APPEALS SETTLEMENT GUIDELINES
CONSTRUCTION/REAL ESTATE INDUSTRY
PERCENTAGE OF COMPLETION METHOD
TIMING OF COST RECOGNITION
1. Whether, when computing a long-term contract’s “completion factor” under Treas.
Reg. §1.460-4(b)(5), contractors may postpone the recognition of costs they incur
for the work of their subcontractors by arguing that construction contracts represent
contracts for property that are not "accepted" until substantially complete, and thus
(a) Whether, under the economic performance rules of I.R.C. § 461(h) and
the regulations thereunder, construction contracts of the type described
herein usually represent contracts for several items, including services,
property (raw materials), and the use of property (rental equipment).
(b) Whether property (raw materials) provided by subcontractors are
deemed accepted, within the meaning of Treas. Reg. § 1.461-4(d)(6)(iii),
only upon substantial completion of the subcontract.
2. Whether, under I.R.C. § 446(e) and Treas. Reg. § 1.446-1(e)(2)(i), contractors
are prohibited from changing their method of accounting for subcontractor expenses
without advance consent.
EXAMINATION DIVISION’S POSITION
The Examination Coordinated Issue paper provides a typical scenario in the industry to
illustrate the issues. The Taxpayer (contractor) contracted with a land owner (owner) for the
construction of an office building. The contractor engaged a subcontractor to aid in the
construction. The subcontractor provided raw materials as well as construction services.
The contractor (a calendar year taxpayer) uses the accrual method and must report its
income from long-term contracts (such as the instant contract) under the Percentage of
Completion Method (PCM).
While contractual arrangements may vary, standard contract forms used in the construction
industry always refer to work to be performed. The term "work" means the construction and
services required by the contract documents, whether completed