9057 / Are there any exceptions to the rule that a taxpayer must use the percentage of completion method in accounting for long-term contracts?
Editor’s Note: The 2017 tax reform legislation expands the exception for small long-term construction contracts from the requirement to use the percentage-of-completion method. See heading below.
Yes. The percentage of completion method ( Q 9056) is not required to be used in the case of (1) construction contracts entered into by small contractors and (2) home construction contracts.1
The exemption for small contractors will apply if the following criteria are met:2
(1) The long-term contract must be a construction contract;3
(2) At the time the contract was entered into, it is estimated that the contract will be completed within two years. However, if the contract takes longer than two years to complete due to factors beyond the taxpayer’s control, the small contractor’s exception may still be used;4 and
(3) The contractor or its predecessor’s average annual gross receipts for the three years preceding the year in which the construction contract was entered into is $31 million or less (in 2025, $30 million in 2024, $29 million for 2023, $27 million for 2022, $26 million for 2019-2021, $25 million for 2018 and $10 million or less prior to 2018).5
The home construction contract exemption applies to any construction contract under which at least 80 percent of the estimated total contract costs are reasonably attributed to the building construction, reconstruction or rehabilitation of: (1) dwelling units6 in a building containing four or fewer dwelling units or (2) improvements to real property directly related to such dwelling units and located on the site of such dwelling units.7 If the construction involves both dwelling units and commercial units, costs must be reasonably allocated to determine the contract costs attributable to the dwelling units in order to determine whether the contract will qualify for the exemption.
The 2017 Tax Reform Legislation
The 2017 tax reform legislation expanded the exception for small construction contracts from the requirement to use the percentage-of-completion method. Under the new rules, contracts that fall within the exception include those contracts for the construction or improvement of real property if the contract:
(1) is expected (at the time the contract is entered into) to be completed within two years of commencement of the contract, and
(2) is performed by a taxpayer that (during the tax year in which the contract was entered into) meets the gross receipts test.8
Taxpayers that fail the gross receipts test (see Q 9044) are not eligible for the exception from using the percentage-of-completion method for the tax year. Further, under these rules there is no permitted adjustment under IRC Section 481(a) for contracts entered into before January 1, 2018.9
The new rules governing accounting for long-term contracts are effective for tax years beginning after December 31, 2017.
1. IRC § 460(e).
2. IRC § 460(e)(1)(B); Treas. Reg. § 1.460-3(b)(1).
3. IRC § 460(e )(4); Treas. Reg. § 1.460-3(a).
4. Treas. Reg. §§ 1.460-3(b)(1)(ii), 1.460-1(f)(4).
5. IRC § 460(e)(1)(B)(ii); Treas. Reg. § 1.460-3(b)(3).
6. Dwelling unit is defined in IRC § 168(e)(2)(A)(ii)(I).
7. IRC § 460(e)(6)(A); Treas. Reg. § 1.460-3(b)(2)(i).
8. IRC §§ 460(e)(1)(B)(ii), 448(c).
9. IRC § 460(e)(2)(B).