Maximize Your Real Estate Gains with the Alternative Cost Method

Maximize Your Real Estate Gains with the Alternative Cost Method

The alternative cost method is an optional safe harbor method of accounting for real estate developers. The IRS has released guidance to assist developers in determining when common improvement costs can be included in the basis of individual units of real property in a development project to determine the gain or loss from sales of those units. The alternative cost method is an accrual method of accounting and is an alternative to the general economic performance requirements. The alternative cost method guidance and the related accounting method change procedures are effective for tax years beginning after December 31, 2022.

Background Information

In general, developers cannot add common improvement costs to the basis of benefitted units until the costs are incurred under the economic performance requirements. Thus, common improvement costs that have not been incurred when the units are sold cannot be included in the units’ basis in determining the gain or loss resulting from the sales. However, under the alternative cost method, developers estimate the share of the cost of common improvements on the basis of units sold, without meeting the economic performance requirements.

Common improvement costs include any real property or improvements to real property that benefit two or more units 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 must not be able to recover the cost of the common improvement through depreciation.

Using the Alternative Cost Method

The alternative cost method must be applied to all projects in a trade or business that meet the definition of a qualifying project. The allocation of the estimated cost of common improvements among the benefitted units or completed contract method contracts (CCM) in the qualifying project is made using any method that is applied on a consistent basis within that qualifying project and reasonably reflects the benefits provided to the units (or the CCM contracts) in that qualifying project.

Alternative Cost Limitation

The sum of the amount of estimated cost of common improvements included in the basis of (or otherwise taken into account with respect to) all of the units in the qualifying project that have been sold as of the end of the tax year, or treated as incurred allocable contract costs for purposes of determining income for CCM contracts completed as of the end of the tax year, may not exceed the total amount of common improvement costs that have been incurred, with respect to the qualifying project as of the end of the tax year.

The alternative cost method is applied on a trade or business-by-trade or business basis. However, the alternative cost limitation is calculated on a project-by-project basis. Thus, common improvement costs incurred for one qualifying project may not be included in the alternative cost method calculations of a separate qualifying project.

Accounting Method Change

A change to this alternative cost method is a change in the method of accounting. An eligible taxpayer that wants to change to new rules for the alternative cost method or to change from the prior guidance for the alternative cost method, must use the automatic change procedures to file for the method change and satisfy the requirements for tax years beginning after December 31, 2022.

alternative cost method for real estate developers

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Please call our office if you would like to discuss the alternative cost method and the procedures for filing an accounting method change. We are here to assist real estate developers at any stage.

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2023-10-30T17:14:17+00:00April 5th, 2023|Business, Real Estate|

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