On July 1, the Senate’s version of the “One Big Beautiful Bill” passed the Senate. Such bill included a new provision (not in the House bill) that would provide significant tax relief to condominium developers. The bill provides that condominium developers will be able to use the completed contract method for reporting income from sales of to-be-built condominiums rather than the percentage-of-completion method.
Issue under current law
Under current law, condominium developers are required to use the percentage-of-completion method for reporting income from sales of condominium units being developed. This requires that income be recognized on a current basis with respect to a sales contract based on the expected gain and the percentage of construction completed. In other words, the developer may be required to pay taxes on pre-sold condominium units before there is a completed sale and before the full or sometimes even any proceeds are actually received (even if the condominium developers receive a portion of the purchase price from the buyer, the condominium developers may be restricted from using the deposited funds under applicable law (including in New York) and there is a risk that they will never receive the funds (e.g., if the condominium is not completed and delivered on time and the buyer withdraws)).
There is an exception to this rule under current law for residential buildings containing four or fewer dwelling units. Developers have long argued that each condominium unit should be treated as its own building, which would allow the income from the sale to be taxed under the completed contract method instead (tax event arises on closing of sale). While rowhouses and townhouses (“horizontal construction”) are treated as separate buildings (and thus are exempt from percentage-of-completion reporting), high-rise condominiums (“vertical construction”) does not currently benefit from the same rule. Proposed regulations that would provide parity between horizontal construction and vertical construction have been under consideration for many years but never finalized.
Proposed change
The Senate bill provides relief from “phantom income” in most cases by expanding the exception to the percentage-of-completion method to include all “residential construction contracts” (rather than limiting the exception to buildings having four or fewer units). A residential construction contract is defined as any construction contract where 80% or more of the estimated contract costs are reasonably expected to be attributable to construction (and related expenses) of residential units. Income from such contracts would not be taxable until the sales actually closed — allowing for better matching of the income tax reporting and cash flow. This is a long-awaited, welcome change for the industry that may incentivize additional construction. The change would apply to contracts entered into after the bill’s enactment.
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