Construction is generally considered to be a domestic production activity eligible for a deduction typically equal to 9% of the taxable income attributable to these activities - with limitations. While regulations were promulgated years ago, calculation and interpretation ambiguities persist. Recently, temporary and proposed regulations were issued that cover a variety of these Section 199 issues.
The proposed regulations would provide clarification as to the definition of construction activities that can be deducted. Currently, these activities include those performed for the erection or substantial renovation of real property, including work by a general contractor. The proposals would clarify that activities primarily limited to approving or authorizing invoices or payments as a general contractor (or in any other activity) will not be eligible for a deduction.
Currently, the term "substantial renovation" is defined as the renovation of a major component or substantial structural part of real estate that (i) materially increases the value of the property, (ii) substantially prolongs the useful life of the property, or (iii) adapts the property for a new or different use. Many of the terms and concepts found in the current regulations are defined and used in the tangible property regulations that were finalized last year. The proposals would change the definition to cross-reference the tangible property regulations. Under the proposed definition, a substantial renovation would be an activity where the costs are required to be capitalized under the tangible property regulations with certain exceptions.
The proposals provide an example to help determine qualifying gross receipts in the construction industry. In the example, a construction company purchases a property with two buildings. The first building is substantially renovated by the taxpayer; renovations on the second building do not rise to the level of a substantial renovation. The taxpayer later sells the property with the two buildings. The example concludes that the taxpayer can allocate the sales price between the two buildings using any reasonable method in determining the qualifying gross receipts. But, the taxpayer is not permitted to treat the entire purchase price as qualifying gross receipts unless the two properties, considered together, were substantially renovated. Some taxpayers take the position that all sales proceeds from the sale of a multiple-building project are qualifying gross receipts even if only one building is substantially renovated. The IRS disagrees.
The proposed regulations would be effective for taxable years beginning on or after the date final regulations are published in the Federal Register.
Questions? Contact your Berdon advisor
Berdon LLP, New York Real Estate Accountants.