We know developers have big ideas and visions for vacant land that most neither see nor understand at first glance. What these visionary developers may fail to see is their unique tax and accounting issues - here are three to consider.
One such issue is the required IRS rules for cost capitalization – Land developers acquire land and improve it for future sale. The substantial costs for acquisition, direct improvements, and various indirect costs (financing and other soft costs), are treated as additional cost basis to the land. These costs are not expensed until the land is sold. The IRS has complex rules not only for capitalization of these costs but also for a portion of the company’s operating costs (Section 263A). In addition, it is important to know what costs can be expensed in the current year. Unfortunately matching the revenues and costs is not as simple as it is with other industries. Various methods are available including the specific identification method that allow costs incurred to be recorded on a lot by lot basis. Tracking these costs by lot and phase within the accounting system becomes important because as lots are sold, their costs are matched to the revenue. This system may be found beneficial at tax time, as failure to do so can push profits or losses in the wrong tax years.
A second issue is that of land classification - As developers continue to buy more land and further subdivide it into phases, the time to make these improvements can become lengthy. Correctly reporting the land into the appropriate category can make a significant difference at tax time. Land may be classified into different categories as follows:
- held for investment and not currently developed
- currently under development
- fully developed and available for sale
- The allocation and treatment of these costs, particularly interest and property taxes, differs significantly for each category as it is dependant on the intent and circumstances of the land each tax year.
Third, is the issue of estate planning – Larger land developments with the potential for significant wealth creation can offer opportunities for estate planning. Passing down wealth to future generations through the use of trusts and gifting may be available, particularly if it is incorporated into the development and entity planning prior to purchasing the land.