Prop. regs. broaden scope of home construction contract exemption.

• Author: Chou, Yuan

On August 4, 2008, the IRS issued proposed regulations (REG-120844-07) expanding the types of contracts eligible for the home construction contract exemption from the percentage of completion method and amending the rules for taxpayer-initiated changes in methods of accounting to comply with Sec. 460 and the regulations thereunder. Tax practitioners and taxpayers generally have viewed these proposed regulations as being favorable to taxpayers. The regulations, if finalized, would permit a greater number of taxpayers in the home construction industry--such as land developers, condominium developers, contractors, and subcontractors--to qualify for the home construction contract exemption.

Home Construction Contracts

In general, Sec. 460(a) requires taxpayers to use the percentage of completion method (PCM) to account for taxable income from any long-term contract. However, Sec. 460(e) excepts home construction contracts from the general requirement to use the PCM and permits the use of an exempt method. Exempt methods commonly used to account for home construction contracts include the completed contract method (CCM) and the accrual method. Sec. 460(e)(6)(A) defines a home construction contract as any construction contract in which 80% or more of the estimated total contract costs, as of the close of the tax year in which the contract was entered into, are reasonably expected to be attributable to the construction of

* Dwelling units contained in buildings containing four or fewer dwelling units; and

* Improvements to real property directly related to such dwelling units and located on the site of such dwelling units.

Townhouses, Rowhouses, and Condominiums

For purposes of the home construction contract exemption, Sec. 460(e)(6)(A) states that each townhouse or rowhouse shall be treated as a separate building. The proposed regulations expand the definition of "home construction contract" in Sec. 460(e)(6)(A) to expressly state that each individual condominium unit will be treated as a separate townhouse or rowhouse for purposes of the home construction contract exemption. Thus, an individual condominium unit would be treated as a separate building. According to the Service, the terms "condominium" and "townhouse" are sometimes used interchangeably to describe similar structures. Further, individual condominium units share many physical and economic commonalities generally associated with townhouses and rowhouses, such as private ownership...