The Internal Revenue Service has now made it much easier for real estate developers across asset classes to benefit from the alternative cost method. It enables multi-unit developers to receive tax benefits for common improvement costs they plan to make in the future, as opposed to only allowing a deduction for costs already incurred.
The Department of the Treasury and the IRS recently recognized there was a problem with the outdated and burdensome requirements to use the alternative cost method, which have been in place since 1992 under Revenue Procedure 92-29. To receive consent to use the method, the developer was required to file a request for each project detailing information about the developer, the project, and calculations of the common improvement costs that benefit multiple units. Further, the use of the method was conditioned on the developer agreeing to extend the statutory period of limitation for audits for each taxable year the method was used. The developer had to agree to file detailed annual statements as well. It could all add up to a ton of paperwork for each project in a developer’s portfolio.
On January 27, the IRS released new rules and conditions to ease the administrative burden of using the alternative cost method. Under Revenue Procedure 2023-9, developers can now use a simple form to apply the accounting change to all qualifying projects in their entire portfolio. They can smooth out the common improvement costs of a project for up to 10 years, and they can make adjustments each year if necessary. Revenue Procedure 2023-9 also provides streamlined rules for application of the completed contract method of accounting, rules for allocating estimated common improvement costs, methods for determining cost limitations, and examples for application of its rules. Additionally, the IRS waived an eligibility rule prohibiting developers from filing the method change if the developer has requested a change on the same item during the last five taxable years.
It is important to note that developers who want to utilize the alternative cost method going forward will have to make portfolio-wide elections and will not be able to pick and choose which projects they use it for. It is possible there could be tax benefits in using the standard accrual method, rather than the alternative cost method, for projects that will have almost all of the common improvement costs in the first year. In short, it comes down to how much the developer wants to smooth out those costs – and as a result, the gains they are taxed on – over the life of the project. (It can be valuable to partner with counsel in assessing the pros and cons of each method.)
Developers can start using the streamlined implementation of the alternative cost method for tax years beginning after December 31, 2022.
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