusion in property valuation

Real estate developers will face many challenges in the years to come in their attempts to recover from a slowed economy. One such current challenge is compliance with Rev. Proc. 92-29. Effective for sales of property after 1992, it requires "a developer of real estate to obtain the Commissioner's consent to use an alternative to the general method under section 461(h) of the Internal Revenue Code for determining when common improvement costs may be included in the basis of properties sold for purposes of determining the gain or loss resulting from the sales."

What are the consequences of not following these new guidelines? "A developer that fails to substantially comply with the provisions of this revenue procedure will not be permitted to use the alternative cost method and therefore may not include common improvement costs that have not been incurred under section 461(h) of the Code in the basis of benefited properties...."

Rev. Proc. 92-29 defines common improvements as "any real property or improvements to real property that benefit two or more properties that are separately held for sale by a developer. The developer must be contractually obligated or required by law to provide the common improvement and the cost of the common improvement must not be properly recoverable through depreciation by the developer." Common improvements include streets, sidewalks, sewer lines, club-houses, golf courses, tennis courts and swimming pools.

Rev. Proc. 75-25 previously allowed a subdivider of real estate to request permission from the district director to include the estimated cost of certain common improvements in the basis of lots sold, when determining the gain or loss resulting from the sale of lots. Many developers failed to follow the procedure to the letter but continued to deduct estimated future costs, arguing that there was a proper matching of income with expenses. Subsequent to the issuance of proposed regulations under Sec. 461(h) on June 7, 1990, Notice 91-4 provided guidelines to be followed for sales after 1990. Some developers continued to believe that it was still possible to deduct future costs without properly filing with the IRS. It is now clear that Rev. Proc. 92-29 is to be followed if a developer is to include the allocable share of the estimated cost of common improvements in the basis of properties sold. To comply with the new revenue procedure, the developer should apply the "alternative cost method" when allocating...