New IRS Guidance for Real Estate Developers
On January 27, 2023, the IRS released Rev. Proc. 2023-09, which provides new rules and conditions for determining when common improvement costs may be included in the basis of real property for purposes of determining gain or loss from the sale of lots or units. This new revenue procedure, which is effective for tax years beginning after December 31, 2022, modifies the alternative cost method (“ACM”). ACM is an elective method of accounting for determining the amount of future development costs to be included in the basis of lots sold, subject to certain limitations.
Rev. Proc. 2023-09 reduces the ambiguity and filing requirements, as well as providing additional taxpayer friendly provisions. For an abundance of clarity, the ACM will still be available. Instead of applying the burdensome procedures of the now obsolete Rev. Proc. 92-29, developers will use Rev. Proc. 2023-09.
Unless ACM is elected, developers cannot add common improvement costs to the basis of the benefitted units until such costs are incurred under Internal Revenue Code (IRC) § 461(h). Thus, any common improvement costs that have not been incurred under IRC § 461(h) when the benefitted units are sold, cannot be included in the basis of the units in determining the gain or loss resulting from the sales. Examples of common improvement costs include streets, sidewalks, sewer lines, playgrounds, clubhouses, tennis courts and swimming pools that the developer is contractually obligated or required by law to make, as long as the costs are not properly recoverable through depreciation by the developer.
In Rev. Proc. 2023-09, the Department of the Treasury and IRS recognizes that aspects of Rev. Proc. 92-29 were “outdated,” and 2023-09 was issued to “reduce the administrative, recordkeeping and compliance burdens.” The agreement to extend the statute of limitations (Form 921 or 921-A) is no longer required. Additionally, the annual statement detailing information about the developer, the project and updates to the common improvement cost calculations are no longer required to be filed with the taxpayer’s return or the District Director, an antiquated position of the IRS. A developer using the ACM must keep and timely provide records that are sufficient to establish compliance with Rev. Proc. 2023-09.
If you are a developer with significant common improvement costs, the ACM may be a tax preferred method of accounting. Rev. Proc. 2023-09 provides clarity and reduced filing requirements compared to Rev. Proc. 92-29. For developers with ongoing projects, there may be transition relief to adopt the ACM. If you would like to learn more about the ACM or have questions, please contact your tax advisor to further discuss.