Reg. § 1.460-3 Long-term construction contracts.
(a) In general Section generally requires a taxpayer to determine the income from a long-term construction contract using the percentage-of-completion method described in . A contract not completed in the contracting year is a long-term construction contract if it involves the building, construction, reconstruction, or rehabilitation of real property; the installation of an integral component to real property; or the improvement of real property (collectively referred to as construction). Real property means land, buildings, and inherently permanent structures, as defined in , such as roadways, dams, and bridges. Real property does not include vessels, offshore drilling platforms, or unsevered natural products of land. An integral component to real property includes property not produced at the site of the real property but intended to be permanently affixed to the real property, such as elevators and central heating and cooling systems. Thus, for example, a contract to install an elevator in a building is a construction contract because a building is real property, but a contract to install an elevator in a ship is not a construction contract because a ship is not real property.
(b) Exempt construction contracts
(1) In general The general requirement to use the PCM and the cost allocation rules described in or does not apply to any long-term construction contract described in this (exempt construction contract). Exempt construction contract means any—
(i) Home construction contract; and
(ii) Other construction contract, entered into after December 31, 2017, in a taxable year ending after December 31, 2017, by a taxpayer, other than a tax shelter prohibited from using the cash receipts and disbursements method of accounting (cash method) under section , who estimates at the time such contract is entered into that such contract will be completed within the 2-year period beginning on the contract commencement date, and who meets the gross receipts test described in of this section for the taxable year in which such contract is entered into.
(2) Home construction contract
(i) In general A long-term construction contract is a home construction contract if a taxpayer (including a subcontractor working for a general contractor) reasonably expects to attribute 80 percent or more of the estimated total allocable contract costs (including the cost of land, materials, and services), determined as of the close of the contracting year, to the construction of—
(A) Dwelling units, as defined in section , contained in buildings containing 4 or fewer dwelling units (including buildings with 4 or fewer dwelling units that also have commercial units); and
(B) Improvements to real property directly related to, and located at the site of, the dwelling units.
(ii) Townhouses and rowhouses Each townhouse or rowhouse is a separate building.
(iii) Common improvements A taxpayer includes in the cost of the dwelling units their allocable share of the cost that the taxpayer reasonably expects to incur for any common improvements (e.g., sewers, roads, clubhouses) that benefit the dwelling units and that the taxpayer is contractually obligated, or required by law, to construct within the tract or tracts of land that contain the dwelling units.
(iv) Mixed use costs If a contract involves the construction of both commercial units and dwelling units within the same building, a taxpayer must allocate the costs among the commercial units and dwelling units using a reasonable method or combination of reasonable methods, such as specific identification, square footage, or fair market value.
(3) Gross receipts test
(i) In general A taxpayer, other than a tax shelter prohibited from using the cash method under section , meets the gross receipts test of this if it meets the gross receipts test of section and . This gross receipts test applies even if the taxpayer is not otherwise subject to section .
(ii) Application of gross receipts test
(A) In general In the case of any taxpayer that is not a corporation or a partnership, and except as provided in and of this section, the gross receipts test of section and the accompanying regulations are applied in the same manner as if each trade or business of such taxpayer were a corporation or partnership.
(B) Gross receipts of individuals, etc Except when the aggregation rules of section apply, the gross receipts of a taxpayer other than a corporation or partnership are the amount derived from all trades or businesses of such taxpayer. Amounts not related to a trade or business are excluded from the gross receipts of the taxpayer. For example, an individual taxpayer's gross receipts do not include inherently personal amounts, such as personal injury awards or settlements with respect to an injury of the individual taxpayer, disability benefits, Social Security benefits received by the taxpayer during the taxable year, and wages received as an employee that are reported on Form W-2.
(C) Partners and S corporation shareholders Except when the aggregation rules of section apply, each partner in a partnership includes a share of partnership gross receipts in proportion to such partner's distributive share (as determined under section ) of items of gross income that were taken into account by the partnership under section . Similarly, a shareholder includes the pro rata share of S corporation gross receipts taken into account by the S corporation under section .
(D) Examples The operation of this is illustrated by the following examples:
(1) Example 1 Taxpayer A is an individual who operates two separate and distinct trades or business that are reported on Schedule C, Profit or Loss from Business, of A's Federal income tax return. For 2020, one trade or business has annual average gross receipts of $5 million, and the other trade or business has average annual gross receipts of $35 million. Under of this section, for 2020, neither of A's trades or businesses meets the gross receipts test of of this section ($5 million + $35 million = $40 million, which is greater than the inflation-adjusted gross receipts test amount for 2020, which is $26 million).
(2) Example 2 Taxpayer B is an individual who operates three separate and distinct trades or business that are reported on Schedule C of B's Federal income tax return. For 2020, Business X is a retail store with average annual gross receipts of $15 million, Business Y is a dance studio with average annual gross receipts of $6 million, and Business Z is a car repair shop with average annual gross receipts of $12 million. Under of this section, B's gross receipts are the combined amount derived from all three of B's trades or businesses. Therefore, for 2020, X, Y and Z do not meet the gross receipts test of of this section ($15 million + $6 million + $12 million = $33 million, which is greater than the inflation-adjusted gross receipts test amount for 2020, which is $26 million).
(iii) Method of accounting A change in the method of accounting used for exempt construction contracts described in of this section is a change in method of accounting under section and the accompanying regulations. For rules distinguishing a change in method from adoption of a method, see . A taxpayer changing its method of accounting must obtain the consent of the Commissioner in accordance with . For rules relating to the clear reflection of income and the pattern of consistent treatment of an item, see section and . A change in method of accounting shall be implemented pursuant to the applicable administrative procedures to obtain the consent of the Commissioner to change a method of accounting under section as published in the Internal Revenue Bulletin (IRB) (see Revenue Procedure 2015-13 (2015-5 IRB 419) (or successor) (see )). A taxpayer that uses the percentage of completion method for exempt contracts described in of this section that wants to change to another exempt contract method is to use the applicable administrative procedures to obtain the automatic consent of the Commissioner to change such method under section as published in the IRB. A taxpayer-initiated change in method of accounting will be permitted only on a cut-off basis, and thus, a section adjustment will not be permitted or required. See .
(c) Residential construction contracts A taxpayer may determine the income from a long-term construction contract that is a residential construction contract using either the PCM or the percentage-of-completion/capitalized-cost method (PCCM) of accounting described in . A residential construction contract is a home construction contract, as defined in of this section, except that the building or buildings being constructed contain more than 4 dwelling units.
(d) Applicability Dates and of this section apply, for contracts entered into in taxable years beginning on or after January 5, 2021. However, for contracts entered into after December 31, 2017, in a taxable year ending after December 31, 2017, and before January 5, 2021, a taxpayer may apply the paragraphs described in the first sentence of this , provided that the taxpayer follows all the applicable rules contained in the regulations under section for such taxable year and all subsequent taxable years.
[T.D. 8929, 66 FR 2231, Jan. 11, 2001, as amended by T.D. 9942, 86 FR 272, Jan. 5, 2021; 86 FR 32186, June 17, 2021]