The Internal Revenue Service has now made it much easier for real estate developers across asset classes to secure certain tax benefits. The benefits are tied to what’s called the alternative cost method, which enables developers to accelerate the tax benefits they receive for common improvement costs they plan to make in the future. The longer the time horizon of a project, generally speaking, the higher the benefit can be of using the alternative cost method.
The Department of the Treasury and the IRS recently recognized there was a problem with that method though: the requirements to implement it were outdated and burdensome. They came from Revenue Procedure 92-29, which the IRS issued in 1992. 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 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 (Short Form 3115) to apply the accounting change to all qualifying projects in their entire portfolio. Revenue Procedure 2023-9 also provides 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 5 taxable years.
It is important to note that developers who want to reap the benefits of this change 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. 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.